** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K/A**

**(Amendment No. 1)**

 
| **(Mark One)**                                         | ** ** |
|--------------------------------------------------------|------------|
| **ý**                                             | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                   |
| **For the fiscal year ended  September 30, 2004** |
| ** **                                             |
| **or**                                                 |
| ** **                                             |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom           to           **

 

**Commission file number 0-21196**

 

 

**Mothers Work, Inc.**

(Exactname of Registrant as specified in its charter)

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

 

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

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 
| **Title of each class** | ** ** | **Name of each exchange on which  registered** |
|-------------------------|------------|------------------------------------------------|
| None                    |       | N/A                                            |

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

**Common Stock, par value $.01 per shareSeries B Junior Participating Preferred Stock Purchase Rights**(Titleof class)

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes ý No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein and will not be contained, to thebest of Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  ý

 

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

 

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

 

Theaggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to $26.65, the price at which the commonequity was last sold as of March 31, 2004 (the last business day of theRegistrant’s most recently completed second fiscal quarter), was approximately$124,000,000.

 

OnDecember 10, 2004, there were 5,225,495 shares of the Registrant’s commonstock, $.01 par value, outstanding.

 

 

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**DOCUMENTSINCORPORATED BY REFERENCE**

** **

Portionsof the Registrant’s Proxy Statement to be filed with the Commission inconnection with the Annual Meeting of Stockholders scheduled to be held on January 21,2005 are incorporated by reference into Part III of this Form 10-K.

 

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**EXPLANATORY NOTE**

 

As previously disclosed in our Current Reporton Form 8-K dated May 10, 2005, on May 5, 2005, the Audit Committee of ourBoard of Directors concluded that a restatement of our historical consolidatedfinancial statements was necessary to correct errors resulting from our priormethod of accounting for lease transactions. After consultation with our independent registered public accountingfirm, KPMG LLP, we determined, like many other publicly-held companies in theretail industry, that we would change our method of accounting for leases,including our method of accounting for tenant improvement allowances, rentholidays and amortization of leasehold improvements.  These changes are consistent with the viewsexpressed by the Office of the Chief Accountant of the Securities and ExchangeCommission (the “SEC”) on February 7, 2005 in a letter to the AmericanInstitute of Certified Public Accountants and other recent interpretationsregarding certain operating lease accounting issues and their application undergenerally accepted accounting principles. Accordingly, this Amendment No. 1 on Form 10-K/A (the “Form 10-K/A”) toour Annual Report on Form 10-K for the fiscal year ended September 30, 2004,initially filed with the SEC on December 15, 2004 (the “Original Filing”), isbeing filed to reflect restatements of (i) our consolidated balance sheets asof September 30, 2004 and 2003 and (ii) our consolidated statements ofoperations, stockholders’ equity and cash flows for the years ended September30, 2004, 2003 and 2002, and the notes related thereto (the“Restatement”).  The restatedconsolidated financial statements reflect adjustments that will not have anyimpact on our previously reported sales, comparable sales or our compliancewith any financial covenant under our revolving credit facility or other debtinstruments.  For a more detaileddescription of the Restatement, see Note 2, “Restatement of ConsolidatedFinancial Statements,” of the notes to the accompanying consolidated financialstatements in this Form 10-K/A and the section entitled “Restatement of PriorFinancial Information” in Item 7. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations in this Form 10-K/A.

 

For theconvenience of the reader, this Form 10-K/A sets forth both the amendedand restated items, as well as unchanged information from the Original Filingin its entirety.  However, this Form 10-K/Aonly amends and restates Part II, Items 6, 7, 8 and 9A of the Original Filingto reflect the Restatement.  Theforegoing items have not been updated to reflect other events occurring afterthe Original Filing or to modify or update any other disclosures affected bysubsequent events.  Information notaffected by the Restatement is unchanged and reflects the disclosures made atthe time of the Original Filing. Accordingly, this Form 10-K/A should be read in conjunction withour filings made with the SEC subsequent to the Original Filing, including anyamendments to those filings.  Inaddition, Part IV, Item 15 of the Original Filing has been amended tocontain the consent of our independent registered public accounting firm andcurrently dated certifications from our Chief Executive Officer and ChiefFinancial Officer, as required by Sections 302 and 906 of the Sarbanes-OxleyAct of 2002.  The consent of ourindependent registered public accounting firm and the certifications of ourChief Executive Officer and Chief Financial Officer are attached to this Form 10-K/Aas Exhibits 23, 31.1, 31.2, 32.1 and 32.2, respectively.

 

We have not amended and do not intend to amend our previously filedAnnual Reports on Form 10-K or our Quarterly Reports on Form 10-Q for theperiods affected by the Restatement that ended prior to September 30, 2004.  For this reason, the consolidated financialstatements, report of independent registered public accounting firm and relatedfinancial information for the affected periods contained in such reports shouldno longer be relied upon.

 

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**PART I.**

** **

**Item 1.**              Business

** **

**General**

** **

Weare the leading designer and retailer of maternity apparel in the UnitedStates, operating 1,115 retail locations, including 883 stores in all 50states, Puerto Rico and Canada, and 232 leased departments.  We design and contract manufactureapproximately 90% of the merchandise we sell in our retail locations,predominantly under the Motherhood Maternity® (“Motherhood”), Mimi Maternity®(“Mimi”) and A Pea in the Pod® brands. We operate stores under four different retail concepts: MotherhoodMaternity, Mimi Maternity, A Pea in the Pod and Destination MaternityTM and alsosell our merchandise on the Internet at our MaternityMall.comTM and ourchain-specific websites.  Our strategy isto fulfill, in a high-service store environment, all of an expectant mother’sclothing needs, including casual and career wear, formal attire, lingerie,sportswear and outerwear.  We use avertically integrated business model to ensure that we offer the broadest assortmentof in-stock, fashionable merchandise. Our three retail brands collectively target all of the price points inmaternity apparel, ranging from Motherhood at value prices to A Pea in the Podat luxury prices.  In addition to our 883stores, our retail locations include 232 leased departments located withindepartment and specialty stores, which sell primarily Motherhood and TwoHeartsTM Maternity branded apparel.  Wehave achieved 11.6% compounded annual sales growth over the past five years,resulting in sales of $518.1 million for our fiscal 2004.  Our fiscal year ends on September 30.  All references in this discussion to ourfiscal years refer to the fiscal year ended on September 30 in the yearmentioned.  For example, our fiscal 2004ended on September 30, 2004.

 

Weplan to open approximately 30-40 new retail stores during fiscal 2005, of whichapproximately 15-20 will be new multi-brand stores, including DestinationMaternity superstores, with the balance primarily under the Motherhoodbrand.  We plan to close approximately 48-60stores, with approximately 30-40 of these planned store closings related to theopening of new multi-brand stores.

 

Inaddition, based on the success of the initial launch in April 2004 of ourTwo Hearts Maternity collection, which is available exclusively at selectedSears® locations, we will be expanding the distribution of our Two HeartsMaternity collection from the current 71 Sears locations to a total ofapproximately 645 Sears locations beginning in March 2005.  This proprietary brand will replace theexisting maternity apparel lines in those locations and will become theexclusive maternity apparel offering in Sears stores.

 

InFebruary 2005, we will launch our Oh Baby! by MotherhoodTM collection atKohl’s® stores throughout the United States and on Kohls.com.  The Oh Baby! by Motherhood collection,available exclusively at Kohl’s under a licensed arrangement, will replace theexisting maternity apparel lines at Kohl’s and will become their exclusivematernity apparel line. As of October 31, 2004, Kohl’s operatesapproximately 637 stores in 40 states.

 

MothersWork was founded by Dan and Rebecca Matthias in 1982 as a mail-order maternityapparel catalog.  We began operatingretail stores in 1985 and completed our initial public offering in 1993.  To address multiple price points in maternityapparel and improve operating productivity, we acquired Motherhood and A Pea inthe Pod in 1995 and eSpecialty Brands, LLC (“iMaternity”) in October 2001.  Since the acquisitions of Motherhood and APea in the Pod, we have developed and grown these brands along with our Mimibrand. In connection with each of our acquisitions, we have consolidated someoverlapping locations and closed under-performing stores, resulting in increasedoperating efficiency through reductions of acquired store expenses and improvedinventory utilization.

 

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**RetailConcepts and Product Distribution**

** **

***MotherhoodMaternity.   ***MotherhoodMaternity serves the value-priced portion of the maternity apparel industrywith the greatest number of customers and is our largest chain with 717 storesas of September 30, 2004. Motherhood is positioned with everyday lowprices, broad assortment, fashion and quality. We believe that the Motherhood customer shops at moderate-priceddepartment stores and discount stores when she is not expecting. Motherhoodstores average approximately 1,700 square feet and are located primarily inenclosed malls, strip and power centers and central city businessdistricts.  Motherhood stores include 106outlet locations that carry predominantly Motherhood-branded product, includingsome closeout merchandise.  In addition,as of September 30, 2004, we operate 131 Motherhood leased departments in departmentand specialty stores such as Macy’s®, Babies “R” Us®, Lazarus® and Rich’s®.Between 1998 and 2000, we successfully broadened Motherhood’s customer base bylowering price points approximately 40% to 45%. This new price position significantly expanded the brand’s targetmarket, increased revenues per store and increased unit volumes during thisperiod. In fiscal 2004, we opened 29 new Motherhood stores and outlets,excluding leased departments and net of store closings and store conversions.  As of September 30, 2004, we operate 26Motherhood stores in Canada and believe that market opportunities may permit usto open additional stores in Canada in the future.  We may also have the opportunity to grow thenumber of our Motherhood leased departments in the United States.

 

***MimiMaternity.   ***As of September 30,2004, we had 121 Mimi Maternity stores that serve the middle market pricedportion of the maternity apparel industry. The brand is positioned as trendy, contemporary, fun and affordable.  We believe that the Mimi customer shops atdepartment stores and specialty apparel chains when she is not expecting.  Mimi stores average approximately 2,000square feet and are located primarily in regional malls, lifestyle centers andcentral business districts.

 

*Single-BrandMimi Stores.*   Asof September 30, 2004, 91 of our Mimi stores predominantly carryMimi-branded product, as well as a small selection of maternity merchandisedeveloped by contemporary vendors exclusively for Mimi, and average approximately1,600 square feet.  As of September 30,2004, we also operate 29 Mimi leased departments in Marshall Field’s® andBloomingdale’s®. Mimi was historically price positioned just below A Pea in thePod. When Motherhood’s prices were lowered, there was an opportunity for Mimito broaden its customer base by including lower price points. Mimi was,therefore, repositioned during fiscal 2002 and its merchandise price points nowrange from just above Motherhood to the lower end of A Pea in the Pod.  This repositioning resulted in an expansionof Mimi’s target customer base, and provided us the opportunity to increase thenumber of Mimi stores over time.

 

*Multi-BrandMimi Stores.*   Weare continuing to test, develop and expand our multi-brand store concepts. Ourcurrent multi-brand store concepts operated under the Mimi name includetwo-brand stores (which carry both the Mimi and Motherhood brands) and triplexstores (which carry the Mimi, Motherhood and A Pea in the Pod brands).  These multi-brand stores are larger (averageof approximately 3,000 square feet) and have higher average sales volumethan our average store, and provide the opportunity to lower our storeoperating expense percentage and improve store operating profit margins overtime.  Opening these multi-brand storeswill typically involve closing two smaller stores and consolidating theirbusiness into one store, and frequently will involve one-time store closingcosts resulting primarily from early lease terminations.  As of September 30, 2004, 30 of ourstores are multi-brand stores using the Mimi name, consisting of 28 two-brandMimi combo stores and 2 Mimi triplex stores. We plan to continue to open additional multi-brand stores carrying bothMimi and Motherhood product, using the Mimi store name.

 

Infiscal 2004, at Mimi Maternity, we opened four single-brand stores, 16two-brand combo stores, two triplex stores and an additional four stores as aresult of net store conversions, excluding leased departments, and closed 24stores.

 

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***APea in the Pod.   ***A Pea in thePod is the leading luxury maternity brand in the United States, with 41 storelocations as of September 30, 2004. The brand is positioned as exclusive, designer and luxury. A Pea in thePod stores average approximately 2,400 square feet and are located in upscalevenues, including Madison Avenue, Oak Street, Beverly Hills, South Coast Plazaand Bal Harbor.  We also operate one APea in the Pod leased department in Macy’s flagship Herald Square store in NewYork City.  During fiscal 2004, we openedtwo stores and closed five stores. In addition to offering a wide selection ofboth A Pea in the Pod and Mimi branded products in almost all A Pea in the Pod stores,we seek out designer and contemporary brands and assist them in developingmaternity versions of select styles exclusively for our A Pea in the Podstores.  Publicity, including celebritieswearing our clothes, is an important part of the marketing and positioning ofthe brand.  As scarcity is part of theconcept’s luxury image, we have chosen to further develop the brand primarilyby optimizing our customers’ in-store experience rather than by opening newstores.  We therefore continuouslyupgrade the quality of the locations, our store designs, the product stylingand our publicity to enhance our brand image.

 

***DestinationMaternity superstores.   ***On March 4,2004, we opened our first Destination Maternity superstore in Danbury,Connecticut, a nearly 4,000 square foot test store carrying all three of ourbrands plus a greatly expanded line of nursing accessories, fertility-relatedproducts and maternity-related exercise gear, books, and body and nutritionalproducts.  This store also has adedicated “learning center” area for maternity-related classes, as well as a“relax area” for husbands and shoppers alike, and an inside play area for thepregnant mom’s toddlers and young children. These elements combine to give our Destination Maternity superstore notonly by far the largest assortment of maternity apparel and accessoriesavailable, but also a new and engaging atmosphere and experience for thematernity customer.  Our superstoreformat is highly differentiated from the stores of our maternity competitors,which do not even carry the breadth of selection we carry in one of our threebrands presented in the superstore. Opening these superstores will typically involve closing two or moresmaller stores and consolidating their business into one store, and frequentlywill involve one-time store closing costs resulting primarily from early leaseterminations.  We believe the superstoremodel will improve store profitability margins by reducing store operatingexpense percentages and may increase overall sales in the geographical marketsthey serve.  We are actively working tocontinue to refine our maternity superstore concept and to find additionalsuitable new locations for the concept. We opened three additional Destination Maternity superstores during August 2004,for a total of four stores open as of September 30, 2004, with fouradditional superstores scheduled to open during the first six months of fiscal2005.  We may open additional superstoresin fiscal 2005 as we find and evaluate additional potential locations and obtainadditional results and insights from our existing superstores.  As the only national retailer that is solelyfocused on maternity, we are further differentiating ourselves as the ultimatematernity destination with these large, well-assorted, “must visit” superstores.

 

***TwoHearts Maternity.   ***Two HeartsMaternity launched in selected Sears stores in April 2004 and, as of September 30,2004, is carried in leased departments in 71 Sears stores.  Based on the success of the initial launch,the Two Hearts Maternity collection is expanding to a total of approximately645 Sears stores beginning in March 2005. This proprietary brand will become the exclusive maternity appareloffering in Sears stores.  Two HeartsMaternity is a new fashionable collection including career and casualsportswear as well as dresses, lingerie, swimwear and nursing sleepwear, withmost items priced under $40.  The averageTwo Hearts Maternity leased department retail space covers approximately 400square feet.

 

***OhBaby! by Motherhood.*****  **Oh Baby! by Motherhood collection will launch in February 2005at Kohl’s stores throughout the United States and on Kohls.com.  Available exclusively at Kohl’s under aproduct and license agreement, the collection will feature a modern andcomplete assortment of sportswear, intimate apparel and sleepwear, with mostitems priced under $40.

 

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**OurCompetitive Strengths**

** **

***Weare the leader in maternity apparel.   ***We are theleading designer and retailer of maternity apparel in the United States and arethe only nationwide chain of maternity specialty stores in the UnitedStates.  We believe that our brands arethe most recognized in maternity apparel. We have established a broad distribution network, with stores in a widerange of geographic areas and retailing venues. In addition, we have a leading position at every price point ofmaternity apparel through our three distinct brands. Our leadership positionenables us to gain a unique understanding of the needs of our maternitycustomers, as well as keep abreast of fashion and product developments.  We enhance our leadership position, increasemarket penetration and further build our brands by operating leased departmentsin department and baby specialty stores.

 

***Weoffer a wide product assortment.   ***A primaryconsideration for expectant mothers shopping for maternity clothes is productassortment, as pregnant women need to replace almost their entirewardrobe.  We believe that we offer thewidest selection of merchandise in the maternity apparel industry.  We also offer product for multiple seasons,as pregnant women’s clothing needs vary depending on their due date.  Our ability to offer a broad assortment ofproduct is due, in large part, to our vertically integrated business model,which includes our extensive in-house design and contract manufacturingcapabilities, as well as our rapid inventory replenishment system.

 

***Weare vertically integrated.   ***We designand contract manufacture approximately 90% of the merchandise we sell in ourstores.  We believe that verticalintegration enables us to offer the widest product selection in maternityapparel, to respond quickly to fashion trends and to ensure industry-leadingin-stock levels.  We combine our in-housedesign expertise, domestic and international sourcing capabilities, a rapidinventory replenishment process and extensive proprietary systems to enhanceoperational and financial results.

 

***Weutilize a rapid inventory replenishment system.  ***Sincematernity apparel is a niche industry, store profitability is usually optimizedin smaller store formats.  We are able tooffer a wide selection of merchandise in our stores, which averageapproximately 1,800 square feet, due, in large part, to our rapid inventoryreplenishment system.  Our proprietarysystem enables us to offer more than 3,000 stock keeping units, or SKUs, perstore without dedicating retail space to storage.  We coordinate the rapid replenishment ofinventory for all of our stores through our Philadelphia and Canadiandistribution centers, which send individually tailored selections to specificstore locations between two and six times per week.

 

***Wehave proprietary systems that support our business******.  ***In order tosupport our vertically integrated business model, we have developed a fullyintegrated, proprietary enterprise resource planning (ERP) system.  This system includes point-of-sale (POS)systems, our TrendTrackTM merchandise analysis and planning system, ourmaterials requirement planning (MRP) system and our web-based, global sourcingand logistics systems.  These systemsalso support our automated picking and sorting systems and other aspects of ourlogistics infrastructure.  We believethat our proprietary systems are critical to our competitive strengths ofoffering a broad product assortment, responding quickly to fashion trends,helping to reduce product costs and rapidly replenishing inventory in ourstores.

 

***Weare able to obtain prime real estate locations.  ***We believethat we are able to obtain attractive real estate locations due to the brandawareness of our concepts, our multiple price point approach and our soughtafter maternity customer.  We are theonly maternity apparel retailer to provide mall operators with the ability tochoose from three differently priced concepts, depending on the mall’s targetdemographics.  We are also able toprovide multiple stores or a multi-brand store for malls that want to offertheir maternity customers a range of price alternatives.  In addition, in the case of multi-malloperators, we have the flexibility to provide several stores across multiplemalls.  As a result, we have been able tolocate stores

 

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inmany of what we believe are the most desirable shopping malls in the countryand are able to obtain attractive locations within these malls.

 

***Wehave a highly experienced management team.   ***DanMatthias, our Chairman and Chief Executive Officer, and Rebecca Matthias, ourPresident and Chief Operating Officer, founded the Company over 20 yearsago and are leaders in maternity apparel retailing.  In recent years, we have added to ourmanagement team and have a management team with significant experience in allaspects of the retail and apparel business.

 

**TheMaternity Apparel Industry**

** **

Weare unaware of any data on the size of the maternity apparel industry.  However, based on our own analysis, webelieve there are approximately $1.2 billion of maternity clothes soldeach year in the United States.  Inaddition, we believe that there is an opportunity to grow the market by sellingmaternity clothes to pregnant women who currently purchase loose-fitting orlarger-sized non-maternity clothing as a substitute for maternity wear.  We also believe that the market can grow byreducing the amount of “hand-me-down” and “borrowing” associated with maternityapparel, particularly in the value-priced market where low-priced, fashionablenewly-purchased maternity apparel could provide an economical alternative tosecondhand maternity wear.  Further, webelieve that the demand for maternity apparel is relatively stable whencompared to non-maternity apparel. Expectant mothers continue to need to replace their clothes and thecurrent steady rate of approximately four million U.S. births per year hasremained stable over the last decade.  Webelieve that maternity apparel is also less fashion sensitive than specialtyapparel in general, as demand is driven by the need to replace wardrobe basicsas opposed to current fashion trends.

 

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**Brands**

** **

Weoperate our maternity stores under four retail concepts offering a full rangeof casual and career wear, formal attire, lingerie and outerwear under threeprimary apparel brands.  We have positionedour four retail concepts and three primary apparel brands to target the entirespectrum of pregnant women, serving a smaller customer base at the highestprice points and broadening the market as the price points are reduced.  The following table sets forth certaininformation regarding our portfolio of stores as of September 30, 2004,including each store concept’s target location, brand positioning, price rangefor dresses and approximate average store size:

 
| ** **            | ** ** | ** **                                                         | ** ** | ** **                                                 | ** ** | ** **           | ** ** | **Average**         | ** ** |
|-----------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **            | ** ** | ** **                                                         | ** ** | ** **                                                 | ** ** | **Dress**            | ** ** | **Store Size** | ** ** |
| ** **            | ** ** | **Description of**                                            | ** ** | ** **                                                 | ** ** | **Price**            | ** ** | **(square**         | ** ** |
| **Brand**             | ** ** | **Target Location**                                           | ** ** | **Brand Positioning**                                 | ** ** | **Range**            | ** ** | **feet)**           | ** ** |
| Motherhood  Maternity |       | Moderate regional malls, strip centers and  power centers          |       | Broad assortment, fashion, quality and  everyday low price |       | $17 - $60  |       | 1,700               |       |
|                  |       |                                                               |       |                                                       |       |                 |       |                |       |
| Mimi  Maternity       |       | Mid-priced regional malls and lifestyle  centers                   |       | Contemporary, fun, trendy and affordable                   |       | $48 - $168 |       | 2,000               | (1)        |
|                  |       |                                                               |       |                                                       |       |                 |       |                |       |
| A Pea in the  Pod     |       | Exclusive, high-end regional malls and  affluent residential areas |       | Exclusive, designer and luxury                             |       | $90 - $450 |       | 2,400               |       |

 

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(1)             Oursingle-brand Mimi stores average 1,600 square feet and our multi-brand Mimistores average 3,000 square feet.

 

Wealso have four Destination Maternity superstores open as of September 30,2004.  These superstores are located inor near regional malls and shopping centers, generally include the brands ofMotherhood, Mimi and A Pea in the Pod, as well as products unique to thesuperstore, with dress price ranges indicative of the brands represented.  The average size of these four DestinationMaternity superstores is approximately 4,500 square feet.  We expect future superstores will typicallybe 6,000 square feet or more.

 

Majorregional malls with several department stores and a wide range of price pointsmay be able to accommodate a multi-brand store, or more than one maternitystore.  We have the ability to addressmultiple price alternatives at a given mall, with Motherhood as ourvalue-oriented brand, Mimi as our mid-priced brand and A Pea in the Pod as ourluxury brand. As of September 30, 2004, we had at least two of our storeconcepts in 47 major regional malls. In addition, almost all 41 of our A Pea in the Pod stores and 23 of ourMotherhood stores carry Mimi-branded merchandise, and 30 of our Mimi storescarry Motherhood-branded merchandise.

 

**InternetOperations**

** **

Webelieve that many pregnant women turn to the Internet for maternity-relatedinformation and products, including on-line purchases of maternityclothes.  Our websites are therefore importanttools for educating existing and potential customers about our brands anddriving traffic to our stores.  Ourwebsites sell merchandise and provide store location information.  Each of our concepts has its own dedicatedwebsite that is reached primarily through the brand name, for exampleMotherhood.com.  Our content site andportal, MaternityMall.com, is another likely way for a consumer to reach one ofour brand-specific websites.  In additionto providing links to all of our websites, MaternityMall.com contains maternityadvice and information, related baby product information and editorialcontent.  We also operate the

 

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iMaternity.comwebsite, which sells Motherhood merchandise. Our marketing and technology capabilities, and the replenishmentcapabilities of our distribution center and stores enable us to incorporateInternet design, operations and fulfillment into our existing operations.

 

**MarketingPartnerships**

** **

Weexpand and leverage the relationship we have with our customers and earnincremental revenues through a variety of marketing partnership programsutilizing our extensive opt-in customer database and various in-store marketinginitiatives, focused on baby and parent-related products and services.

 

**Brand-SpecificOperations Teams**

** **

Toobtain maximum efficiencies, we are organized primarily along functional lines,such as merchandising, store operations, design and production.  Since our business consists of three separatebrands requiring decisions on a brand-specific basis, we have built businessteams by brand where the functional leaders within each brand worktogether.  Each brand team is led by thehead merchant and includes the director of stores for that brand, the headdesigner, the head planner and distributor and the key production manager.  These teams also include visual, fabricpurchasing and other necessary professionals.

 

**StoreOperations**

** **

Thetypical maternity customer, especially the first-time mother, seeks more adviceand assistance than the typical non-maternity customer does.  Therefore, we aim to employ skilled,motivated store team members who are trained to provide the high level ofservice and reassurance needed by our customers.  We attempt to provide a boutique level ofattentive service that differentiates us from our competitors, particularly sofrom moderate and discount stores.  Ourcentralized merchandising and store operations also enable our store teammembers to focus primarily on selling and maintaining the appearance of thestores.  In addition, visual merchantscoordinate with the merchandising department to develop floor-sets, designstore display windows and define and enhance the product presentation.

 

Eachof our three primary store brands has a director of stores.  At Motherhood and Mimi, the managementreporting chain consists of regional managers, district managers and storemanagers.  At A Pea in the Pod, due toits smaller number of stores, the district managers report to the director ofstores.  Our store, district and regionalmanagers are eligible to receive incentive-based compensation related to store,district and regional-level performance.

 

**Merchandising,Design and Inventory Planning**

** **

***Merchandising.   ***We strive tomaintain an appropriate balance between new merchandise and proven styles, aswell as between basic and fashion items. Our merchandising decisions are based on current fashion trends, as wellas input from our designers and outside vendors.  This information is used in conjunction withthe item-specific sales data provided by our proprietary merchandising andreplenishment system.  Each brand has itsown team of merchants, designers and planners. These teams are led by the head merchant of the brand.

 

***Design.   ***Our designdepartment creates and produces samples and patterns for ourcontract-manufactured products under the guidance of the merchandisingdepartment.  This capabilitydifferentiates us from many of our competitors, who source their products froma limited number of maternity wear vendors. The design of our products begins with a review of European and New Yorkrunway trends, current non-maternity retail trends, fashion reporting serviceslides and fabric samples.  The designersreview our best selling items from prior seasons and integrate current fashionideas from the non-maternity apparel market.

 

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***InventoryPlanning and Allocation.   ***Our planningand allocation department is responsible for planning future inventorypurchases and markdowns, as well as targeting overall inventory levels andturnover.  We establish targetinventories for each store using our inventory planning system with the goalsof optimizing our merchandise assortment and turnover, maintaining adequatedepth of merchandise by style and managing closeout and end-of-seasonmerchandise consolidation.  Ourproprietary capabilities enable us to continually monitor and respond quicklyto consumer demand and are integral to our inventory management program.  These capabilities are facilitated by ourTrendTrack system, which provides daily product sell-through data andmerchandising information.

 

**Productionand Distribution**

** **

Wedesign and contract for the production for approximately 90% of ourmerchandise.  We contract our sewing tofactories throughout the world, including domestic facilities, and we continueto seek additional contractors for our sourcing needs.  No individual contractor represents amaterial portion of our sewing. A majority of our merchandise is purchased“full package” as finished product made to our specifications, typicallyutilizing our designs.  Fabric, trim andother supplies are obtained from a variety of sources.  As we have expanded our stores and increasedvolumes over the past several years, we have generally been able to reduce ourproduct costs, thereby increasing gross margins.  However, our most recent fiscal year’s grossmargin decreased by about one-half percent, primarily driven by increasedmarkdowns recognized.

 

Ourproduction and quality assurance personnel monitor production at contractorfacilities in the United States and work with our agents abroad to ensurequality control, compliance with our design specifications and timely deliveryof finished goods.  This quality controleffort is enhanced by our worldwide Internet-based contracting and logisticssystems, which include advanced features such as measurement specifications anddigital photography.  We also use a thirdparty consulting firm to help monitor working conditions at our contractors’facilities on a worldwide basis.

 

Finishedgarments from contractors and other manufacturers are received at our UnitedStates distribution facility in Philadelphia, Pennsylvania, and our Canadiandistribution center.  Garments areinspected using statistical sampling methods and stored for picking.  Our distribution facility utilizes the latestfulfillment technology to serve as a replenishment center, as opposed to solelya distribution center.  The facilitysends an individually tailored selection from our approximately 24,000  SKUs to our store locations two to six timesper week.  Store replenishment decisionsare made automatically based upon target inventories established by theallocation department and individual store sales data.  The distribution facility uses severalautomated systems, including our pick-to-light system for flat-packed goods andour hanging garment sortation system, which speed up deliveries to our storesand reduce costs.

 

Shipmentsto stores are tracked by our proprietary delivery tracking software.  Freight is routed through zone-skipping,over-the-road carriers running 24 hours per day and delivered locally by avariety of carriers, and is supplemented by a small percentage of second-dayair, providing one to three-day delivery to our store locations.

 

InNovember 2003, we were certified to participate in Customs-TradePartnership Against Terrorism, or C-TPAT, a United States Department ofHomeland Security sponsored program that enhances our standing with UnitedStates Customs and Border Protection through our implementation and monitoringof procedures to manage the security of our supply chain as part of the effortto protect the United States against potential acts of terrorism.

 

**ManagementInformation and Control Systems**

** **

Webelieve that our proprietary systems are instrumental to our ability to offerthe broadest assortment of maternity merchandise and accomplish rapidreplenishment of inventory.  Wecontinuously

 

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develop,maintain and upgrade our systems and currently employ an in-house team ofprogrammers.  Our stores havepoint-of-sale terminals that provide information used in our customizedTrendTrack merchandise analysis and planning system.  This system provides daily financial andmerchandising information that is integral to monitoring trends and makingmerchandising decisions.  The TrendTracksystem has numerous features designed to integrate our retail operations withour design, manufacturing and financial functions.  These features include custom merchandiseprofiles for each store, rapid inventory replenishment, item-tracking providingdaily updated selling information for every style, classification open-to-buyand inventory control, as well as the daily collection of customer paymentdata, including cash, check and credit card sales data.

 

Aspart of our proprietary ERP system, we employ a comprehensive MRP system tomanage our production inventories, documentation, work orders andscheduling.  This system provides aperpetual inventory of raw materials, actual job costing, scheduling and billof materials capabilities.  Thefoundation of our ERP system is a perpetual inventory of finished goods bylocation across all of our retail stores, which interfaces directly with ourdistribution facility.

 

Infiscal 2003, we rolled out a proprietary, upgraded point-of-sale system to ourstores and integrated this system with our existing systems.  This Internet-based system provides real-timeaccess to financial and merchandising information in addition to rapid creditauthorization.  This upgradedpoint-of-sale system has significantly reduced the amount of training requiredfor new sales associates and store managers. In addition, we plan to continue to add new features and functionalityto the system, and anticipate that the system will improve our customerrelationship management capabilities by allowing the creation of customizedpromotional and marketing strategies.

 

Giventhe importance of our management information systems, we have taken extensivemeasures to ensure their responsiveness and security.  Our hardware and communications systems arebased on a redundant and multiprocessing architecture, which allows theircontinued operation on a parallel system in the event that there is adisruption within the primary system. Our main computer system, located in our Philadelphia facility, isduplicated by a fully mirrored system in a separate part of the building with aseparate power source that is designed to assume full operations shoulddisruption in the primary system occur. In addition, our software programs anddata are backed up and stored off-site. Our communications links come from two telephone frame rooms and aredelivered through underground and aboveground feeds.

 

**Pricing**

** **

Eachof our brands targets customers at different price points of the maternityapparel industry.  Our Motherhood brandis positioned primarily on everyday low prices, Mimi employs middle-marketpricing and A Pea in the Pod employs luxury pricing.  None of our concepts relies on point-of-salehigh/low promotional strategies to drive traffic into the stores.  Our price reductions are done at theindividual style level and are used to accelerate the sale of slower sellingmerchandise.  Merchandise that is sellingslowly is quickly marked down, moved to another store where the item is sellingfaster, or moved to a Motherhood Outlet store.

 

**Advertisingand Marketing**

** **

Webelieve that the power of our brands, customer referrals and our convenientmall locations drive traffic into our stores. Therefore, we have modest advertising and marketing expenditures. Ouradvertising and publicity efforts include in-store marketing, prenatalconsumer-targeted advertising and our Internet websites.  We also run full-page ads for all of ourbrands in pregnancy-targeted publications, as well as prenatal issues ofleading baby and parenting magazines.  Weadvertise in several key prenatal magazines, including *AmericanBaby, Pregnancy, ePregnancy, Healthy Pregnancy* and *Shape Fit Pregnancy*. A Pea in the

 

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Pod,Mimi and Motherhood are also advertised in fashion and broad-reach magazines,such as *Vogue*, *In Style,Lucky, People* and *Glamour*.  We also utilize our publicity efforts togenerate free editorial coverage in broadcast television, magazines, radio andselected newspapers for all of our brands.

 

**Competition**

** **

Ourbusiness is highly competitive, characterized by low barriers to entry.  The following are several important factorsin competing successfully in the retail apparel industry: breadth of selectionin sizes; colors and styles of merchandise; product procurement and pricing;ability to anticipate fashion trends and customer preferences; inventorycontrol; reputation; quality of merchandise; store design and location; visualpresentation and advertising and customer service.  We face competition in our maternity apparellines from various sources, including department stores, specialty retailchains, discount stores, independent retail stores and catalog andInternet-based retailers, from both new and existing competitors.  Many of our competitors are larger and havesubstantially greater financial and other resources than us.  Further, we do not typically advertise usingtelevision and radio media and thus do not reach customers through means ourcompetitors may use.  Our mid- andluxury-priced merchandise faces a highly fragmented competitive landscape thatincludes locally based, single unit retailers, as well as a handful ofmulti-unit maternity operations, none of which we believe has more than 15stores nationwide.  In the value-pricedmaternity apparel business, we currently face competition on a nationwide basisfrom retailers such as Fashion Bug®, GAP®, JC Penney®, Kmart®, Kohl’s®, OldNavy®, Target®, Sears® and Wal-Mart®. Several of these competitors, includingGap® and Old Navy®, also sell maternity apparel on their websites.  We believe there has been increasedcompetition in the maternity apparel industry, from both new and existingcompetitors.  We currently face maternitycompetition in over 1,000 more competitive locations than a year ago.  Our market share and results of operationsmay be materially and adversely affected by this competition, including thepotential for increased competition in the future.  While we have competed with both Sears andKohl’s in the past, our relationship with both of them is now changing.  We will be expanding our Two Hearts Maternitycollection to a total of approximately 645 Sears stores in March 2005under a leased department arrangement. In February 2005, we will launchour Oh Baby! by Motherhood collection at Kohl’s stores throughout the UnitedStates and on Kohls.com, available exclusively at Kohl’s under a product andlicense agreement.

 

**Employees**

** **

Asof September 30, 2004, we had 2,624 full-time and 2,401 part-timeemployees.  None of our employees arecovered by a collective bargaining agreement. We consider our employee relations to be good.

 

**ExecutiveOfficers of the Company**

** **

Thefollowing table sets forth the name, age and position of each of our executiveofficers:

 
| **Name**             | ** ** | **Age** | ** ** | **Position**                                               |
|----------------------|------------|---------|------------|------------------------------------------------------------|
| Dan  W. Matthias     |       | 61      |       | Chairman  of the Board and Chief Executive Officer         |
| Rebecca  C. Matthias |       | 51      |       | President,  Chief Operating Officer and Director           |
| Edward  M. Krell     |       | 42      |       | Executive  Vice President—Chief Financial Officer     |
| David  Mangini       |       | 60      |       | Executive  Vice President—General Merchandise Manager |

 

*Dan W. Matthias***co-founded Mothers Work in 1982 (along with Rebecca C.Matthias) and has served as Chairman of the Board since our inception. From1983 to 1993, Mr. Matthias served as our Executive Vice President, andsince January 1993, Mr. Matthias has been our Chief ExecutiveOfficer.  Prior to Mothers Work, Mr. Matthiashad been involved in the computer and electronics industry, serving as adirector of Zilog, Inc. and as the President of a division of a subsidiaryof Exxon Corporation.

 

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*Rebecca C. Matthias***co-founded Mothers Work in 1982 (along with Dan W. Matthias)and has served as a director and our President since our inception.  Since January 1993, Ms. Matthiashas also served as our Chief Operating Officer. In 1992, Ms. Matthias was chosen as “Regional Entrepreneur of theYear” by *Inc*. magazine and Merrill LynchCorporation, and in September 2003, Ms. Matthias was recognized as atop woman entrepreneur by the United States Small Business Administration.  Prior to 1982, Ms. Matthias was aconstruction engineer for the Gilbane Building Company.  Ms. Matthias also serves as a member ofthe Board of Trustees of Drexel University, a director on the Board ofDirectors of CSS Industries, Inc., and a director on the Board ofDirectors of Russell Corporation.

 

*Edward M. Krell***has served as Executive Vice President-Chief FinancialOfficer since November 2003, having served as Senior Vice President-ChiefFinancial Officer from the time he joined Mothers Work in January 2002until November 2003.  Prior tojoining Mothers Work, Mr. Krell served as Executive Vice President andChief Financial Officer of Mammoth Sports Group, Inc., an Internet andcatalog retailer of golf equipment and accessories, from December 1999 to July 2000and as an independent financial consultant from July 2000 to January 2002.  From 1995 to 1999, Mr. Krell served asExecutive Vice President and Chief Financial Officer of London Fog Industries, Inc.,a wholesale and retail distributor of rainwear and outerwear. Mr. Krellbegan his career as an investment banker with Kidder, Peabody & Co.Incorporated.

 

*David Mangini***has served as Executive Vice President-General MerchandiseManager since August 2001.  Prior tojoining Mothers Work, Mr. Mangini served as Today’s Man’s ChiefMerchandising Officer from 1999 to 2000. From 1998 to 1999, Mr. Mangini served as Chief Operating Officer ofGadzooks.  From 1987 to 1997, Mr. Manginiwas an officer at Limited, Inc., including President and Chief ExecutiveOfficer of its Structure brand.

 

Ourexecutive officers are elected annually by the Board of Directors and serve atthe discretion of the Board.  Other thanthe husband and wife relationship between Dan and Rebecca Matthias, there areno family relationships among any of our other executive officers.

 

**Trademarks**

** **

Weown trademark and service mark rights that we believe are sufficient to conductour business as currently operated.  Weown several trademarks, including Mothers Work®, A Pea in the Pod®, MimiMaternity®, Motherhood®, Motherhood Maternity®, Destination MaternityTM, TwoHearts MaternityTM, Oh Baby!TM, Oh Baby! by MotherhoodTM, Motherhood MaternityOutlet®, Steena® and MaternityMall.com®. As a result of the iMaternity acquisition, we also own the iMaternity®,Dan Howard® and iMaternity.comTM marks. Additionally, we own the marks futuretrustTM, Real Time Retailing®, What’sShowing is Your Style®, Motherhood: It’s Hot!TM, Motherhood is Everything GoodTM,Motherhood Baby® and Maternity Redefined®. We are not aware of any material pending claims of infringement or otherchallenges to our rights or to the use of our marks in the United States orCanada.

 

**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 our 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, net salesand profitability contributed by new stores, increases or decreases

 

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incomparable store sales, 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.

 

**Securitiesand Exchange Commission Filings**

** **

Securitiesand Exchange Commission (“SEC”) filings are available free of charge on ourwebsite, www.motherswork.com.  Our annualreports on Form 10-K, quarterly reports on Form 10-Q, current reportson Form 8-K and amendments to those reports are posted on our website assoon as practicable after we furnish such materials to the SEC.

 

**Item 2.**              Properties

** **

Weown our principal executive offices and distribution facility, which is locatedat 456 North Fifth Street, Philadelphia, Pennsylvania, subject to a mortgageunder the terms of which we owe approximately $3.1 million as of September 30,2004.  This facility consists of approximately318,000 square feet, of which 45,000 square feet is dedicated to office spaceand the remaining square footage to finished goods warehousing anddistribution.  On August 26, 2002,we entered into a 10-year lease for a facility located at 2001 Kitty HawkAvenue, Philadelphia, Pennsylvania in the Philadelphia Naval BusinessCenter.  The area leased at thisfacility, which we use for raw material cutting and warehousing, consists of64,000 square feet of space.  Tofacilitate our store growth in Canada, we entered into a three-year leasecommencing November 1, 2002 for 12,000 square feet of finished goodswarehouse and distribution space in Mississauga, Ontario in Canada.  We believe that these facilities will beadequate to support our anticipated distribution needs for the near term and,potentially, longer.  In the event weneed additional space to meet our future distribution needs, we believe thatsuch space would be readily available. Our facilities are subject to state and local regulations that rangefrom building codes to health and safety.

 

Welease our store premises for terms averaging from seven to ten years.  Certain leases allow us to terminate ourobligations at specified points in time in the event that the applicable storedoes not achieve a specified sales volume. Some of our store leases also provide for contingent payments based onsales volume, escalations of the base rent, as well as increases in operatingcosts, marketing costs and real estate taxes.

 

Asof September 30, 2004, the following number of store leases are set toexpire as listed in the table below.  Wedo not expect the expiration of any leases to have a material adverse impact onour business or operations.

 
| **Fiscal Year   Leases Expire** | ** ** | **Number  of Stores** | ** ** |
|------------------------------------------------|------------|----------------------------|------------|
| 2005                                           |       | 113                        |       |
| 2006                                           |       | 79                         |       |
| 2007                                           |       | 88                         |       |
| 2008                                           |       | 73                         |       |
| 2009                                           |       | 128                        |       |
| 2010 and  later                                |       | 402                        |       |
| Total                                          |       | 883                        |       |

 

Inaddition, we have arrangements with department and specialty stores, includingBabies ”R” Us®, Bloomingdale’s®, Burdine’s®, Lazarus®, Macy’s®, MarshallField’s®, Rich’s® and Sears® to operate maternity departments in theirstores.  These leased departmentstypically involve the lease partner collecting all of the revenue from theleased department and remitting all but a fixed percentage to us.  We

 

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provideat least some amount of staffing for each of the leased departments, with theamount varying depending on the specific arrangement.

 

**Item 3.**              LegalProceedings

** **

Wewere a party to an action filed against us alleging that certain former andcurrent employees should have received overtime compensation under Washingtonlaw in Spokane County Superior Court. The plaintiffs in this action sought unspecified actual damages, penaltiesand attorneys’ fees.  On or about April 23,2003, one purported subclass of the plaintiffs accepted a settlementarrangement in the amount of $50,000, plus attorney’s fees and costs incurredthrough such date.  After a trial withthe remaining purported subclass, in May 2003, the jury found for us onall but one claim, for which it awarded the remaining plaintiffs damages in theamount of $106,000.  The parties arecurrently contesting fees, costs and expenses being sought by the plaintiffs inthe amount of approximately $390,000.  Werecorded expenses during fiscal 2004 and 2003 of $78,000 and $546,000,respectively, for the estimated legal fees and settlement costs of this case,including the contested costs and expenses noted above.

 

Inaddition, from time to time, we are named as a defendant in legal actionsarising from our normal business activities. Although the amount of any liability that could arise with respect tocurrently pending actions cannot be accurately predicted, we do not believethat the resolution of any pending action will have a material adverse effecton our financial position, results of operations or liquidity.

 

**Item 4.**              Submissionof Matters to a Vote of Security Holders

** **

Notapplicable.

 

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**PART II.**

** **

**Item 5.**       Market forRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities

** **

Ourcommon stock is traded on the Nasdaq National Market under the symbol“MWRK.”  The following table sets forthfor the periods indicated below the reported high and low sales prices of ourcommon stock as reported on the Nasdaq National Market:

 
| ** **                                      | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------------------|------------|----------|------------|---------|------------|
| **Fiscal  Year Ended September 30, 2003:** |       |     |       |    |       |
| Quarter  ended December 31, 2002           |       | $        | 43.00      |    | $          | 29.50 |   |
| Quarter  ended March 31, 2003              |       | 38.00    |       | 18.60   |       |
| Quarter  ended June 30, 2003               |       | 28.00    |       | 19.72   |       |
| Quarter  ended September 30, 2003          |       | 37.87    |       | 25.81   |       |
|                                            |       |     |       |    |       |
| **Fiscal  Year Ended September 30, 2004:** |       |     |       |    |       |
| Quarter  ended December 31, 2003           |       | $        | 30.76      |    | $          | 22.30 |   |
| Quarter  ended March 31, 2004              |       | 28.07    |       | 22.70   |       |
| Quarter  ended June 30, 2004               |       | 27.57    |       | 20.00   |       |
| Quarter  ended September 30, 2004          |       | 20.74    |       | 14.34   |       |

 

Asof December 1, 2004, there were 837 holders of record and 2,030 estimatedbeneficial holders of our common stock.

 

Wehave not paid any cash dividends on our common stock since our initial publicoffering and do not anticipate paying cash dividends on our common stock in theforeseeable future.  In addition, theterms of our senior notes and our credit facility significantly restrict ourability to declare or pay dividends on our common stock.  Even if we were not restricted under theterms of our $125.0 million of 111¤4% seniornotes due 2010 (the “New Senior Notes”) or our credit facility from being ableto pay dividends, any future payment of dividends would still be at thediscretion of our Board of Directors and would be based upon certainrestrictive financial covenants, earnings, capital requirements and ourfinancial condition, among other factors, at the time any such dividend isconsidered.

 

Upto a total of 1,975,000 options may be issued under our 1987 Stock Option Planand up to a total of 200,000 options may be issued under our separate DirectorStock Option Plan.

 

InMarch 2003, our Board of Directors approved a share repurchase programunder which we may repurchase up to $10.0 million of our outstanding commonstock from time to time in private transactions or on the open market until March 2005.  As of September 30, 2004, we haverepurchased and retired 142,269 shares in the aggregate at a total cost of $3.2million, for an average cost of $22.79 per share.  The indenture governing our New Senior Notesand the terms of our credit facility contain restrictions that place limits oncertain payments by us, including payments to repurchase shares of our commonstock.  Our repurchases of common stockhave been made in compliance with all restrictions under the indenturegoverning the New Senior Notes and the terms of our credit facility.

 

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Thefollowing table provides information about purchases by us during the quarterended September 30, 2004 of equity securities that are registered by uspursuant to Section 12 of the Securities Exchange Act of 1934:

 

**IssuerPurchases of Equity Securities**

** **
| **Period**                                  | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased as  Part of a Publicly  Announced Program (2)** | ** ** | **Maximum  Approximate Dollar  Value of Shares that  May Yet Be Purchased  Under the Program (1)** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1 to July 30, 2004           |       | —                                       |       | —                                           |       | —                                                                                                                           |       | $                                                                                                                                                    | 6,756,983  |   |
| August 1 to August 31, 2004       |       | —                                       |       | —                                           |       | —                                                                                                                           |       | $                                                                                                                                                    | 6,756,983  |   |
| September 1 to September 30, 2004 |       | —                                       |       | —                                           |       | —                                                                                                                           |       | $                                                                                                                                                    | 6,756,983  |   |
| Total                                       |       | —                                       |       | —                                           |       | —                                                                                                                           |       | $                                                                                                                                                    | 6,756,983  |   |

 

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(1)             On March 6, 2003, the Board of Directors approved a share repurchaseprogram under which we may buy up to $10.0 million of our outstanding commonstock from time to time in open market purchases or through privatetransactions until March 2005.

 

(2)             As of September 30, 2004, we had repurchased an aggregate of 142,269shares at a total cost of approximately $3.2 million pursuant to the repurchaseprogram that we publicly announced in March 2003, of which 75,715 shareswere repurchased during fiscal 2004, at an average cost of $23.44 per share.

 

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| **Item 6.** | **Selected Consolidated  Financial and Operating Data (Restated-see Note 2 of the Notes to  Consolidated Financial Statements)** |
|-------------|----------------------------------------------------------------------------------------------------------------------------------|

** **

Thefollowing tables set forth selected data pertaining to the consolidatedstatement of operations, pro forma statement of operations, operating, cashflow and other, and balance sheet as of and for the periods indicated.  The selected consolidated statement ofoperations and balance sheet data for each of the five fiscal years presentedbelow are derived from our audited consolidated financial statements.  You should read this information inconjunction with the “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and our consolidated financial statementsand the related notes included elsewhere in this report.

 
| ** **                                            | ** ** | **Year Ended September 30,**                           | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **2002 (2)** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                            | ** ** | **(in thousands, except per share amounts)** | ** ** |
| ** **                                            | ** ** | **(Restated)**                                                        | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| **Statement  of Operations Data (1):**                |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Net sales                                             |       | $                                                                     | 518,051    |   | $ | 492,447 |   | $ | 453,159 |   | $ | 388,306 |   | $ | 366,283 |   |
| Cost of  goods sold                                   |       | 239,613                                                               |       | 225,191 |   | 211,689 |   | 194,320 |   | 183,300 |   |
| Gross profit                                          |       | 278,438                                                               |       | 267,256 |   | 241,470 |   | 193,986 |   | 182,983 |   |
| Selling,  general and administrative expenses         |       | 255,168                                                               |       | 231,236 |   | 208,325 |   | 173,390 |   | 158,154 |   |
| Operating  income                                     |       | 23,270                                                                |       | 36,020 |   | 33,145 |   | 20,596 |   | 24,829 |   |
| Interest  expense, net (3)                       |       | 14,765                                                                |       | 14,469 |   | 16,476 |   | 14,867 |   | 15,877 |   |
| Other income                                          |       | —                                                                |       | — |   | — |   | 594 |   | — |   |
| Income  before income taxes                           |       | 8,505                                                                 |       | 21,551 |   | 16,669 |   | 6,323 |   | 8,952 |   |
| Income tax  provision (3)                        |       | 3,466                                                                 |       | 8,337 |   | 6,269 |   | 3,248 |   | 4,128 |   |
| Net income                                            |       | 5,039                                                                 |       | 13,214 |   | 10,400 |   | 3,075 |   | 4,824 |   |
| Dividends on  preferred stock                         |       | —                                                                |       | — |   | 3,942 |   | 1,491 |   | 1,389 |   |
| Net income  available to common stockholders (2) |       | $                                                                     | 5,039      |   | $ | 13,214 |   | $ | 6,458 |   | $ | 1,584 |   | $ | 3,435 |   |
| Net income  per share—Basic (2)             |       | $                                                                     | 0.97       |   | $ | 2.52 |   | $ | 1.65 |   | $ | 0.46 |   | $ | 1.00 |   |
| Average  shares outstanding—Basic                |       | 5,212                                                                 |       | 5,236 |   | 3,914 |   | 3,456 |   | 3,443 |   |
| Net income  per share—Diluted (2)           |       | $                                                                     | 0.92       |   | $ | 2.34 |   | $ | 1.52 |   | $ | 0.44 |   | $ | 0.94 |   |
| Average  shares outstanding—Diluted              |       | 5,501                                                                 |       | 5,646 |   | 4,261 |   | 3,605 |   | 3,641 |   |

 

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| ** **                                                                              | ** ** | **Year Ended September 30,**                           | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **2002 (2)** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                              | ** ** | **(in thousands, except per share amounts)** | ** ** |
| ** **                                                                              | ** ** | **(Restated)**                                                        | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| **Pro  Forma Statement of Operations Data (1)(4):**                                |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Net income  available to common stockholders                                            |       | $                                                                     | 5,039      |   | $ | 13,214 |   | $ | 6,458 |   | $ | 1,584 |   | $ | 3,435 |   |
| Add back  goodwill amortization                                                         |       | —                                                                |       | — |   | — |   | 2,207 |   | 2,216 |   |
| Pro forma  net income available to common stockholders, excluding goodwill amortization |       | $                                                                     | 5,039      |   | $ | 13,214 |   | $ | 6,458 |   | $ | 3,791 |   | $ | 5,651 |   |
| Pro forma  net income per share—Basic                                              |       | $                                                                     | 0.97       |   | $ | 2.52 |   | $ | 1.65 |   | $ | 1.10 |   | $ | 1.64 |   |
| Pro forma  net income per share—Diluted                                            |       | $                                                                     | 0.92       |   | $ | 2.34 |   | $ | 1.52 |   | $ | 1.05 |   | $ | 1.55 |   |

 

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(1)             Fiscal years2000 through 2004 have been restated from amounts previously reported toreflect certain lease accounting adjustments as discussed in Note 2 of theNotes to Consolidated Financial Statements.

 

(2)             In August 2002,as part of a refinancing, we repurchased our existing 125¤8% seniornotes and Series A and Series C Preferred Stock and, in connectiontherewith, incurred $3.0 million of one-time charges, includingapproximately $2.6 million of non-cash charges.  Excluding the impact of the $3.0 millionof one-time charges, fiscal 2002 net income available to common stockholders wouldhave been approximately $9.5 million, or $2.23 per share (diluted).  We have presented this adjusted earningsfigure because management believes it enhances the reader’s understanding ofour operating results by adjusting for the one-time charges related to therefinancing. See “Management’s Discussion and Analysis of Financial Conditionand Results of Operations.”

 

(3)             In fiscal2003, we adopted the provisions of Financial Accounting Standards Board(“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 145.  The provisions of this statement require,effective in fiscal years beginning after May 15, 2002, thereclassification of certain gains or losses on extinguishment of debt that werepreviously classified as an extraordinary item in prior periods.  Accordingly, we have reclassified the $1.6 millionextraordinary loss on early extinguishment of debt, net of tax, as reported forfiscal 2002 related to our fourth quarter fiscal 2002 refinancing, to a$2.5 million increase in interest expense and a related $0.9 millionreduction in our income tax provision, which had no impact on reported netincome.  In fiscal 2002, prior to theadoption of SFAS No. 145, we had reported interest expense for fiscal2002 of $14.0 million.

 

(4)             As a resultof our adoption of SFAS No. 142 on October 1, 2001, we no longeramortize goodwill.  The pro formastatement of operations data reflects an adjustment to exclude amortizationexpense recognized in the prior periods as presented.

 

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| ** **                                                   | ** ** | **Year Ended September 30,**                                                        | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2004**                                                                                           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                   | ** ** | **(unaudited; in thousands, except operating data and ratios)** | ** ** |
| ** **                                                   | ** ** | **(Restated)**                                                                                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| **Operating  Data:**                                         |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| Same store  sales increase (decrease) (1)               |       | (4.9                                                                                               | )%         | 0.3 | % | 2.2 | % | (2.4 | )% | 8.3 | % |
| Average net  sales per gross square foot (2)            |       | $                                                                                                  | 309        |   | $ | 343 |   | $ | 363 |   | $ | 365 |   | $ | 390 |   |
| Average net  sales per store (3)                        |       | $                                                                                                  | 537,000    |   | $ | 572,000 |   | $ | 589,000 |   | $ | 583,000 |   | $ | 609,000 |   |
| Gross retail  location square footage at period end (4) |       | 1,693,000                                                                                          |       | 1,541,000 |   | 1,313,000 |   | 1,100,000 |   | 980,000 |   |
| Number of  retail locations at period end:                   |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| Motherhood  Maternity stores                                 |       | 717                                                                                                |       | 688 |   | 616 |   | 523 |   | 480 |   |
| Mimi  Maternity stores                                       |       | 121                                                                                                |       | 119 |   | 104 |   | 74 |   | 71 |   |
| A Pea in the  Pod stores                                     |       | 41                                                                                                 |       | 44 |   | 43 |   | 42 |   | 41 |   |
| Destination  Maternity superstores                           |       | 4                                                                                                  |       | — |   | — |   | — |   | — |   |
| Total stores                                                 |       | 883                                                                                                |       | 851 |   | 763 |   | 639 |   | 592 |   |
| Leased  departments                                          |       | 232                                                                                                |       | 155 |   | 146 |   | 132 |   | 111 |   |
| Total retail  locations                                      |       | 1,115                                                                                              |       | 1,006 |   | 909 |   | 771 |   | 703 |   |
| **Cash  Flow and Other Data (5):**                           |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| EBITDA (6)                                              |       | $                                                                                                  | 37,540     |   | $ | 48,950 |   | $ | 44,934 |   | $ | 34,840 |   | $ | 38,043 |   |
| Cash flows  provided by operating activities                 |       | 18,256                                                                                             |       | 36,139 |   | 31,056 |   | 23,467 |   | 22,763 |   |
| Cash flows  used in investing activities                     |       | (23,020                                                                                            | )          | (22,169 | ) | (20,219 | ) | (16,087 | ) | (17,968 | ) |
| Cash flows  used in financing activities                     |       | (2,500                                                                                             | )          | (4,648 | ) | (14,786 | ) | (98 | ) | (2,859 | ) |
| Capital  expenditures                                        |       | 21,540                                                                                             |       | 25,344 |   | 12,242 |   | 15,533 |   | 17,759 |   |
| Ratio of  total debt to EBITDA                               |       | 3.4x                                                                                               |       | 2.6x |   | 2.9x |   | 3.7x |   | 3.3x |   |
| Ratio of  EBITDA to interest expense (7)                |       | 2.5x                                                                                               |       | 3.4x |   | 2.7x |   | 2.3x |   | 2.4x |   |
| **Balance  Sheet Data (at end of period) (5):**              |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| Working  capital                                             |       | $                                                                                                  | 67,833     |   | $ | 62,708 |   | $ | 55,214 |   | $ | 30,223 |   | $ | 27,869 |   |
| Total assets                                                 |       | 271,370                                                                                            |       | 263,536 |   | 247,139 |   | 197,382 |   | 189,963 |   |
| Total debt                                                   |       | 127,917                                                                                            |       | 128,047 |   | 128,282 |   | 128,842 |   | 127,179 |   |
| Accrued  dividends on Series A Preferred Stock          |       | —                                                                                             |       | — |   | — |   | 7,055 |   | 6,037 |   |
| Stockholders’  equity:                                  |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| Series A  Preferred Stock (8)                      |       | $                                                                                                  | —     |   | $ | — |   | $ | — |   | $ | 10,773 |   | $ | 11,500 |   |
| Common stockholders’  equity                            |       | 62,903                                                                                             |       | 58,858 |   | 45,708 |   | 2,559 |   | 229 |   |
| Total  stockholders’ equity                             |       | $                                                                                                  | 62,903     |   | $ | 58,858 |   | $ | 45,708 |   | $ | 13,332 |   | $ | 11,729 |   |

 

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(1)             Same storesales figures represent sales at retail locations that have been in operationby Mothers Work for at least twelve full months at the beginning of the periodfor which such data is presented.  Asused in this Form 10-K, “retail locations” include stores and leaseddepartments.

 

(2)             Based onretail locations in operation by Mothers Work during the entire twelve-monthperiod.

 

(3)             Based onstores in operation by Mothers Work during the entire twelve-month period.

 

(4)             Based on allretail locations in operation at the end of the period.

 

(5)             Fiscal years2000 through 2004 have been restated from amounts previously reported toreflect certain lease accounting adjustments as discussed in Note 2 of theNotes to Consolidated Financial Statements.

 

(6)             EBITDArepresents income before interest expense, income tax provision, anddepreciation and amortization expense. We have presented EBITDA to enhance your understanding of our operatingresults.  EBITDA is provided becausemanagement believes it is an important measure of financial

 

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performance commonly usedin the retail industry to determine the value of companies within the industryand to define standards for borrowing from institutional lenders.  You should not construe EBITDA as analternative to operating income as an indicator of our operating performance,or as an alternative to cash flows from operating activities as a measure ofour liquidity, as determined in accordance with generally accepted accountingprinciples.  We may calculate EBITDAdifferently than other companies.

 

(7)             Ratio ofEBITDA to interest expense for fiscal 2002 reflects the inclusion in interestexpense of an approximately $2.5 million loss on early extinguishment ofdebt related to our fiscal 2002 refinancing.

 

(8)             We haveredeemed all of the outstanding Series A Preferred Stock for$13.4 million, including accrued and unpaid dividends, of which$12.4 million has been paid as of September 30, 2004 and$1.0 million will be paid out upon submission of proper documentation fromthe remaining holders of the Series A Preferred Stock.  The $1.0 million is reflected in ourconsolidated balance sheet as of September 30, 2004 in accrued expensesand other current liabilities.

 

**Reconciliationof Operating Income to EBITDA(in thousands)(unaudited)**

** **
| ** **                                  | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                  | ** ** | **(Restated)**                              | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Operating  income                           |       | $                                           | 23,270     |   | $ | 36,020 |   | $ | 33,145 |   | $ | 20,596 |   | $ | 24,829 |   |
| Add:  depreciation and amortization expense |       | 14,270                                      |       | 12,930 |   | 11,789 |   | 13,650 |   | 13,214 |   |
| Add: other  income                          |       | —                                      |       | — |   | — |   | 594 |   | — |   |
| EBITDA                                      |       | $                                           | 37,540     |   | $ | 48,950 |   | $ | 44,934 |   | $ | 34,840 |   | $ | 38,043 |   |

 

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**Item 7.**              Management’sDiscussion and Analysis of Financial Condition and Results of Operations

** **

**Overview**

** **

Thefollowing discussion should be read in conjunction with the consolidatedfinancial statements and their related notes included elsewhere in this report.

 

We are the leading designer and retailer ofmaternity apparel in the United States with 1,115 retail locations, including883 stores in all 50 states, Puerto Rico and Canada and 232 leaseddepartments.  We operate our stores underthe Motherhood Maternity, Mimi Maternity, A Pea in the Pod and DestinationMaternity brands and also sell our merchandise on the Internet at ourMaternityMall.com and our brand-specific websites.  In addition to our 883 stores, our retaillocations include 232 leased departments, primarily Motherhood-branded, withindepartment and specialty stores.  Wedesign and contract manufacture approximately 90% of the merchandise we sell inour retail locations.

 

**Restatement of Prior FinancialInformation**

 

In May 2005,we completed a review of our historical lease accounting methods to determinewhether these methods were in accordance with the views expressed by the Officeof the Chief Accountant of the SEC on February 7, 2005 in a letter to theAmerican Institute of Certified Public Accountants and other recentinterpretations regarding certain operating lease accounting issues and theirapplication under accounting principles generally accepted in the United Statesof America (“GAAP”).  As a result of ourreview, we determined that, with regard to our method of accounting for leases,our historical methods of accounting for rent holidays and tenant improvementallowances, and of determining the amortization period for leaseholdimprovements for certain leased properties, were not in accordance withGAAP.  As a result, on May 10, 2005,we filed a Current Report on Form 8-K with the SEC announcing our decisionto restate the previously issued consolidated financial statements contained inour Annual Report on Form 10-K for the year ended September 30, 2004and our Quarterly Report on Form 10-Q for the quarterly period ended December 31,2004  (the “Restatement”).

 

A discussion ofeach of the aforementioned lease accounting matters is presented below:

 

*RentHoliday*.   We historically have recognized rent holidayperiods and scheduled rent increases on a straight-line basis over the leaseterm beginning with the commencement date of the lease, which is typically thestore opening date.  We have determinedthat the lease term should commence on the date we take possession of theleased property, which is generally four to six weeks prior to a store’sopening date.

 

*TenantImprovement Allowances.   *We historically accounted for tenantimprovement allowances as reductions to the related leasehold improvements inour consolidated balance sheets and as reductions of capital expenditures ininvesting activities in our consolidated statements of cash flows.  We have now determined that allowances shouldbe recorded as deferred rent liabilities in our consolidated balance sheets andas a component of operating activities in our consolidated statements of cashflows.

 

*Amortizationof Leasehold Improvements.*   Historically, the life used for certainleasehold improvements by us in some instances was longer than thestraight-line rent expense period for such related leases.  As part of our review associated with leasematters, we have determined that the amortization period for leaseholdimprovements should be consistent with the straight-line rent expense periodfor each of our leases.  The lives forall leasehold improvements have been reviewed to ensure that the amortizationis now recorded based on the lesser of the estimated useful life of the assetor the lease term.

 

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The primary effects of the corrections are:(i) to accelerate the rent expense on properties we occupied before payment ofrents was required (rent holidays); (ii) to increase depreciation andamortization expense and decrease store occupancy expense (both of which arecomponents of selling, general and administrative expenses) to reflect theproper accounting for tenant improvement allowances; and (iii) to acceleratethe amortization of leasehold improvements on those leased properties where thelease term is shorter than the estimated useful economic life of those assets.  The cumulative effect of these accountingchanges is a reduction to retained earnings of $1.4 million as of the beginningof fiscal 2002 and incremental decreases to retained earnings of $0.8 million,$0.7 million and $0.4 million for fiscal 2004, fiscal 2003 and fiscal 2002,respectively.  The Restatement decreasedreported diluted earnings per share by $0.15, $0.13 and $0.09 for fiscal 2004,fiscal 2003 and fiscal 2002, respectively. The restated consolidated financial statements reflect adjustments thatwill not have any impact on our previously reported sales, comparable sales orour compliance with any financial covenant under our revolving credit facilityor other debt instruments.

 

The consolidated financial statementsincluded in this Form 10-K/A have been restated to reflect the adjustmentsdescribed above.  See Note 2 of the Notesto Consolidated Financial Statements included in this Form 10-K/A for asummary of the impact of the Restatement on (i) the consolidated balancesheets as of September 30, 2004 and 2003, (ii) the consolidatedstatements of operations for the three years ended September 30, 2004, (iii) theconsolidated statements of stockholders’ equity, and (iv) the consolidatedstatements of cash flows for the three years ended September 30, 2004.

 

**CriticalAccounting Policies and Estimates**

** **

Ourconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States.  These generally accepted accountingprinciples require management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of our consolidated financial statements and thereported amounts of net sales and expenses during the reporting period.

 

Oursignificant accounting policies are described in Note 2 of “Notes toConsolidated Financial Statements.”  Webelieve that the following discussion addresses our critical accountingpolicies, which are those that are most important to the portrayal of ourfinancial condition and results of operations and require management’s mostdifficult, subjective and complex judgments, often as a result of the need tomake estimates about the effect 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.   *We value ourinventories, which consist primarily of maternity apparel, at the lower of costor market. Cost is determined on the first-in, first-out method (FIFO) andincludes the cost of merchandise, freight, duty and broker fees.  A periodic review of inventory quantities onhand is performed in order to determine if inventory is properly valued at thelower of cost or market.  Factors relatedto current inventories such as future consumer demand and fashion trends,current aging, current analysis of merchandise based on receipt date, currentand anticipated retail markdowns or wholesale discounts, and class or type ofinventory are analyzed to determine estimated net realizable values.  Criteria utilized by us to quantify agingtrends include factors such as the amount of merchandise received within thepast twelve months, merchandise received more than one year before withquantities on-hand in excess of 12 months

 

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ofsales, and merchandise currently selling below cost.  A provision is recorded to reduce the cost ofinventories to the estimated net realizable values, if required. Inventories asof September 30, 2004 and 2003 totaled $92.7 million and$84.5 million, respectively, representing approximately 34.2% and 32.1% oftotal assets, respectively.  Given thesignificance of inventories to our consolidated financial statements, thedetermination of net realizable values is considered to be a criticalaccounting estimate.  Any significantunanticipated changes in the factors noted above could have a significantimpact on the value of our inventories and our reported operating results.

 

*Long-Lived Assets.  *Ourlong-lived assets consist principally of store leasehold improvements and areincluded in the “Property, Plant and Equipment, net” line item in ourconsolidated balance sheets.  Theselong-lived assets are recorded at cost and are amortized using thestraight-line method over the shorter of the lease term or their useful life,generally ten years.  Net property, plantand equipment as of September 30, 2004 and 2003 totaled $78.5 millionand $73.4 million, respectively, representing approximately 28.9% and27.8% of total assets, respectively.

 

Inassessing potential impairment of these assets, we periodically evaluate thehistorical and forecasted operating results and cash flows on a store-by-storebasis.  Newly opened stores may take timeto generate positive operating and cash flow results.  Factors such as (i) store type, that is,company store or leased department, (ii) store concept, that is,Motherhood, Mimi, A Pea in the Pod or Destination Maternity (iii) storelocation, for example, urban area versus suburb, (iv) current marketplaceawareness of our brands, (v) local customer demographic data, (vi) anchorstores within the mall in which our store is located and (vii) currentfashion trends are all considered in determining the time frame required for astore to achieve positive financial results, which is assumed to be within twoyears from the date a store location is opened. If economic conditions are substantially different from ourexpectations, the carrying value of certain of our long-lived assets may becomeimpaired.  As a result of our impairmentassessment, we recorded write-downs of long-lived assets of $1.8 millionand $0.6 million during fiscal 2004 and fiscal 2003, respectively.

 

*Goodwill.  *The purchasemethod of accounting for business combinations requires the use of estimatesand judgments to allocate the purchase price paid for acquisitions to the fairvalue of the net tangible and identifiable intangible 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 September 30,2004 and 2003, goodwill totaled $50.4 million, representing 18.6% and19.1% of total assets, respectively. In June 2001, the FASB issuedSFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142requires that goodwill no longer be amortized, but instead be tested forimpairment at least annually or as impairment indicators arise.  Prior to our adoption of SFAS No. 142on October 1, 2001, goodwill was amortized using the straight-line methodover a period of 20 years.

 

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.  The factors taken intoaccount in determining the fair market value of our outstanding common stock ona control basis are: (i) the trading value of our outstanding common stockon an established public market, and (ii) the premium over the tradingprice of our outstanding common stock that an investor would pay for a controlownership interest in the company, as determined through a third partyevaluation.  The carrying value of oursingle reporting unit, expressed on a per share basis, is represented by our bookvalue per share of outstanding common stock. We performed the initial adoption impairment test in early fiscal2002.  The results of the initialimpairment test and the annual impairment test performed as of September 30,2004, 2003 and 2002 indicated the fair value of the reporting unit exceeded itscarrying value.  At September 30,2004, our book value was $12.08 per share of

 

25

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outstandingcommon stock and the closing trading price of our common stock was $14.50 pershare.  If the fair value of ouroutstanding common stock on a control basis were less than $12.08 per share on September 30,2004, our goodwill would have become impaired.

 

*Accounting for IncomeTaxes.  *As part ofthe process of preparing our consolidated financial statements, we are requiredto 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.  Actual resultscould differ from this assessment if adequate taxable income is not generatedin future periods.  Net deferred taxassets as of September 30, 2004 and 2003 totaled $18.0 million and$19.6 million, respectively, representing approximately 6.6% and 7.4% 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 forContingencies.  *From time totime, we are named as a defendant in legal actions arising from our normalbusiness activities.  We account forcontingencies such as these in accordance with SFAS No. 5, “Accounting forContingencies.” SFAS No. 5 requires us to record an estimated losscontingency when information available prior to issuance of our financialstatements indicates that it is probable that an asset has been impaired or aliability has been incurred at the date of the financial statements and theamount of the loss can be reasonably estimated. An interpretation of SFAS No. 5 further states that when there is arange of loss and no amount within that range is a better estimate than anyother, then the minimum amount of the range shall be accrued.  Accounting for contingencies arising fromcontractual or legal proceedings requires company management, after consultationwith outside legal counsel, to use its best judgment when estimating an accrualrelated to such contingencies.  Asadditional information becomes known, our accrual for a loss contingency couldfluctuate, thereby creating variability in our results of operations fromperiod to period.  Likewise, an actualloss arising from a loss contingency which significantly exceeds the amountaccrued for in our financial statements could have a material adverse impact onour operating results for the period in which such actual loss becomes known.

 

26

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**Resultsof Operations**

** **

Thefollowing table sets forth certain operating data from our consolidatedstatements of operations as a percentage of net sales and as a percentagechange for the periods indicated:

 
| ** **                                    | ** ** | **% of Net Sales (1)** | ** ** | **% Increase (Decrease)**     | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                    | ** ** | **Year ended  September 30,**    | ** ** | **Year ended  September 30,** | ** ** |
| ** **                                    | ** ** | **2004**                                   | ** ** | **2003**                                | ** ** | **2002** | ** ** | **2004  vs. 2003** | ** ** | **2003  vs. 2002** | ** ** |
| ** **                                    | ** ** | **(Restated)**                             | ** ** | **(Restated)**                          | ** ** |
| Net sales                                     |       | 100.0                                      | %          | 100.0                                   | %          | 100.0 | % | 5.2 | % | 8.7 | % |
| Cost of  goods sold                           |       | 46.3                                       |       | 45.7                                    |       | 46.7 |   | 6.4 |   | 6.4 |   |
| Gross profit                                  |       | 53.7                                       |       | 54.3                                    |       | 53.3 |   | 4.2 |   | 10.7 |   |
| Selling,  general and administrative expenses |       | 49.3                                       |       | 47.0                                    |       | 46.0 |   | 10.3 |   | 11.0 |   |
| Operating  income                             |       | 4.5                                        |       | 7.3                                     |       | 7.3 |   | (35.4 | ) | 8.7 |   |
| Interest  expense, net                        |       | 2.9                                        |       | 2.9                                     |       | 3.6 |   | 2.0 |   | (12.2 | ) |
| Income  before income taxes                   |       | 1.6                                        |       | 4.4                                     |       | 3.7 |   | (60.5 | ) | 29.3 |   |
| Income tax  provision                         |       | 0.7                                        |       | 1.7                                     |       | 1.4 |   | (58.4 | ) | 33.0 |   |
| Net income                                    |       | 1.0                                        |       | 2.7                                     |       | 2.3 |   | (61.9 | ) | 27.1 |   |
| Dividends on  preferred stock                 |       | —                                     |       | —                                  |       | 0.9 |   | — |   | (100.0 | ) |
| Net income  available to common stockholders  |       | 1.0                                        | %          | 2.7                                     | %          | 1.4 | % | (61.9 | )% | 104.6 | % |

 

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

 

Thefollowing table sets forth certain information regarding the number of ourretail locations, including stores and leased maternity departments for thefiscal years indicated:

 
| ** **                                              | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Retail Locations**                               | ** ** | **Stores**                                  | ** ** | **Leased  Departments** | ** ** | **Total  Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total  Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total  Retail  Locations** | ** ** |
| Beginning of period                                     |       | 851                                         |       | 155 |   | 1,006 |   | 763 |   | 146 |   | 909 |   | 639 |   | 132 |   | 771 |   |
| Acquired iMaternity locations, net of related  closures |       | (14                                         | )          | — |   | (14 | ) | (8 | ) | — |   | (8 | ) | 78 |   | — |   | 78 |   |
| Opened                                                  |       | 93                                          |       | 81 |   | 174 |   | 108 |   | 13 |   | 121 |   | 59 |   | 16 |   | 75 |   |
| Closed                                                  |       | (47                                         | )          | (4 | ) | (51 | ) | (12 | ) | (4 | ) | (16 | ) | (13 | ) | (2 | ) | (15 | ) |
| End of period                                           |       | 883                                         |       | 232 |   | 1,115 |   | 851 |   | 155 |   | 1,006 |   | 763 |   | 146 |   | 909 |   |

 

**YearsEnded September 30, 2004 and 2003**

** **

*Net Sales.  *Our netsales for fiscal 2004 increased by 5.2%, or approximately $25.7 million,to $518.1 million from $492.4 million for fiscal 2003.  Net sales increased primarily from theincremental sales generated by the 32 net stores added during fiscal 2004, aswell as the full year sales impact in fiscal 2004 of the 88 net stores addedduring fiscal 2003, partially offset by a decrease in comparable storesales.  Comparable store sales decreasedby 4.9% during fiscal 2004, based on 765 retail locations, versus a comparablestore sales increase of 0.3% during fiscal 2003, based on 702 retail locations.  The decrease in comparable store sales infiscal 2004 reflected the impact of increased competition in the maternityapparel market and some weakness in the fashion portion of our product lineearlier in the year.  We estimate thatthere are over 1,000 more competitor locations at the end of fiscal 2004compared to the end of fiscal 2003.  Webelieve this increased competition caused an oversupply of maternity apparel inthe market and that

 

27

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theincreasingly deep markdowns taken by our competitors to stimulate sales andclear seasonal inventories further adversely affected our net sales for thesecond half of fiscal 2004.

 

Asof September 30, 2004, we operated a total of 883 stores and 1,115 totalretail locations: 717 Motherhood Maternity stores (including 106 MotherhoodMaternity Outlet stores), 121 Mimi Maternity stores, 41 A Pea inthe Pod stores, four Destination Maternity superstores, and 232 leasedmaternity departments, of which 71 were in Sears® stores and the balance wereprimarily under the Motherhood brand. In comparison, as of September 30,2003, we had 1,006 total retail locations: 688 Motherhood Maternity stores(including 104 Motherhood Maternity Outlet stores), 113 Mimi Maternity stores,44 A Pea in the Pod stores and 155 leased departments.  As of September 30, 2004, our storetotal included 35 multi-brand stores, including four Destination Maternitysuperstores, with the remaining multi-brand stores predominantly under the MimiMaternity brand. In comparison, as of September 30, 2003, we operated 6multi-brand stores.  These multi-brandstore figures for fiscal 2004 and fiscal 2003 exclude our A Pea in the Podstores, which have traditionally carried a full line of both A Pea in the Podand Mimi branded merchandise.  During fiscal2004, we opened 93 stores, including 22 multi-brand stores, and closed 61stores, with 38 of these store closings related to multi-brand store openings,including the opening of our first four Destination Maternity superstores.  In addition, during fiscal 2004, the Companyopened 81 leased department locations and closed four leased departmentlocations, with the openings predominantly coming from the exclusiveintroduction of our new Two Hearts Maternity collection in 71 Sears® stores toreplace the existing maternity lines in these stores.

 

*Gross Profit.  *Our grossprofit for fiscal 2004 increased by 4.2%, or approximately $11.1 million,to $278.4 million compared to $267.3 million for fiscal 2003,reflecting the increase in net sales, partially offset by a decrease in grossprofit margin.  Gross profit as apercentage of net sales was 53.7% for fiscal 2004, compared to 54.3% for fiscal2003.  The 52 basis points (0.52 percentagepoints of net sales) decrease in gross margin compared to last year primarilyreflects the increased markdowns recognized in fiscal 2004 compared to fiscal2003.

 

*Selling, General andAdministrative Expenses.  *Our selling,general and administrative expenses for fiscal 2004 increased by 10.3%, orapproximately $24.0 million, to $255.2 million from$231.2 million for fiscal 2003. Compared to fiscal 2003, store rent and related expenses increased by$12.1 million and store wages and related benefits costs increased by $7.1 million,primarily resulting from our new store openings.  As a percentage of net sales, selling,general and administrative expenses increased to 49.3% for fiscal 2004 comparedto 47.0% for fiscal 2003, primarily reflecting an increased store occupancyexpense ratio and, to a lesser extent, increased store payroll expense ratiosresulting from the 4.9% decrease in comparable store sales for the year,partially offset by a lower legal expense and employee benefits expenseratios.  In addition, we incurred chargesrelating to store closings of $1.8 million for fiscal 2004 versus $0.3 millionfor fiscal 2003.

 

*Operating Income.  *Ouroperating income for fiscal 2004 decreased by 35.4%, or $12.7 million, to$23.3 million from $36.0 million for fiscal 2003, due to our higherselling, general and administrative expenses, and lower gross margin, whichmore than offset the impact of increased sales volume.  Operating income as a percentage of net salesfor fiscal 2004 decreased to 4.5% from 7.3% for fiscal 2003, reflecting the increasedselling, general and administrative expense ratio and, to a much lesser extent,decreased gross margin.

 

*Interest Expense,Net.  *Our netinterest expense for fiscal 2004 increased by 2.0%, or $0.3 million, to$14.8 million from $14.5 million in fiscal 2003.  The increase in interest expense for fiscal2004 is primarily related to the impact in fiscal 2003 of a $0.3 millionnon-recurring interest expense credit related to our credit facility.  During fiscal 2004 and fiscal 2003, we didnot have any direct borrowings under our credit facility.

 

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*Income Taxes.  *Oureffective tax rate was a provision of 40.8% in fiscal 2004, compared to 38.7%in fiscal 2003, reflecting an increase in our composite estimated effectivestate income tax rate.  See Note 13of the Notes to Consolidated Financial Statements for the reconciliation of thestatutory federal income tax rate to our effective tax rate.

 

*Net Income Available toCommon Stockholders.  *Net incomeavailable to common stockholders for fiscal 2004 was $5.0 million, or$0.92 per share (diluted), compared to $13.2 million for fiscal 2003, or$2.34 per share (diluted), representing a 61.9% decrease in net income and a60.7% decrease in diluted earnings per share.

 

Theaverage diluted shares outstanding of 5,501,000 shares for fiscal 2004 was 2.6%lower than the 5,646,000 shares outstanding in fiscal 2003.  The decrease in average diluted sharesoutstanding primarily reflects a reduction in the dilutive impact fromoutstanding stock options and our repurchase of shares of our common stockpursuant to our repurchase program, partially offset by the impact of stockoption exercises.  As of September 30,2004, we have repurchased 142,269 shares of our common stock pursuant to ourshare repurchase program, of which 75,715 shares were repurchased during fiscal2004.

 

**YearsEnded September 30, 2003 and 2002**

** **

*Net Sales.  *Our netsales for fiscal 2003 increased by 8.7%, or approximately $39.2 million,to $492.4 million from $453.2 million for fiscal 2002.  Comparable store sales increased by 0.3%during fiscal 2003, based on 702 retail locations, versus a comparable storesales increase of 2.2% during fiscal 2002, based on 653 retail locations.  The increase in sales for fiscal 2003resulted primarily from the incremental revenues generated by the 97 net retaillocations added during fiscal 2003, as well as the full year sales impact infiscal 2003 of the 138 net retail locations added during fiscal 2002.  The relatively flat comparable store sales infiscal 2003 reflected the continued difficult retail environment during theperiod, some cannibalization impact on our existing stores by our new storesopened in the same geographic markets and, perhaps, the effect of increasedcompetitive pressures in the maternity apparel market.

 

Asof September 30, 2003, we operated a total of 851 stores and 1,006 totalretail locations: 688 Motherhood Maternity stores (including 104 MotherhoodMaternity Outlet stores), 119 Mimi Maternity stores, 44 A Pea inthe Pod and 155 leased maternity departments, primarily under theMotherhood brand.  In comparison, as of September 30,2002, we had 763 stores and 909 total retail locations: 616 MotherhoodMaternity stores (including 92 Motherhood Maternity Outlet stores), 104 MimiMaternity stores, 43 A Pea in the Pod stores, and 146 leaseddepartments, primarily under the Motherhood brand.  For theyear ended September 30, 2003, we opened 108 new stores and closed 20stores, including eight iMaternity stores closed in connection with the consolidationof that acquired store chain.  As of September 30,2003, we had closed a total of 96 of the 166 acquired iMaternity stores wherewe believed we could transfer a sufficient portion of the sales to our existingstores within the same area while eliminating acquired store expenses andimproving inventory utilization. In addition, during fiscal 2003, we opened 13 leased departmentlocations and closed four leased department locations.

 

*Gross Profit.  *Our grossprofit for fiscal 2003 increased by 10.7%, or $25.8 million, to$267.3 million from $241.5 million for fiscal 2002, due to increasednet sales and improved gross margin compared to fiscal 2002.  Gross profit as a percentage of net sales forfiscal 2003 increased by 98 basis points (0.98 percentage points of net sales)to 54.3% from 53.3% for fiscal 2002.  Theincrease in gross margin versus fiscal 2002 primarily reflects the reduction ofour product costs as a result of the continued expansion and refinement of ourglobal sourcing initiatives, partially offset by additional markdowns taken tomanage inventory levels in the face of weaker than expected sales.

 

*Selling, General andAdministrative Expenses.  *Our selling,general and administrative expenses for fiscal 2003 increased by 11.0%, or$22.9 million, to $231.2 million from $208.3 million for fiscal2002.  Compared to fiscal 2002, storewages and related benefits costs increased by $7.9 million and store rent

 

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andrelated expenses increased by $8.5 million, primarily resulting from ournew store openings and increased medical benefits expenses.  As a percentage of net sales, selling,general and administrative expenses increased to 47.0% for fiscal 2003 comparedto 46.0% for fiscal 2002, primarily reflecting increased store occupancy, store payroll, and employee benefits expenseratios resulting from the essentially flat comparable store sales for the year,the planned higher store expense ratios of our new store openings, andincreases in health insurance costs, as well as a legal expense charge of$0.9 million related to employment-related litigation in California andWashington that was settled in fiscal 2003.

 

*Operating Income.  *Ouroperating income for fiscal 2003 increased by 8.7%, or $2.9 million, to$36.0 million from $33.1 million for fiscal 2002, due to our higher salesvolume and improved gross margin and additional revenue generated by our opt-incustomer database and related marketing partnership programs, partially offsetby higher operating expenses.  Operatingincome as a percentage of net sales remained relatively constant at 7.3% forboth fiscal 2003 and 2002, with our increased gross margin offset by a higheroperating expense ratio.

 

*Interest Expense,Net.  *Our net interestexpense for fiscal 2003 decreased by 12.2%, or $2.0 million, to$14.5 million from $16.5 million in fiscal 2002.  The decrease in interest expense for fiscal2003 is due to the $2.5 million loss on early extinguishment of debtincluded in interest expense for fiscal 2002, related to our fiscal 2002refinancing, partially offset by a somewhat higher overall debt balancecompared to the prior year due to the net impact of the refinancing.  In fiscal 2003, we adopted the provisions ofSFAS No. 145, which require, effective in fiscal years beginningafter May 15, 2002, the reclassification of certain gains or losses onextinguishment of debt that were previously classified as an extraordinary itemin prior periods.  Accordingly, wereclassified the $1.6 million extraordinary loss on early extinguishmentof debt, net of tax, as reported for fiscal 2002 related to our fourth quarterfiscal 2002 refinancing, to a $2.5 million increase in interest expenseand a related $0.9 million reduction in our income tax provision, whichhad no impact on reported net income.  Infiscal 2002, prior to the adoption of SFAS No. 145, we had reportedinterest expense for fiscal 2002 of $14.0 million.  During fiscal 2003, we did not have anydirect borrowings under our credit facility.

 

*Income Taxes.  *Oureffective tax rate increased to 38.7% in fiscal 2003 from 37.6% in fiscal 2002primarily due to an increase in our composite estimated effective state incometax rate.  See Note 13 of the Notesto Consolidated Financial Statements for the reconciliation of the statutoryfederal income tax rate to our effective tax rate.

 

*Dividends on PreferredStock.  *We had nopreferred stock dividends during fiscal 2003, compared to $3.9 million forfiscal 2002, reflecting the redemption of our Series A Preferred Stock andrepurchase of our Series C Preferred Stock in the fourth quarter of fiscal2002 using the proceeds of our debt and common equity offerings.

 

*Net Income Available toCommon Stockholders.  *Net incomeavailable to common stockholders for fiscal 2003 was $13.2 million, or $2.34per share (diluted), compared to $6.5 million for fiscal 2002, or $1.52 pershare (diluted), representing a 104.6% increase in net income available tocommon stockholders and a 53.9% increase in diluted earnings per share.

 

Duringthe fourth quarter of fiscal 2002, we repurchased our outstanding 125/8% seniornotes and our Series A and Series C Preferred Stock with the proceedsfrom the issuance of new 111⁄4% senior notes and 1,165,000 new shares of commonstock. In connection with this refinancing, we incurred certain one-timecharges, related to the early repayment of the 125/8% seniornotes and the repurchase of the Series A and Series C PreferredStock.  These one-time charges totaledapproximately $3.0 million, which included approximately $2.6 millionof non-cash charges and reduced diluted earnings per common share for fiscal2002 by approximately $0.71.  On a proforma basis, excluding the impact of the $3.0 million of one-time charges,fiscal 2002 net income available to common stockholders was $9.5 million,or $2.23 per common share (diluted).  Wehave presented this pro forma earnings figure because we believe it enhancesthe

 

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reader’sunderstanding of our fiscal 2002 operating results by adjusting for theone-time charges related to the refinancing.

 

**Reconciliationof Fiscal 2002 Earnings Per Share and Pro Forma Earnings Per Share**

** **

**(inthousands, except per share data)**

** **

**(unaudited)**

** **
| ** **                                                                                      | ** ** | **Fiscal Year Ended  September 30, 2002** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **Net Income**                                           | ** ** | **Average  Shares  Outstanding** | ** ** | **Diluted  Income Per  Share** | ** ** |
| ** **                                                                                      | ** ** | **(Restated)**                                                | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| **Pro  Forma Adjusted for One-Time Charges Related to Fourth Quarter Fiscal 2002  Refinancing** |       |                                                          |       |   |   |   |   |
| As  reported—Diluted                                                                       |       | $                                                             | 6,458      |   | 4,261 |   | $ | 1.52 |   |
| Pro forma  adjustments to add back—                                                        |       |                                                          |       |   |   |   |   |
| Loss on  early extinguishment of debt, reported as interest expense                             |       | 2,515                                                         |       | — |   | 0.59 |   |
| Write-off of  discount on Series C Preferred Stock                                         |       | 1,310                                                         |       | — |   | 0.30 |   |
| Duplicative  interest expense and dividends                                                     |       | 131                                                           |       | — |   | 0.03 |   |
| Tax effect  of adjustments                                                                      |       | (908                                                          | )          | — |   | (0.21 | ) |
| Total  one-time charges related to the refinancing                                              |       | 3,048                                                         |       | — |   | 0.71 |   |
| Pro forma  adjusted for one-time charges related to the refinancing                             |       | $                                                             | 9,506      |   | 4,261 |   | $ | 2.23 |   |

 

Netincome for fiscal 2002 was favorably impacted by our adoption, as of October 1,2001, of the provisions of SFAS No. 142, which requires that goodwillno longer be amortized.  Through theapplication of the provisions of this statement, we showed improved earnings asa result of not recognizing any goodwill amortization in fiscal 2002, comparedto recognizing $2.2 million ($0.61 per diluted common share) of goodwillamortization in fiscal 2001.

 

**Liquidityand Capital Resources**

** **

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

 

InAugust 2002, we completed debt and equity offerings whereby we issued$125.0 million of 111⁄4% senior notes due 2010 (the “New Senior Notes”) and1,165,000 new shares of common stock (including the full exercise of theover-allotment option by the underwriters of our common stock offering), andused the net proceeds therefrom: (i) to repay the existing 125/8% seniornotes (the “Old Senior Notes”), plus accrued and unpaid interest and relatedfees and expenses; (ii) to repay our subordinated notes issued to formerholders of shares of our Series A Preferred Stock in lieu of accrued andunpaid dividends; (iii) to redeem all of the outstanding shares of our Series APreferred Stock and to purchase, through an offer to purchase, all of theoutstanding shares of our Series C Preferred Stock, in each case, for aprice which included all accrued and unpaid dividends; (iv) to repay theoutstanding borrowings under our credit facility and (v) for generalcorporate purposes.

 

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Wereceived net proceeds from these debt and equity offerings of approximately$147.9 million after deducting fees and expenses of the offerings.  We used approximately $92.7 million ofthe net proceeds of the offerings for the repurchase of our Old Senior Notes,including accrued and unpaid interest and related fees and expenses.  We used approximately $2.6 million forthe repayment of subordinated notes that had been issued in lieu of cashdividends on shares of Series A Preferred Stock previously converted intocommon stock.  We used approximately$13.4 million to redeem all of the outstanding Series A PreferredStock, including accrued and unpaid dividends, of which $12.4 million has beenpaid as of September 30, 2004, and $1.0 million will be paid out uponsubmission of proper documentation from the remaining holders of the Series APreferred Stock.  The remaining$1.0 million amount is reflected in our consolidated balance sheet as of September 30,2004 in accrued expenses and other current liabilities.  We used approximately $20.9 million ofthe net proceeds from the offerings for the repurchase of the Series CPreferred Stock issued to the sellers of iMaternity in October 2001,including accrued and unpaid dividends. The remaining $18.3 million of net proceeds from the offerings wereused to repay all of the outstanding borrowings under our credit facility, withthe balance invested in short-term investments and available for generalcorporate purposes.  The net proceeds ofapproximately $147.9 million from the debt and equity offerings includesapproximately $0.6 million of cash proceeds from the exercise of stockoptions by certain selling stockholders in conjunction with the equityoffering.

 

TheNew Senior Notes were issued at 98.719% of their face amount, resulting in anannual effective interest rate of 11.50%. Interest on the New Senior Notes is payable semi-annually in cash on February 1and August 1, commencing on February 1, 2003.  The New Senior Notes were issued by MothersWork, are senior unsecured obligations of Mothers Work and are unconditionallyguaranteed on a senior basis by all of our domestic subsidiaries.  See Note 15 of the Notes to ConsolidatedFinancial Statements.  The New SeniorNotes are redeemable at our option, in whole or in part at any time on or afterAugust 1, 2006 at 105.625% of their face amount, plus accrued and unpaidinterest, declining ratably to 100% of their face amount, plus accrued andunpaid interest, on or after August 1, 2009.  Additionally, before August 1, 2005, wemay redeem, at our option, up to 35% of the aggregate principal amount of theNew Senior Notes with the proceeds from equity offerings at 111.25% of theirprincipal amount, plus accrued and unpaid interest.  The New Senior Notes impose certainrestrictions on our ability to, among other things, incur additionalindebtedness, pay dividends, repurchase stock, and enter into other varioustypes of transactions.

 

Cashand cash equivalents decreased by $7.3 million during fiscal 2004 comparedto an increase of $9.3 million during fiscal 2003.  Cash provided by operations of $18.3 millionfor fiscal 2004 decreased by approximately $17.8 million from$36.1 million for fiscal 2003.  Thisdecrease was primarily the result of decreased net income, as well as greateruse of cash for operating working capital compared to fiscal 2003.  During fiscal 2004, we utilized our cash flowfrom operations to pay for the predominant portion of our capitalexpenditures.  During fiscal 2003, weutilized our cash flow from operations primarily to pay for our capitalexpenditures and to increase our cash and cash equivalents.

 

Forfiscal 2004, we spent $21.5 million on capital expenditures, including$18.1 million for leasehold improvements, fixtures and equipmentprincipally for new store facilities, as well as improvements to existingstores, and $3.4 million for our distribution and corporate facilities andinformation systems.  This compares to$25.3 million in capital expenditures for fiscal 2003, of which$19.7 million was spent for new store facilities and improvement toexisting stores and retail locations, and $5.6 million for ourdistribution and corporate facilities and information systems.  The decrease in capital expenditures was dueto reduced expenditures for store remodeling, relocations and expansions,compared to last year, and the completion last year of several projectsrelating to expanding the capacity and throughput of our distribution centerand the rollout of our new proprietary point-of-sale system to our stores.

 

InMarch 2003, our Board of Directors approved a share repurchase programunder which we may repurchase up to $10.0 million of our outstandingcommon stock from time to time in private transactions or open market purchasesuntil March 2005.  As of September 30,2004, we have repurchased and retired

 

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142,269shares in the aggregate pursuant to this program at a total cost ofapproximately $3.2 million, at an average cost of $22.79 per share,including repurchases during fiscal 2004 of 75,515 shares of common stock at acost of $1.8 million.  The indenturegoverning the New Senior Notes and the terms of both our new and previouscredit facilities contain restrictions that place limits on certain payments byus, including payments to repurchase shares of our common stock.  Our repurchases of common stock have beenmade in compliance with all restrictions under the indenture governing the NewSenior Notes and the terms of both our new and old credit facilities.

 

OnOctober 15, 2004, we entered into a new five-year $60.0 million seniorsecured revolving credit facility (the “New Credit Facility”) which replacedour former $60 million credit facility. The New Credit Facility will mature on October 15, 2009.  Upon our request and with the consent of thelender, permitted borrowings under the New Credit Facility may be increased upto an additional $15.0 million, in increments of $2.5 million,****up to a maximum limit of $75.0 million.  Proceeds from advances under the New CreditFacility, with certain restrictions, may be used to provide financing forworking capital, letters of credit, capital expenditures, debt prepayments,dividends, share repurchases and other general corporate purposes.  We paid certain closing fees in connectionwith the negotiation and execution of the New Credit Facility.  We also pay an unused line fee under the NewCredit Facility and certain early termination fees if the New Credit Facilityis terminated prior to its third anniversary. The New Credit Facility contains various affirmative and negativecovenants and representations and warranties. There are no financial covenantrequirements under the New Credit Facility unless either (i) Excess Availability (as defined in the agreement)falls below $10 million, or (ii) average Financial Covenant AdjustedAvailability (as defined in the agreement) for any calendar month is less than$15 million.  If either of the events initem (i) or (ii) above occurs, we would be required to meet a certainminimum fixed charge coverage ratio (which increases from 1.00x during thefirst two years of the New Credit Facility to 1.10x during the fifth year ofthe New Credit Facility).  The New Credit Facility is secured by a security interest in our accountsreceivable, inventory, real estate interests, letter of credit rights, cash,intangibles and certain other assets. The interest rate on outstanding borrowings is equal to, at ourelection, either the lender’s prime rate or the lender’s LIBOR rate plus theapplicable margin.  The applicable marginfor LIBOR rate borrowings is variable, ranging from 1.25% to 1.75%, based uponthe availability calculation made in accordance with the agreement.  Any amounts outstanding under the NewCredit Facility may be accelerated and become due and payable immediately andall loan and letter of credit commitments thereunder may be terminated upon anevent of default and expiration of any applicable cure period.  Events of default include: (i) nonpaymentof obligations due under the New Credit Facility; (ii) failure to performany covenant or agreement contained in the New Credit Facility; (iii) materialmisrepresentations; (iv) failure to pay, or certain other defaults underother material indebtedness; (v) certain bankruptcy or insolvency events; (vi) achange of control, (vii) material uninsured losses; (viii) indictmentsof us or senior management in a material forfeiture action; and (ix) customaryERISA defaults, among others.

 

Theletter of credit obligations that were in place under the former creditfacility and the special purpose letter of credit facility are now governed bythe terms of the New Credit Facility. Such letter of credit obligations totaled $6.9 million as of September 30,2004.

 

Priorto entering into the New Credit Facility, we had a $60 million creditfacility maturing on September 15, 2005, which included a$56.0 million borrowing base revolving line of credit and approximately$4 million to support a special purpose letter of credit facility.  Amounts available for direct borrowings, netof letters of credit outstanding, were limited to the lesser of (a) theunused portion of the credit facility or (b) the Aggregate AdjustedAvailability (“AAA”) as defined in the agreement based on a percentage ofeligible inventory, receivables and cash. The credit facility was secured by a security interest in our accountsreceivable, inventory, equipment, fixtures, cash and other assets.  There were no financial covenant requirementsin the agreement unless the AAA fell below $10 million.  In such event, we would

 

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havehad to achieve minimum cash flow, as defined in the agreement, of not less thanzero.  During fiscal 2004, 2003 and 2002,we always exceeded the minimum required AAA.

 

Asof September 30, 2004, outstanding borrowings under the credit facilityconsisted of no direct borrowings and $3.7 million in letters of creditwith AAA and available borrowings of $52.3 million, compared to no directborrowings and $3.9 million in letters of credit with AAA and availableborrowings of $52.1 million as of September 30, 2003.  In addition, pursuant to the special purposeletter of credit facility, as of September 30, 2004 and 2003, we had anoutstanding standby letter of credit of $3.1 million and$3.3 million, respectively, to collateralize an outstanding industrialrevenue bond.  As of September 30,2003, we had a $1.0 million letter of credit to collateralize a governmentmortgage note; this letter of credit was subsequently cancelled during fiscal2004.  Borrowings under the creditfacility as of September 30, 2004 would have borne interest at the rate ofbetween approximately 3.9% and 4.8% per annum. We had no direct borrowings under the credit facility during fiscal 2004or 2003.  We expect that we may haveborrowings under our New Credit Facility during certain periods of fiscal 2005,reflecting seasonal fluctuations in cash flow.

 

Ourmanagement believes that our current cash and working capital positions,expected operating 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.

 

**ContractualObligations and Commercial Commitments**

** **

Wehave entered into agreements that create contractual obligations and commercialcommitments.  These obligations andcommitments will have an impact on future liquidity and the availability ofcapital resources.  The tables below setforth a summary of these obligations and commitments as of September 30,2004 (in thousands):

 

*ContractualObligations:*

 
| ** **                          | ** ** | ** **             | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------|------------|
| **Description**                     | ** ** | **Total  Obligations** | ** ** | **Less  Than One  Year**             | ** ** | **One  to Three  Years** | ** ** | **Three  to Five  Years** | ** ** | **After  Five  Years** | ** ** |
| Long-term  debt                     |       | $                      | 129,216    |                                      | $          | 288 |   | $ | 611 |   | $ | 659 |   | $ | 127,658 |   |
| Operating  leases (1)          |       | 319,365                |       | 52,618                                    |       | 93,490 |   | 76,879 |   | 96,378 |   |
| Capital  lease obligations          |       | —                 |       | —                                    |       | — |   | — |   | — |   |
| Purchase  obligations (2)           |       | —                 |       | —                                    |       | — |   | — |   | — |   |
| Total  contractual cash obligations |       | $                      | 448,581    |                                      | $          | 52,906 |   | $ | 94,101 |   | $ | 77,538 |   | $ | 224,036 |   |

 

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(1)             Includesstore operating leases, which generally provide for payment of direct operatingcosts in addition to rent.  The amountsreflected include future minimum lease payments and exclude such directoperating costs.

 

(2)             Our purchaseorders with contract manufacturers are cancelable by us at any time prior toour acceptance of the merchandise. Excludes purchase orders for supplies in the normal course of business.

 

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*CommercialCommitments:*

 
| ** **                       | ** ** | ** **             | ** ** | **Amount of Commitment Per Period** | ** ** |
|----------------------------------|------------|------------------------|------------|---------------------------------------------------------|------------|
| **Description**                  | ** ** | **Total  Obligations** | ** ** | **Less  Than One  Year**                           | ** ** | **One  to Three  Years** | ** ** | **Three  to Five  Years** | ** ** | **After  Five  Years** | ** ** |
| Credit  facility (1)        |       | $                      | 3,740      |                                                    | $          | 3,740 |   | $ | — |   | $ | — |   | $ | — |   |
| Other  standby letters of credit |       | 3,149                  |       | 3,149                                                   |       | — |   | — |   | — |   |
| Total  commercial commitments    |       | $                      | 6,889      |                                                    | $          | 6,889 |   | $ | — |   | $ | — |   | $ | — |   |

 

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(1)             Consists ofoutstanding letter of credit commitments.

 

**NewAccounting Pronouncements**

** **

*FASBExposure Draft*

* *

OnMarch 31, 2004, the FASB issued its exposure draft, “Share-Based Payment,”which is a proposed amendment to SFAS No. 123, “Accounting for Stock-BasedCompensation.”  Generally, the approachin the exposure draft is similar to the approach described in SFAS No. 123.  However, the exposure draft would require allshare-based payments to employees, including grants of employee stock options,to be recognized in our statement of operations based on their fairvalues.  There are a number of issuesthat are not resolved in the exposure draft, including the final methodologyfor calculating fair value.  The FASBexpects to issue a final standard in the near future that would be effectivefor interim and annual periods beginning after June 15, 2005.  The pro forma impact of the adoption of SFAS No. 123on our historical financial statements is included in Note 2 of the Notes toConsolidated Financial Statements.  Weexpect to continue to grant stock-based compensation to employees.  The impact of the new standard, when and ifissued, may have a material adverse impact on our future results of operations.

 

**Inflation**

** **

Wedo not believe that the relatively moderate levels of inflation which have beenexperienced in the United States in recent years have had a significant effecton our net sales or profitability. However, there can be no assurance that our business will not be affectedby inflation in the future.

 

**Forward-LookingStatements**

** **

Someof the information in this report, including the information incorporated byreference (as well as information included in oral statements or other writtenstatements made or to be made by us), contains forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended (the “Exchange Act”).  Theforward-looking statements 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 limited to: the success of our newbusiness initiatives, future sales trends in our existing store base, changesin consumer spending patterns, raw material price increases, consumerpreferences and overall economic conditions, the impact of competition andpricing, availability of suitable store locations, continued availability ofcapital and financing, ability to hire and develop senior management and salesassociates, ability to develop and source merchandise, ability to receiveproduction from foreign sources on a timely basis, potential stock repurchases,potential debt repurchases, war or acts of terrorism and other factorsreferenced in this report, including those set forth under the caption “RiskFactors.”

 

Inaddition, these forward-looking statements necessarily depend upon assumptions,estimates and dates that may be incorrect or imprecise and involve known andunknown risks, uncertainties and other

 

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factors.  Accordingly, any forward-looking statementsincluded in this report do not purport to be predictions of future events orcircumstances and may not be realized. Forward-looking statements can be identified by, among other things, theuse of forward-looking terms such as “believes,” “expects,” “may,” “will,”“should,” “seeks,” “pro forma,” “anticipates,” “intends,” “continues,” “could,”“estimates,” “plans,” “potential,” “predicts,” “goal,” “objective,” or thenegative of any of these terms, or comparable terminology, or by discussions ofour outlook, plans, goals, strategy or intentions.  Forward-looking statements speak only as ofthe date made.  We assume no obligationto update any of these forward-looking statements to reflect actual results,changes in assumptions or changes in other factors affecting theseforward-looking statements.

 

**RiskFactors**

** **

***Wemay not be successful in expanding our business and opening new stores.***

*** ***

Anyfuture growth depends significantly on our ability to successfully open andoperate new stores (including combination stores and superstores) on aprofitable basis.  This expansion, if itoccurs, will place increased demands on our management, operational andadministrative resources.  Theseincreased demands and operating complexities could cause us to operate ourbusiness less effectively, which, in turn, could cause a deterioration in thefinancial performance of our stores and slow our new store growth.  Our planned expansion will also require thatwe continually monitor and upgrade our management information and othersystems, as well as our distribution infrastructure.

 

Ourability to open and operate new stores successfully depends on many factors,including, among others, our ability to:

 

•       identify andobtain suitable store locations, including mall locations, the availability ofwhich is outside of our control;

 

•       negotiatefavorable lease terms, including desired tenant improvement allowances;

 

•       negotiatefavorable lease terminations for existing store locations in markets where weintend to open new combination stores or superstores;

 

•       sourcesufficient levels of inventory to meet the needs of new stores;

 

•       successfullyaddress competition, merchandising and distribution challenges; and

 

•       hire, trainand retain a sufficient number of qualified store personnel.

 

Therecan be no assurance that we will be able to achieve our store expansiongoals.  Even if we succeed in opening newstores as planned, we cannot assure you that our newly opened stores willachieve planned revenue or profitability levels in the time periods estimatedby us, or at all.  If our stores fail toachieve or are unable to sustain acceptable revenue and profitability levels,we may incur significant costs associated with operating or closing thosestores.

 

***Ourcomparable store sales and quarterly operating results have fluctuated in thepast and can be expected to continue to fluctuate in the future.***

*** ***

Ourcomparable store sales and quarterly results of operations have fluctuated inthe past and can be expected to continue to fluctuate in the future and areaffected by a variety of factors, including:

 

•                    the openingof new stores, the relative proportion of new stores to mature stores and theexpansion of stores;

 

•                    the timingof new store openings;

 

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•                    the extentof cannibalization of sales volume of some of our existing stores by our newstores opened in the same geographic markets;

 

•                    changes inour merchandise mix;

 

•                    the pricerepositioning of our Mimi brand to the middle market price segment;

 

•                    generaleconomic conditions and, in particular, the retail sales environment;

 

•                    calendarshifts, including shifts of holiday or seasonal periods, or shifts in thenumber of weekend days occurring in a given month;

 

•                    pregnancyrates;

 

•                    actions ofcompetitors;

 

•                    mall anchortenants;

 

•                    fashiontrends; and

 

•                    weatherconditions.

 

If,at any time, our comparable store sales or quarterly results of operationsdecline or do not meet the expectations of Wall Street research analysts, theprice of our common stock could decline substantially.

 

***Ourmarket share may be adversely impacted at any time by a significant number ofcompetitors.***

*** ***

Weoperate in a highly competitive environment characterized by low barriers toentry.  We compete against departmentstores, specialty retail chains, discount stores, independent retail stores andcatalog and Internet-based retailers, including both new and existingcompetitors.  Many of our competitors arelarger and have substantially greater financial and other resources thanus.  Further, we do not typicallyadvertise using television and radio media and thus do not reach customersthrough means our competitors may use. Our mid- and luxury-priced merchandise faces a highly fragmentedcompetitive landscape that includes locally based, single unit retailers, aswell as a handful of multi-unit maternity operations, none of which we believehave more than 15 stores nationwide.  Inthe value-priced maternity apparel business, we face competition on anationwide basis from retailers such as Fashion Bug®, GAP®, JC Penney®, Kmart®,Kohl’s®, Old Navy®, Target®, Sears® and Wal-Mart®. Several of thesecompetitors, including Gap® and Old Navy®, also sell maternity apparel on theirwebsites.  There has been increased competitionin the maternity apparel industry, from both new and existing competition.  We currently face maternity competition inover 1,000 more competitor locations than a year ago.  Our market share and results of operationsmay be materially and adversely affected by this competition, including thepotential for increased competition in the future.  While we have competed with both Sears andKohl’s in the past, our relationship with both of them is now changing.  We will be expanding our Two Hearts Maternitycollection to a total of approximately 645 Sears stores in March 2005under a leased department arrangement. In February 2005, we will launch our Oh Baby!by Motherhood collection at Kohl’s stores throughout the United States andon Kohls.com, available exclusively at Kohl’s under a product and licenseagreement.

 

***Theexpansion of our leased/licensed relationships with third-party retailers maynot be successful.***

*** ***

Anunsuccessful expansion of our leased department and licensed brand businesseswith third-party retailers such as Sears® and Kohl’s® (which expansion is setto occur during the upcoming fiscal year) would have a material adverse effecton our results of operations.  Thisexpansion will place increased demands on our management, operational andadministrative resources.  Theseincreased demands and operating complexities could cause us to operate ourbusiness less effectively, which, in turn, could slow or

 

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terminatethe growth of our leased department and licensed brand businesses.  Our planned expansion will also require thatwe continually monitor and upgrade our management information and othersystems, as well as our distribution infrastructure.  Our failure to properly manage our leased departmentsand licensed brand businesses (including any failure by us in timely deliveringgoods to any third party retailer) would have a direct impact on theprofitability and continuation of these relationships.

 

***Werequire a significant amount of cash to service our indebtedness, which reducesthe cash available to finance any growth.***

*** ***

Wehave a significant amount of indebtedness. As of September 30, 2004, our total indebtedness, including currentmaturities, was $129.2 million, and we had the ability to borrow anadditional $52.3 million under our then existing credit facility.  Our required interest payments under our NewSenior Notes are expected to be approximately $14.1 million for each offiscal 2005 and 2006.

 

Ourability to make required payments on our indebtedness, as well as to fund ouroperations and future growth, depends upon our ability to generate cash.  Our success in generating cash depends uponthe results of our operations, as well as upon general economic, financial,competitive and other factors beyond our control.

 

Ourindebtedness could, among other things:

 

•                    make us morevulnerable to unfavorable economic conditions;

 

•                    make it moredifficult for us to open new stores or improve or expand existing stores;

 

•                    restrict ourability to pay dividends or make distributions to our stockholders;

 

•                    restrict ourability to incur additional indebtedness;

 

•                    require usto pledge all or substantially all of our assets as collateral to secureindebtedness;

 

•                    make it moredifficult for us to pursue strategic acquisitions, alliances and partnerships;and

 

•                    require usto dedicate or reserve a large portion of our cash flow from operations tomaking payments on our indebtedness, which would prevent us from using cashflow for other purposes.

 

***Weare heavily dependent on our management information systems and our ability tomaintain and upgrade these systems from time to time.***

*** ***

Theefficient operation of our business is heavily dependent on our fullyintegrated, internally developed management information systems.  In particular, we rely on point-of-saleterminals, which provide information to our customized TrendTrack merchandiseanalysis and planning system used to track sales and inventory.  The TrendTrack system helps integrate ourdesign, manufacturing, distribution and financial functions, and also providesdaily financial and merchandising information. As a result, our business and operations could be materially andadversely affected if our systems were inoperable or inaccessible.

 

Fromtime to time, we improve and upgrade our management information systems.  We have rolled out a proprietary, upgradedInternet-based point-of-sale system and integrated this system with our currentsystems.  If we are unable to maintainand upgrade our systems or to integrate new and updated systems in an efficientand timely manner, our business and results of operations could be materiallyand adversely affected.

 

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***Werely significantly on foreign sources of production.***

*** ***

Wereceive apparel and other merchandise from foreign sources, both purchaseddirectly in foreign markets and indirectly through domestic vendors withforeign sources.  To the extent that anyof our vendors are located overseas or rely on overseas sources for a largeportion of their products, any event causing a disruption of imports, includingthe imposition of import restrictions, could harm our ability to sourceproduct.  This disruption could materiallylimit the merchandise that we would have available for sale and reduce ourrevenues and earnings.  The flow ofmerchandise from our vendors could also be adversely affected by financial orpolitical instability, or war, in or affecting any of the countries in whichthe goods we purchase are manufactured or through which they flow.  Trade restrictions in the form of tariffs orquotas, or both, that are applicable to the products that we sell also couldaffect the import of those products and could increase the cost and reduce thesupply of products available to us.  Anymaterial increase in tariff levels, or any material decrease in quota levels oravailable quota allocation, could negatively impact our business.  Further, changes in tariffs or quotas formerchandise imported from individual foreign countries could lead us to shiftour sources of supply among various countries. Any such shift we undertake in the future could result in a disruptionof our sources of supply and lead to a reduction in our revenues andearnings.  Supply chain securityinitiatives undertaken by the U.S. government that impede the normal flow ofproduct could also negatively impact our business.  In addition, decreases in the value of theU.S. dollar against foreign currencies could increase the cost of products thatwe purchase from overseas vendors.

 

***Wecould be materially and adversely affected if our distribution operations weredisrupted.***

*** ***

Tosupport our retail operations in the United States and Canada, we operate ourmain distribution facility in Philadelphia, Pennsylvania and a significantlysmaller Canadian distribution facility in Mississauga, Ontario,respectively.  Finished garments fromcontractors and other manufacturers are inspected and stored for distributionto our stores.  We do not have otherdistribution facilities to support our distribution needs.  If our Philadelphia distribution facility wasto shut down or otherwise become inoperable or inaccessible for any reason, wecould incur significantly higher costs and longer lead times associated with thedistribution of our products to our stores during the time it takes to reopenor replace this facility.  In light ofour strategic emphasis on rapid replenishment as a key competitive advantage, adistribution disruption might have a disproportionately adverse effect on ouroperations and profitability relative to other retailers.  In addition, the loss or material disruptionof service from any of our shippers for any reason, whether due to freightdifficulties, strikes or other difficulties at our principal transportproviders or otherwise, could have a material adverse impact on our businessand results of operations.

 

***Wecould be materially and adversely affected if we are unable to obtainsufficient raw materials or maintain satisfactory manufacturing arrangements.***

*** ***

Wedo not own any manufacturing facilities and therefore depend on third partiesto manufacture our products.  We placeour orders for production of merchandise and raw materials by purchase orderand do not have any long-term contracts with any manufacturer or supplier.  We compete with many other companies forproduction facilities and raw materials. Furthermore, we have received in the past, and may receive in thefuture, shipments of products from manufacturers that fail to conform to ourquality control standards.  In suchevent, unless we are able to obtain replacement products in a timely manner, wemay lose sales.  If we fail to maintainfavorable relationships with these third parties, or if we cannot obtain anadequate supply of quality raw materials on commercially reasonable terms, itcould harm our business and results of operations.

 

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***Ourstores are heavily dependent on the customer traffic generated by shoppingmalls.***

*** ***

Wedepend heavily on locating our stores in prominent locations within successfulshopping malls in order to generate customer traffic.  We cannot control the development of newshopping malls, the availability or cost of appropriate locations withinexisting or new shopping malls or the success of existing or new mall stores.

 

Thesuccess of all of our mall stores will depend, in part, on the ability of eachmall’s anchor tenants, such as large department stores, other tenants and areaattractions to generate consumer traffic in the vicinity of our stores, and thecontinuing popularity of malls as shopping destinations.  Sales volume and mall traffic may beadversely affected by economic downturns in a particular area, the closing ofanchor tenants or competition from non-mall retailers and other malls where wedo not have stores.

 

***Oursuccess depends on our ability to identify and rapidly respond to fashiontrends.***

*** ***

Theapparel industry is subject to rapidly changing fashion trends and shiftingconsumer demands.  Accordingly, oursuccess depends on the priority that our target customers place on fashion andour ability to anticipate, identify and capitalize upon emerging fashiontrends.  Our failure to anticipate,identify or react appropriately to changes in styles or trends could lead to,among other things, excess inventories and higher markdowns, as well as thedecreased appeal of our brands.

 

***Thefailure to retain our existing senior management team or to attract and retainhighly skilled and qualified personnel could adversely affect our business.***

*** ***

Ourbusiness requires disciplined execution at all levels of our organization inorder to timely deliver and display fashionable merchandise in appropriatequantities in our stores.  This executionrequires experienced and talented management. We currently have a management team with a great deal of experience withus and in apparel retailing.  If we wereto lose the benefit of this experience and, in particular, if we were to losethe services of Dan Matthias, our Chairman and Chief Executive Officer, orRebecca Matthias, our President and Chief Operating Officer, our business couldbe materially and adversely affected.

 

Inaddition, as our business expands, we believe that our success will dependgreatly on our continued ability to attract and retain highly skilled andqualified personnel.  There is a highlevel of competition for personnel in the retail industry.  The inability to meet our staffingrequirements in the future at costs that are favorable to us, or at all, couldimpair our ability to increase revenue and could otherwise harm our business.

 

***Ourquarterly operating results and inventory levels may fluctuate significantly asa result of seasonality in our business.***

*** ***

Ourbusiness, like that of other retailers, is seasonal.  Results for any quarter are not necessarilyindicative of the results that may be achieved for a full fiscal year.  Our quarterly net sales have historically beenhighest in our third fiscal quarter, corresponding to the Spring selling season,followed by our first fiscal quarter, corresponding to the Fall/holiday sellingseason.  Given the typically higher grossmargin we experience in the third fiscal quarter compared to other quarters,the relatively fixed nature of most of our operating expenses and interestexpense, and the historically higher sales level in the third quarter, we havetypically generated a very significant percentage of our full year operatingincome and net income during the third quarter. Thus, any factors which result in a material reduction of our sales forthe third quarter could have a material adverse effect on our results ofoperations for the fiscal year as a whole. Seasonal fluctuations in sales also affect our inventory levels, as weusually order merchandise in advance of peak selling periods and sometimesbefore new fashion trends are confirmed by customer purchases.  We must carry a significant amount ofinventory, especially before the holiday and Spring selling periods.  If we are

 

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notsuccessful in selling our inventory during this period, we may be forced torely on markdowns or promotional sales to dispose of the excess inventory or wemay not be able to sell the inventory at all, which could have a materialadverse effect on our business and results of operations.

 

***Ourbusiness depends on sustained demand for maternity clothing and is sensitive toeconomic conditions and consumer spending.***

*** ***

Ourbusiness depends upon sustained demand for maternity clothing.  Our future performance will be subject to anumber of factors beyond our control, including demographic changes.  If demand for maternity clothing were todecline for any reason, such as a decrease in the number of pregnancies, ouroperating results could be adversely affected. In addition, the specialtyapparel retail business historically has been subject to cyclicalvariations.  Consumer purchases ofspecialty apparel products, including maternity wear, may decline duringrecessionary periods and at other times when disposable income is lower.  A prolonged economic downturn could have amaterial adverse impact on our business and results of operations.

 

***Ifan independent manufacturer violates labor or other laws, or is accused ofviolating any such laws, or if their labor practices diverge from thosegenerally accepted as ethical, it could harm our business and brand image.***

*** ***

Whilewe maintain policies and guidelines with respect to labor practices thatindependent manufacturers that produce goods for us are contractually requiredto follow, and while we have an independent firm and company employees inspectcertain manufacturing sites to monitor compliance, we cannot control theactions of such manufacturers or the public’s perceptions of them, nor can weassure that these manufacturers will conduct their businesses using ethical orlegal labor practices.  Apparel companiescan be held jointly liable for the wrongdoings of the manufacturers of theirproducts.  While many of our independentmanufacturers are routinely monitored by buying representatives, who assist usin the areas of compliance, garment quality and delivery, we do not control themanufacturers’ business practices or their employees’ employment conditions,and manufacturers act in their own interest which may be in a manner thatresults in negative public perceptions of us, and/or employee allegationsagainst us or court determinations that we are jointly liable.

 

***Ourearnings would decline if our goodwill becomes impaired.***

*** ***

Asa result of purchase accounting for our various acquisitions, we haveaccumulated a substantial amount of goodwill, amounting to $50.4 millionas of September 30, 2004.  EffectiveOctober 1, 2001, goodwill and other intangible assets with indefinitelives are not amortized, but rather tested for impairment annually.  The impairment test requires us to comparethe fair value of business reporting units to their carrying value, includingassigned goodwill.  The fair value of oursingle reporting unit is determined based on the fair market value of ouroutstanding common stock on a control basis. The factors taken into account in determining the fair market value ofour outstanding common stock on a control basis are: (i) the trading valueof the outstanding common stock on an established public market, and (ii) thepremium over the trading price that an investor would pay for a controlownership interest in the company, as determined through a third partyevaluation.  The carrying value of oursingle reporting unit, expressed on a per share basis, is represented by ourbook value per share of outstanding common stock.  The results of the annual impairment testperformed as of September 30, 2004 indicated the fair value of thereporting unit exceeded its carrying value.  At September 30, 2004, our book value was$12.08 per share of outstanding common stock and the closing trading price ofour common stock was $14.50 per share. If the fair value of our outstanding common stock on a control basiswere less than $12.08 per share on September 30, 2004, our goodwill wouldhave become impaired.  If the fair valueof our outstanding common stock on a control basis were to decline in thefuture below the then applicable book value of our outstanding common stock,our goodwill would become impaired.  Ifwe determine in the future that an impairment has occurred, we would berequired to write off the impaired portion of goodwill, which could

 

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substantiallyreduce our earnings and result in a substantial decline in the price of ouroutstanding common stock.

 

***Wemay be unable to protect our trademarks and other intellectual property.***

*** ***

Webelieve that our trademarks and service marks are important to our continuedsuccess and our competitive position due to their recognition with ourcustomers.  We devote substantialresources to the establishment and protection of our trademarks and servicemarks.  We are not aware of any materialpending claims of infringement or challenges to our right to use any of ourtrademarks and service marks in the United States or Canada.  Although we actively protect our intellectualproperty, there can be no assurance that the actions that we have taken toestablish and protect our trademarks, service marks and other intellectualproperty, including our rights in our management information systems, will beadequate to prevent imitation of our marks, products or services by others orto prevent others from seeking to block sales of our products as a violation oftheir trademarks, service marks or other proprietary rights.  Also, others may assert rights in, orownership of, our trademarks and other proprietary rights and we may not beable to successfully resolve these types of conflicts. In addition, the laws ofcertain foreign countries may not protect our trademarks and proprietary rightsto the same extent as do the laws of the United States.

 

***Waror acts of terrorism or the threat of either may negatively impact availabilityof merchandise and otherwise adversely impact our business.***

*** ***

Inthe event of war or acts of terrorism, or if either is threatened, our abilityto obtain merchandise available for sale in our stores may be negativelyaffected.  A substantial portion of ourmerchandise is imported from other countries. If goods become difficult or impossible to import into the UnitedStates, and if we cannot obtain such merchandise from other sources at similarcosts, our sales and profit margins may be adversely affected. In the eventthat commercial transportation is curtailed or substantially delayed, ourbusiness may be adversely impacted, as we may have difficulty shippingmerchandise to our main distribution facility and stores, as well as fulfillingcatalog and website orders.

 

***Oursubstantial indebtedness could adversely affect our financial health, whichwould prevent us from fulfilling our obligations under our senior notes.***

*** ***

Wehave a significant amount of indebtedness and we have the ability to incursubstantial additional indebtedness in the future.  As of September 30, 2004, we had$129.2 million of debt outstanding, including $4.2 million of secureddebt.  Our $60 million creditfacility, under which we had no direct borrowings and approximately$3.7 million in letters of credit outstanding as of September 30,2004, was replaced by the New Credit Facility, which includes a new $60 millionline of credit and matures on October 15, 2009.  As of September 30, 2004, we had$52.3 million available for additional borrowings under the previouscredit facility.

 

Oursubstantial indebtedness could have important consequences. For example, itcould:

 

•       increase ourvulnerability to general adverse economic and industry conditions;

 

•       require usto dedicate a substantial portion of our cash flow from operations to paymentson our indebtedness, thereby reducing the availability of our cash flow toimplement our growth strategy, or to fund working capital, capital expendituresand other general corporate needs;

 

•       limit ourflexibility in planning for, or reacting to, changes in our business and theindustry in which we operate;

 

•       result inhigher interest expense in the event of increases in interest rates as some ofour debt is, and will continue to be, at variable rates of interest, and ouravailable borrowings under our New Credit Facility, to the extent borrowed inthe future, would be at variable rates of interest;

 

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•       place us ata competitive disadvantage compared to our competitors that have less debt, ordebt at lower interest rates;

 

•       limit ourability to borrow additional funds;

 

•       make it moredifficult for us to open new stores or improve or expand existing stores;

 

•       restrict ourability to pay dividends or make distributions to our stockholders;

 

•       require usto pledge all or substantially all of our assets as collateral to secureindebtedness; and

 

•       make it moredifficult for us to pursue strategic acquisitions, alliances and partnerships.

 

Ifwe are unable to meet our expenses and debt obligations, we may need torefinance all or a portion of our indebtedness before the scheduled maturitydates of such debt, sell assets or raise equity.  On such maturity dates, we may need torefinance our indebtedness if our operations do not generate enough cash to paysuch indebtedness in full and if we do not raise additional capital.  Our ability to refinance will depend on thecapital markets and our financial condition at such time.  We cannot assure you that we would be able torefinance any of our indebtedness, sell assets or raise equity on commerciallyreasonable terms or at all, which could cause us to default on our obligationsand impair our liquidity.

 

***Theterms of our debt instruments impose financial and operating restrictions.***

*** ***

Eachof our New Credit Facility and the indenture governing the New Senior Notescontain restrictive covenants that limit our ability to engage in activitiesthat may be in our long-term best interests. These covenants limit or restrict, among other things, our ability to:

 

•       incuradditional indebtedness;

 

•       paydividends or make other distributions in respect of our equity securities, orpurchase or redeem capital stock, or make certain investments;

 

•       have oursubsidiaries pay dividends, make loans or transfer assets to us;

 

•       sell assets,including the capital stock of our subsidiaries;

 

•       enter intoany transactions with our affiliates;

 

•       transfer anycapital stock of any subsidiary or permit any subsidiary to issue capitalstock;

 

•       createliens;

 

•       enter intocertain sale/leaseback transactions; and

 

•       effect aconsolidation or merger or transfer of all or substantially all of our assets.

 

Theselimitations and restrictions may adversely affect our ability to finance ourfuture operations or capital needs or engage in other business activities thatmay be in our best interests.  Inaddition, our ability to borrow under the New Credit Facility is subject toborrowing base requirements.  If webreach any of the covenants in our New Credit Facility or our indenture, we maybe in default under our New Credit Facility or our indenture. If we default,the holders of the New Senior Notes or the lender under our New Credit Facilitycould declare all borrowings owed to them, including accrued interest and otherfees, to be due and payable.

 

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***Ourshare price may be volatile and could decline substantially.***

*** ***

Themarket price of our common stock has been, and is expected to continue to be,volatile, both because of actual and perceived changes in our financial resultsand prospects and because of general volatility in the stock market.  The factors that could cause fluctuations inour share price may include, among other factors discussed in this section, thefollowing:

 

•       actual oranticipated variations in the financial results and prospects of our businessor other companies in the retail business;

 

•       changes infinancial estimates by Wall Street research analysts;

 

•       actual oranticipated changes in the United States economy or the retailing environment;

 

•       changes inthe market valuations of other specialty apparel or retail companies;

 

•       announcementsby our competitors or us; and

 

•       any goodwillimpairment would likely cause a write down that would negatively affect ourstock price.

 

***Ourcharter documents contain certain anti-takeover provisions, and we are entitledto certain other protective provisions under Delaware law.***

*** ***

Weare a Delaware corporation and the anti-takeover provisions of Delaware lawimpose various impediments to the ability of a third party to acquire controlof our company, even if a change of control would be beneficial to our existingstockholders.  We also have adopted astockholder rights plan, commonly known as a “poison pill,” that entitles ourstockholders to acquire additional shares of us, or a potential acquirer of us,at a substantial discount to their market value in the event of an attemptedtakeover.  In addition, our amended andrestated certificate of incorporation and by-laws may discourage, delay orprevent a merger or acquisition involving us that our stockholders may considerfavorable by, among other things:

 

•       authorizingthe issuance of preferred stock, the terms of which may be determined at thediscretion of our Board of Directors;

 

•       restrictingthe ability of stockholders to call special meetings of stockholders;

 

•       providingfor a classified Board of Directors, with staggered three-year terms; and

 

•       establishingadvance notice requirements for nominations for election to the Board ofDirectors or for proposing matters that can be acted on by stockholders atmeetings.

 

Theprovisions, which we have summarized above, may reduce the market value of ourcommon stock.

 

***Wedo not expect to pay cash dividends in the foreseeable future.***

*** ***

Wehave not paid any cash dividends on our common stock since our initial publicoffering and do not anticipate paying cash dividends on our common stock in theforeseeable future.  In addition, theterms of our New Senior Notes and our New Credit Facility significantlyrestrict our ability to declare or pay dividends on our common stock.  Even if we were not restricted under theterms of our New Senior Notes or New Credit Facility from being able to paydividends, any future payment of dividends would still be at the discretion ofour Board of Directors and would be based upon certain restrictive financialcovenants, earnings, capital requirements and our financial condition, amongother factors, at the time any such dividend is considered.

 

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**Item 7A.**            Quantitativeand Qualitative Disclosures About Market Risk

** **

MothersWork is exposed to market risk from changes in interest rates.  We have not entered into any market risksensitive instruments for trading purposes. The analysis below presents the sensitivity of the market value of ourfinancial instruments to selected changes in market interest rates.  The range of changes presented reflects ourview of changes that are reasonably possible over a one-year period.

 

Asof September 30, 2004, the principal components of our debt portfolio werethe $125.0 million of New Senior Notes due 2010 and the $60 million creditfacility, both of which are denominated in U.S. dollars.  The fair value of the debt portfolio is referredto as the “debt value.”  The New SeniorNotes bear interest at a fixed rate 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.

 

Ourprevious credit facility carried a variable interest rate that is tied tomarket indices.  As of September 30,2004, we had no direct borrowings and $3.7 million of letters of creditoutstanding under our previous credit facility (plus an additional$3.1 million of letters of credit outstanding under a special purposeletter of credit facility).  Borrowingsunder the previous credit facility would have borne interest at the rate of betweenapproximately 3.9% to 4.8% per annum.  Anyfuture borrowings under the New Credit Facility would, to the extent ofoutstanding borrowings, be affected by changes in market interest rates.  A change in market interest rates on thevariable portion of the debt portfolio impacts the interest incurred and cashflows, but does not impact the value of the financial instrument.

 

Thesensitivity analysis as it relates to the fixed portion of our debt portfolioassumes an instantaneous 100 basis point move in interest rates from theirlevels as of September 30, 2004, with all other variables heldconstant.  A 100 basis point increase inmarket interest rates would result in a decrease in the value of the debt byapproximately $5.2 million as of September 30, 2004.  A 100 basis point decline in market interestrates would cause the debt value to increase by approximately $5.4 millionas of September 30, 2004.

 

Basedon the variable rate debt included in our debt portfolio as of September 30,2004, a 100 basis point increase in interest rates would result in additionalinterest incurred for the year of less than $0.1 million.  A 100 basis point decrease in interest rateswould correspondingly lower our interest expense for the year by less than$0.1 million.

 

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

 

**Item 8.**              FinancialStatements and Supplementary Data

** **

OurConsolidated Financial Statements appear on pages F-1 through F-39, as setforth in Item 15.

 

**Item 9.**              Changes inand Disagreements with Accountants on Accounting and Financial Disclosure

** **

None.

 

**Item 9A.**           Controls andProcedures

** **

*(a) Evaluation of disclosure controls andprocedures*. Our disclosure controls and procedures are designed to ensure thatinformation required to be disclosed by us in the reports that are filed orsubmitted under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  Thesedisclosure controls and procedures include controls and procedures designed toensure that information required to be disclosed under the Exchange Act isaccumulated and communicated to our management on a timely basis to allowdecisions regarding required disclosure.

 

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In connection with our preparation of this Form 10-K/A for theyear ended September 30, 2004, after consultation with the Company’sindependent registered public accounting firm, KPMG LLP, we implemented changesto our method of accounting for leases, including our method of accounting fortenant improvement allowances, rent expense during store build-out periods(rent holidays), and amortization of leasehold improvements.  These changes are consistent with the viewsexpressed by the Office of the Chief Accountant of the SEC on February 7,2005 in a letter to the American Institute of Certified Public Accountants andother recent interpretations regarding certain operating lease accountingissues and their application under generally accepted accountingprinciples.  Because of these changes inour lease accounting practices, we concluded that we had a material weakness inthe effectiveness of controls over the selection and monitoring of appropriatepractices used in accounting for leases during the periods covered by this Form 10-K/A.  We also concluded that the design andoperations of our disclosure controls and procedures as of September 30,2004 and December 31, 2004 were not effective.  For the quarter ended March 31, 2005, weremediated the material weakness in internal control and the ineffectiveness ofour disclosure controls and procedures by implementing additional reviewprocedures over the selection and monitoring of appropriate practices affectinglease-related accounting to ensure that U.S. generally accepted accountingprinciples are appropriately applied.  Asa result, our Chief Executive Officer and Chief Financial Officer eachconcluded that the Company’s disclosure controls and procedures were effectiveas of March 31, 2005.

 

Weevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures as of the date of this filing.  In performing this evaluation, we consideredthe foregoing changes in our method of accounting for leases, as well as theremediation activities described above. Based on this evaluation, the Company’s Chief Executive Officer andChief Financial Officer have concluded that as of the date of this filing,these controls and procedures were effective.

 

OnMay 5, 2005, the Audit Committee of our Board of Directors concluded thata restatement of the Company’s historical consolidated financial statements wasnecessary to correct errors resulting from our prior method of accounting forleases.  The restatements involve adjustmentsthat have no impact on our previously reported sales, comparable store sales orour compliance with any financial covenant under our revolving credit facilityor other debt instruments.

 

*(b)  Change in Internal Controls*.  There have been no changes in internalcontrol over financial reporting identified in connection with the foregoingevaluation that occurred during the last fiscal quarter ended September 30,2004, that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

**Item 9B.**           OtherInformation

** **

None.

 

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**PART III.**

** **

**Item 10.**             Directorsand Executive Officers of the Registrant

** **

Informationconcerning directors, appearing under the caption “Election of Directors” inour Proxy Statement (the “Proxy Statement”) will be filed with the Securitiesand Exchange Commission in connection with the Annual Meeting of Stockholdersscheduled to be held on January 21, 2005, and information concerningexecutive officers, appearing under the caption “Item 1.Business—Executive Officers of the Company” in Part I of this Form 10-K/A,are incorporated herein by reference in response to this Item 10.

 

TheBoard of Directors has adopted a Code of Business Conduct and Ethics, which wasfiled as an exhibit to last year’s Form 10-K.  We intend to satisfy the amendmentand waiver disclosure requirements under applicable securities regulations byposting any amendments of, or waivers to, the Code of Business Conduct andEthics on our web site.

 

**Item 11.**             ExecutiveCompensation

** **

Theinformation contained in the Proxy Statement in the section titled“Compensation Committee Report on Executive Compensation” up to, but notincluding, the section titled “Security Ownership of Certain BeneficialOwners and Management,” with respect to executive compensation, and in the section titled“Compensation of Directors” with respect to director compensation, isincorporated herein by reference in response to this Item 11.

 

**Item 12.**             SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters

** **

Theinformation contained in the section titled “Security Ownership of CertainBeneficial Owners and Management” in the Proxy Statement, with respect tosecurity ownership of certain beneficial owners and management, and in the section titled“Summary of All Existing Equity Compensation Plans,” with respect to securitiesauthorized for issuance under equity compensation plans, is incorporated hereinby reference in response to this Item 12.

 

**Item 13.**             CertainRelationships and Related Transactions

** **

Theinformation contained in the section titled “Certain Transactions” of theProxy Statement, with respect to certain relationships and related transactions,is incorporated herein by reference in response to this Item 13.

 

**Item 14.**             PrincipalAccountant Fees and Services

** **

Theinformation contained in the Proxy Statement in the section titled“Auditor Fees and Services” is incorporated herein by reference in response tothis Item 14.

 

47

----

 

**PART IV.**

** **

**Item 15.**             Exhibits,Financial Statement Schedules

** **

(a)    (1)      Financial Statements

 

The financial statementslisted in the accompanying Index to Consolidated Financial Statements are filedas part of this Form 10-K/A, commencing on page F-1.

 

(2)      Financial Statement Schedules

 

Schedule II—Valuationand Qualifying Accounts.

 

All other schedules areomitted because they are not applicable or not required, or because the requiredinformation is included in the consolidated financial statements or notesthereto.

 

(3)      Exhibits

 

See following Index ofExhibits.

 

48

----

 

**INDEXOF EXHIBITS**

** **
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *3.1                 |       | Amended  and Restated Certificate of Incorporation of the Company (effective March 10,  1993) (Exhibit 3.3 to the Company’s Registration Statement on Form S-1,  Registration No. 33-57912, dated February 4, 1993 (the “1993 Registration  Statement”)).                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *3.2                 |       | By-Laws  of the Company (Exhibit 3.2 to the Company’s Current Report on Form 8-K  dated November 17, 2004).                                                                                                                                                                                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *3.3                 |       | Amendment  to the Amended and Restated Certificate of Incorporation of the Company dated  February 11, 2003 (Exhibit 3.3 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended March 31, 2003 (the “March 2003  10-Q”)).                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *3.4                 |       | Amendment  to the Certificate of Designation of the Series B Junior Participating  Preferred Stock of the Company dated February 11, 2003 (Exhibit 3.4  to the Company’s March 2003 10-Q).                                                                                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.1                 |       | Specimen  certificate representing shares of the Company’s common stock with legend  regarding Preferred Stock Purchase Rights (Exhibit 4.2 to the Company’s  Current Report on Form 8-K dated October 12, 1995).                                                                                                                                                                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.2                 |       | Amended  and Restated Rights Agreement, dated as of March 17, 1997, between the  Company and StockTrans, Inc. (Exhibit 4.2 to the Company’s Current  Report on Form 8-K dated March 17, 1997).                                                                                                                                                                                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.3                 |       | Amendment  No. 1, dated as of June 4, 1997, to the Amended and Restated Rights  Agreement, dated as of March 17, 1997, between the Company and  StockTrans, Inc. (Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended June 30, 1997).                                                                                                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.4                 |       | Amendment  No. 2 to the Amended and Restated Rights Agreement dated October 24,  2001, between the Company and StockTrans, Inc. (Exhibit 4.8 to the  Company’s Current Report on Form 8-K dated October 24, 2001).                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.5                 |       | Amendment  No. 3 to the Amended and Restated Rights Agreement dated June 4,  2002, between the Company and StockTrans, Inc. (Exhibit 4.9 to the  Company’s Current Report on Form 8-K dated June 4, 2002).                                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.6                 |       | Indenture  dated as of August 5, 2002, among the Company and Cave Springs, Inc.,  eSpecialty Brands, LLC, Dan Howard Industries, Inc., and Mother’s Stores, Inc.,  as guarantors, and J.P. Morgan Trust Company, National Association, a  national banking association, as Trustee (Exhibit 4.11 to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 30, 2002  (the “June 2002 10-Q”)). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *4.7                 |       | Amendment  No. 4 to the Amended and Restated Rights Agreement dated February 14,  2003, between the Company and StockTrans, Inc. (Exhibit 4.7 to the  Company’s Current Report on Form 8-K dated February 14, 2003).                                                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| †*10.1          |       | 1994  Director Stock Option Plan (Exhibit 10.12 to the Company’s Annual Report  on Form 10-K for the year ended September 30, 1994 (the “1994 Form 10-K”)).                                                                                                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| †*10.2          |       | Employment  Agreement dated as of July 14, 1994 between the Company and Dan W.  Matthias (Exhibit 10.25 to the 1994 Form 10-K).                                                                                                                                                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| †*10.3          |       | Employment  Agreement dated as of July 14, 1994 between the Company and  Rebecca C. Matthias (Exhibit 10.26 to the 1994 Form 10-K).                                                                                                                                                                                                                                                                                                                         |

 

49

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                             |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.4                |       | Loan  Agreement dated September 1, 1995 between Philadelphia Authority For  Industrial Development (“PAID”) and the Company (Exhibit 10.26 to the  Company’s Registration Statement on Form S-1, Registration No. 33-97318,  dated October 26, 1995 (the “1995 Registration Statement”)). |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.5                |       | Indenture  of Trust dated September 1, 1995 between PAID and Society National Bank  (Exhibit 10.29 to the 1995 Company’s Registration Statement).                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.6                |       | Variable/Fixed  Rate Federally Taxable Economic Development Bond (Mothers Work, Inc.), Series of  1995, in the aggregate principal amount of $4,000,000 (Exhibit 10.30 to  the Company’s 1995 Registration Statement).                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.7                |       | Residential  Lease dated as of June 28, 1996 between the Company and Daniel &  Rebecca Matthias (Exhibit 10.27 to the Company’s Annual Report on Form 10-K  for the year ended September 30, 1996 (the “1996 Form 10-K”)).                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.8                |       | Note  dated as of February 14, 1996 from the Company to PIDC Local Development  Corporation (Exhibit 10.29 to the 1996 Form 10-K).                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.9                |       | Installment  Sale Agreement dated as of April 4, 1996 by and between PIDC Financing  Corporation and the Company (Exhibit 10.30 to the 1996 Form 10-K).                                                                                                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.10               |       | Open-ended  Mortgage dated as of April 4, 1996 between PIDC Financing Corporation  and the Pennsylvania Industrial Development Authority (“PIDA”) (Exhibit 10.31  to the 1996 Form 10-K).                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.11               |       | Loan  Agreement dated as of April 4, 1996 by and between PIDC Financing Corporation  and PIDA (Exhibit 10.32 to the 1996 Form 10-K).                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| *10.12               |       | Amended  and Restated Loan and Security Agreement dated as of October 15, 2004 by  and among Mothers Work, Inc., Cave Springs, Inc., Mothers Work  Canada, Inc., and Fleet Retail Group, Inc. (Exhibit 10.2 to  the Company’s Current Report on Form 8-K dated October 15, 2004).              |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| †*10.13         |       | 1987  Stock Option Plan (as amended and restated) (Exhibit 4.1 to the Company’s  Registration Statement on Form S-8, Registration No. 333-59529,  dated July 21, 1998).                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| †*10.14         |       | Amendment  to the Company’s 1987 Stock Option Plan, as amended and restated, effective  as of November 13, 2002 (Exhibit 10.25 to the Company’s March 2003  10-Q).                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| †*10.15         |       | Amendment  Agreement dated as of March 14, 2003 between the Company and Dan W.  Matthias (Exhibit 10.26 to the Company’s March 2003 10-Q).                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| †*10.16         |       | Amendment  Agreement dated as of March 14, 2003 between the Company and  Rebecca C. Matthias (Exhibit 10.27 to the Company’s March 2003  10-Q).                                                                                                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| †*10.17         |       | Employment  Agreement effective September 30, 2003 between the Company and  Edward M. Krell. (Exhibit 19 to the Company’s Annual Report on Form 10-K  for the year ended September 30, 2003 (the “2003 Form 10-K”)).                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                        |
| †*10.18         |       | Form of  Non-Qualified Stock Option Agreement under the Company’s 1987 Stock Option  Plan (Exhibit 10.18 to the Company’s Annual Report on Form 10-K for  the year ended September 30, 2004).                                                                                                                 |

 

50

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                      |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                                                                                                 |
| †*10.19         |       | Form of  Non-Qualified Stock Option Agreement under the Company’s 1994 Director Stock  Option Plan (Exhibit 10.19 to the Company’s Annual Report on Form 10-K  for the year ended September 30, 2004). |
|                 |       |                                                                                                                                                                                                                                 |
| *14                  |       | Code  of Business Conduct and Ethics (Exhibit 14 to the 2003 Form 10-K).                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                 |
| *21                  |       | Subsidiaries  of the Company. (Exhibit 21 to the 2003 Form 10-K).                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                 |
| 23                   |       | Consent  of KPMG LLP.                                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                 |
| 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.                               |

 

 

*                    Incorporatedby reference.

 

†                     Managementcontract or compensatory plan or arrangement.

 

51

----

 

**SIGNATURES**

** **

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the City ofPhiladelphia, Commonwealth of Pennsylvania, on October 4, 2005.

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

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed by the following persons on October 4, 2005, in the capacitiesindicated:

 
| /s/ DAN W.  MATTHIAS               |   | Chairman of the Board, Chief Executive  Officer and Director      |
|------------------------------------|--------|-------------------------------------------------------------------|
| **Dan W.  Matthias**               |   | (Principal Executive Officer)                                     |
|                               |   |                                                              |
| /s/ REBECCA  C. MATTHIAS           |   | President, Chief Operating Officer and  Director                  |
| **Rebecca  C. Matthias**           |   |                                                              |
| ** **                         |   |                                                              |
| /s/ EDWARD  M. KRELL               |   | Executive Vice President—Chief Financial  Officer (Principal |
| **Edward  M. Krell**               |   | Financial and Accounting Officer)                                 |
| ** **                         |   |                                                              |
| /s/ JOSEPH  A. GOLDBLUM            |   | Director                                                          |
| **Joseph  A. Goldblum**            |   |                                                              |
| ** **                         |   |                                                              |
| /s/ ELAM M.  HITCHNER, III    |   | Director                                                          |
| **Elam M.  Hitchner, III**    |   |                                                              |
| ** **                         |   |                                                              |
| /s/ DAVID  SCHLESSINGER            |   | Director                                                          |
| **David  Schlessinger**            |   |                                                              |
| ** **                         |   |                                                              |
| /s/ WILLIAM  A. SCHWARTZ, JR. |   | Director                                                          |
| **William  A. Schwartz, Jr.** |   |                                                              |
| ** **                         |   |                                                              |
| /s/ STANLEY  C. TUTTLEMAN          |   | Director                                                          |
| **Stanley  C. Tuttleman**          |   |                                                              |

 

52

----

** **

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

***INDEXTO CONSOLIDATED FINANCIAL STATEMENTSAND FINANCIAL STATEMENT SCHEDULE***

 
| Report  of Independent Registered Public Accounting Firm                                 | F-2          |
|------------------------------------------------------------------------------------------|--------------|
|                                                                                     |         |
| Consolidated Balance Sheets                                                              | F-3          |
|                                                                                     |         |
| Consolidated  Statements of Operations                                                   | F-4          |
|                                                                                     |         |
| Consolidated  Statements of Stockholders’ Equity                                    | F-5          |
|                                                                                     |         |
| Consolidated  Statements of Cash Flows                                                   | F-6          |
|                                                                                     |         |
| Notes  to Consolidated Financial Statements                                              | F-7 to  F-39 |
|                                                                                     |         |
| Schedule Supporting the Consolidated  Financial Statements:                         |         |
| Report of  Independent Registered Public Accounting Firm on Financial Statement Schedule | F-40         |
| Valuation  and Qualifying Accounts                                                       | F-41         |

 

F-1

----

 

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

TheBoard of Directors and StockholdersMothers Work, Inc.:

 

Wehave audited the accompanying consolidated balance sheets of Mothers Work, Inc.and subsidiaries as of September 30, 2004 and 2003, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows foreach of the years in the three-year period ended September 30, 2004.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Mothers Work, Inc.and subsidiaries as of September 30, 2004 and 2003, and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended September 30, 2004, in conformity with U.S generally acceptedaccounting principles.

 

As discussed in Note 2 to the consolidatedfinancial statements, the Company has restated its consolidated financialstatements as of September 30, 2004 and 2003 and for each of the years inthe three-year period ended September 30, 2004.

 

 
| /s/  KPMG LLP                      |   |
|------------------------------------|--------|
|                               |
| Philadelphia,  Pennsylvania        |
| November 17,  2004, except as |
| to  Note 2, which is as of         |
| September 28,  2005           |

 

F-2

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATED BALANCE SHEETS**

** **

**(inthousands, except share and per share amounts)**

** **
|                                                                                                                                   | ** ** | **September 30,**      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                        | ** ** | **2004**                    | ** ** | **2003** | ** ** |
| ** **                                                                                                                        | ** ** | **(Restated,  See Note 2)** | ** ** |
| **ASSETS**                                                                                                                        |       |                        |       |   |   |
| Current  Assets                                                                                                                   |       |                        |       |   |   |
| Cash and cash equivalents                                                                                                         |       | $                           | 8,467      |   | $ | 15,731 |   |
| Short-term investments                                                                                                            |       | 6,400                       |       | 5,000 |   |
| Trade receivables                                                                                                                 |       | 2,911                       |       | 2,385 |   |
| Inventories                                                                                                                       |       | 92,743                      |       | 84,505 |   |
| Deferred income taxes                                                                                                             |       | 4,660                       |       | 4,655 |   |
| Prepaid expenses and other current assets                                                                                         |       | 7,215                       |       | 5,166 |   |
| Total Current Assets                                                                                                              |       | 122,396                     |       | 117,442 |   |
| Property,  Plant and Equipment, net                                                                                               |       | 78,462                      |       | 73,380 |   |
| Assets  Held for Sale                                                                                                             |       | 1,200                       |       | 1,200 |   |
| Other  Assets                                                                                                                     |       |                        |       |   |   |
| Goodwill                                                                                                                          |       | 50,389                      |       | 50,389 |   |
| Deferred financing costs, net of accumulated  amortization of $1,267 and $852                                                     |       | 3,665                       |       | 4,080 |   |
| Other intangible assets, net of accumulated  amortization of $2,476 and $2,447                                                    |       | 946                         |       | 1,126 |   |
| Deferred income taxes                                                                                                             |       | 13,317                      |       | 14,950 |   |
| Other non-current assets                                                                                                          |       | 995                         |       | 969 |   |
| Total Other Assets                                                                                                                |       | 69,312                      |       | 71,514 |   |
| Total Assets                                                                                                                      |       | $                           | 271,370    |   | $ | 263,536 |   |
| ** **                                                                                                                        |       |                        |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                    |       |                        |       |   |   |
| Current  Liabilities                                                                                                              |       |                        |       |   |   |
| Line of credit borrowings                                                                                                         |       | $                           | —     |   | $ | — |   |
| Current portion of long-term debt                                                                                                 |       | 288                         |       | 279 |   |
| Accounts payable                                                                                                                  |       | 19,779                      |       | 19,585 |   |
| Accrued expenses and other current liabilities                                                                                    |       | 34,496                      |       | 34,870 |   |
| Total Current Liabilities                                                                                                         |       | 54,563                      |       | 54,734 |   |
| Long-Term  Debt                                                                                                                   |       | 127,629                     |       | 127,768 |   |
| Deferred  Rent and Other Non-Current Liabilities                                                                                  |       | 26,275                      |       | 22,176 |   |
| Total Liabilities                                                                                                                 |       | 208,467                     |       | 204,678 |   |
| Commitments  and Contingencies (Note 14)                                                                                          |       |                        |       |   |   |
| 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, 5,207,081 and 5,231,114 shares issued and outstanding,  respectively |       | 52                          |       | 52 |   |
| Additional paid-in capital                                                                                                        |       | 62,565                      |       | 63,559 |   |
| Retained earnings (accumulated deficit)                                                                                           |       | 286                         |       | (4,753 | ) |
| Total Stockholders’ Equity                                                                                                   |       | 62,903                      |       | 58,858 |   |
| Total Liabilities and Stockholders’ Equity                                                                                   |       | $                           | 271,370    |   | $ | 263,536 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

F-3

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, except per share amounts)**

** **
| ** **                                    | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                    | ** ** | **(Restated,  See Note 2)**                 | ** ** |
| Net  sales                                    |       | $                                           | 518,051    |   | $ | 492,447 |   | $ | 453,159 |   |
| Cost  of goods sold                           |       | 239,613                                     |       | 225,191 |   | 211,689 |   |
| Gross profit                                  |       | 278,438                                     |       | 267,256 |   | 241,470 |   |
| Selling,  general and administrative expenses |       | 255,168                                     |       | 231,236 |   | 208,325 |   |
| Operating income                              |       | 23,270                                      |       | 36,020 |   | 33,145 |   |
| Interest  expense, net                        |       | 14,765                                      |       | 14,469 |   | 16,476 |   |
| Income before income taxes                    |       | 8,505                                       |       | 21,551 |   | 16,669 |   |
| Income  tax provision                         |       | 3,466                                       |       | 8,337 |   | 6,269 |   |
| Net  income                                   |       | 5,039                                       |       | 13,214 |   | 10,400 |   |
| Dividends  on preferred stock                 |       | —                                      |       | — |   | 3,942 |   |
| Net  income available to common stockholders  |       | $                                           | 5,039      |   | $ | 13,214 |   | $ | 6,458 |   |
|                                          |       |                                        |       |   |   |   |   |
| Net  income per share—Basic              |       | $                                           | 0.97       |   | $ | 2.52 |   | $ | 1.65 |   |
| Average  shares outstanding—Basic        |       | 5,212                                       |       | 5,236 |   | 3,914 |   |
|                                          |       |                                        |       |   |   |   |   |
| Net  income per share—Diluted            |       | $                                           | 0.92       |   | $ | 2.34 |   | $ | 1.52 |   |
| Average  shares outstanding—Diluted      |       | 5,501                                       |       | 5,646 |   | 4,261 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

F-4

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

** **

**(inthousands)**

** **
| ** **                                                 | ** ** | **Series A  Cumulative**     |   | **Common Stock**  | ** ** | ** ** | ** ** | **Retained**                     | ** ** | ** **                          | ** ** |
|------------------------------------------------------------|------------|-----------------------------------|--------|------------------------|------------|------------|------------|----------------------------------|------------|-------------------------------------|------------|
| ** **                                                 | ** ** | **Convertible  Preferred  Stock** |   | **Number  of  Shares** |       | **Amount** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Earnings  (Accumulated Deficit)** | ** ** | **Total** | ** ** |
| Balance  at September 30, 2001 (previously reported)  |       | $                                 | 10,773 |                   | 3,480      |       | $          | 35                               |       | $                                   | 26,949     |   | $ | (23,016 | ) | $ | 14,741 |   |
| Cumulative effect of restatement on prior  years           |       | —                            |   | —                 |       | —     |       | —                           |       | (1,409                              | )          | (1,409 | ) |
| Balance  at September 30, 2001 (restated, see Note 2) |       | 10,773                            |   | 3,480                  |       | 35         |       | 26,949                           |       | (24,425                             | )          | 13,332 |   |
| Exercise of stock options and warrants                     |       | —                            |   | 420                    |       | 4          |       | 3,055                            |       | —                              |       | 3,059 |   |
| Preferred stock conversions                                |       | (3,224                            | )      | 115                    |       | 1          |       | 3,223                            |       | —                              |       | — |   |
| Issuance of warrants, net of repurchases                   |       | —                            |   | —                 |       | —     |       | 311                              |       | —                              |       | 311 |   |
| Issuance of common shares, net of issuance  costs          |       | —                            |   | 1,165                  |       | 12         |       | 28,411                           |       | —                              |       | 28,423 |   |
| Redemption of Series A Preferred Stock                |       | (7,549                            | )      | —                 |       | —     |       | —                           |       | —                              |       | (7,549 | ) |
| Tax benefit of stock option exercises                      |       | —                            |   | —                 |       | —     |       | 1,674                            |       | —                              |       | 1,674 |   |
| Preferred stock dividends                                  |       | —                            |   | —                 |       | —     |       | —                           |       | (3,942                              | )          | (3,942 | ) |
| Net income (restated, see Note 2)                          |       | —                            |   | —                 |       | —     |       | —                           |       | 10,400                              |       | 10,400 |   |
| Balance  at September 30, 2002 (restated, see Note 2) |       | —                            |   | 5,180                  |       | 52         |       | 63,623                           |       | (17,967                             | )          | 45,708 |   |
| Exercise of stock options and warrants                     |       | —                            |   | 118                    |       | 1          |       | 726                              |       | —                              |       | 727 |   |
| Repurchase and retirement of common shares                 |       | —                            |   | (67                    | )          | (1         | )          | (1,466                           | )          | —                              |       | (1,467 | ) |
| Tax benefit of stock option exercises                      |       | —                            |   | —                 |       | —     |       | 676                              |       | —                              |       | 676 |   |
| Net income (restated, see Note 2)                          |       | —                            |   | —                 |       | —     |       | —                           |       | 13,214                              |       | 13,214 |   |
| Balance  at September 30, 2003 (restated, see Note 2) |       | —                            |   | 5,231                  |       | 52         |       | 63,559                           |       | (4,753                              | )          | 58,858 |   |
| Exercise of stock options and warrants                     |       | —                            |   | 51                     |       | 1          |       | 275                              |       | —                              |       | 276 |   |
| Repurchase and retirement of common shares                 |       | —                            |   | (75                    | )          | (1         | )          | (1,774                           | )          | —                              |       | (1,775 | ) |
| Tax benefit of stock option exercises                      |       | —                            |   | —                 |       | —     |       | 311                              |       | —                              |       | 311 |   |
| Non-cash compensation                                      |       | —                            |   | —                 |       | —     |       | 194                              |       | —                              |       | 194 |   |
| Net income (restated, see Note 2)                          |       | —                            |   | —                 |       | —     |       | —                           |       | 5,039                               |       | 5,039 |   |
| Balance  at September 30, 2004 (restated, see Note 2) |       | $                                 | — |                   | 5,207      |       | $          | 52                               |       | $                                   | 62,565     |   | $ | 286 |   | $ | 62,903 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

F-5

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **

**(inthousands)**

** **
| ** **                                                                         | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                         | ** ** | **(Restated,  See Note 2)**                 | ** ** |
| **Cash Flows from Operating Activities**                                           |       |                                        |       |   |   |   |   |
| Net income                                                                         |       | $                                           | 5,039      |   | $ | 13,214 |   | $ | 10,400 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 14,270                                      |       | 12,930 |   | 11,789 |   |
| Loss on impairment of long-lived assets                                            |       | 1,816                                       |       | 616 |   | 303 |   |
| Loss on disposal of assets                                                         |       | 1,223                                       |       | 647 |   | 185 |   |
| Accretion of discount on notes                                                     |       | 149                                         |       | 134 |   | 1,035 |   |
| Deferred income tax provision                                                      |       | 2,329                                       |       | 2,133 |   | 5,332 |   |
| Tax benefit of stock option exercises                                              |       | 311                                         |       | 676 |   | 1,674 |   |
| Amortization of deferred financing costs                                           |       | 415                                         |       | 387 |   | 1,670 |   |
| Other                                                                              |       | 224                                         |       | — |   | — |   |
| Changes in assets and liabilities:                                                 |       |                                        |       |   |   |   |   |
| Decrease (increase) in—                                                       |       |                                        |       |   |   |   |   |
| Trade receivables                                                                  |       | (526                                        | )          | 2,454 |   | 70 |   |
| Inventories                                                                        |       | (8,238                                      | )          | (7,675 | ) | 2,428 |   |
| Prepaid expenses and other assets                                                  |       | (2,031                                      | )          | (2 | ) | (756 | ) |
| Increase (decrease) in—                                                       |       |                                        |       |   |   |   |   |
| Accounts payable, accrued expenses and other  current liabilities                  |       | (824                                        | )          | 6,739 |   | (5,181 | ) |
| Deferred rent and other non-current liabilities                                    |       | 4,099                                       |       | 3,886 |   | 2,107 |   |
| Net cash provided by operating activities                                          |       | 18,256                                      |       | 36,139 |   | 31,056 |   |
| **Cash Flows from Investing Activities**                                           |       |                                        |       |   |   |   |   |
| Purchase of short-term investments                                                 |       | (54,075                                     | )          | (51,200 | ) | (11,900 | ) |
| Proceeds from sale of short-term investments                                       |       | 52,675                                      |       | 54,550 |   | 3,550 |   |
| Acquisition of iMaternity, net of cash  acquired                                   |       | —                                      |       | — |   | 574 |   |
| Capital expenditures                                                               |       | (21,540                                     | )          | (25,344 | ) | (12,242 | ) |
| Purchase of intangible assets                                                      |       | (80                                         | )          | (175 | ) | (201 | ) |
| Net cash used in investing activities                                              |       | (23,020                                     | )          | (22,169 | ) | (20,219 | ) |
| **Cash Flows from Financing Activities**                                           |       |                                        |       |   |   |   |   |
| Decrease in line of credit borrowings                                              |       | —                                      |       | — |   | (32,229 | ) |
| Increase (decrease) in cash overdrafts                                             |       | 684                                         |       | (1,777 | ) | 1,647 |   |
| Proceeds from issuance of long-term debt, net  of issuance costs                   |       | —                                      |       | — |   | 119,144 |   |
| Repayment of long-term debt                                                        |       | (279                                        | )          | (369 | ) | (94,979 | ) |
| Repayment of debt assumed in acquisition of  iMaternity                            |       | —                                      |       | — |   | (8,892 | ) |
| Proceeds from issuance of common stock, net of  issuance costs                     |       | —                                      |       | — |   | 28,633 |   |
| Repurchase of common stock                                                         |       | (1,775                                      | )          | (1,467 | ) | — |   |
| Repurchase of warrants                                                             |       | —                                      |       | — |   | (563 | ) |
| Payout for redeemed Series A Preferred  Stock                                 |       | (1,362                                      | )          | (1,310 | ) | (9,716 | ) |
| Repurchase of Series C Preferred Stock                                        |       | —                                      |       | — |   | (20,890 | ) |
| Deferred financing costs                                                           |       | (44                                         | )          | (242 | ) | — |   |
| Payment of issuance costs of common stock                                          |       | —                                      |       | (210 | ) | — |   |
| Proceeds from exercise of stock options and  warrants                              |       | 276                                         |       | 727 |   | 3,059 |   |
| Net cash used in financing activities                                              |       | (2,500                                      | )          | (4,648 | ) | (14,786 | ) |
| **Net (Decrease) Increase in Cash and Cash  Equivalents**                          |       | (7,264                                      | )          | 9,322 |   | (3,949 | ) |
| **Cash and Cash Equivalents, Beginning of Year**                                   |       | 15,731                                      |       | 6,409 |   | 10,358 |   |
| **Cash and Cash Equivalents, End of Year**                                         |       | $                                           | 8,467      |   | $ | 15,731 |   | $ | 6,409 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

F-6

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.NATURE OF BUSINESS**

** **

MothersWork, Inc. and subsidiaries (“Mothers Work” or the “Company”) is aspecialty designer and retailer of maternity clothing.  The Company operated 1,115 retail locationsas of September 30, 2004, including 883 stores and 232 leased departments,throughout the United States and Canada. Mothers Work, Inc. wasincorporated in Delaware in 1982.

 

OnOctober 17, 2001, the Company completed the acquisition of eSpecialtyBrands, LLC, including its wholly-owned subsidiaries Dan Howard Industries, Inc.,Mother’s Stores, Inc., Confecciones Acona S.A. and Maternity FactoryWarehouse Centre, Inc. (collectively referred to as “iMaternity”).  This acquisition enabled the Company toexpand into new geographic areas, and enhance its presence in areas alreadyserved (see Note 6).

 

InAugust 2002, the Company completed a public offering of 1,165,000 sharesof its common stock (plus an additional 100,000 shares sold in the offering bycertain selling stockholders) at a price of $27.00 per share and issued$125,000,000 of 111¤4% seniornotes due August 1, 2010 (the “New Senior Notes”).  The Company received cash proceeds from theequity offering, net of issuance costs, of approximately $28,400,000 (seeNote 10).  The Company received cashproceeds from the debt offering of approximately $118,900,000, net of issuancediscount of $1,600,000 and debt issuance costs (see Note 9).  In conjunction with the equity offering,certain selling stockholders exercised stock options, which resulted inadditional cash proceeds of approximately $600,000.

 

**2.RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS**

** **

In May 2005,the Company completed a review of its historical lease accounting methods todetermine whether these methods were in accordance with the views expressed bythe Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”)on February 7, 2005 in a letter to the American Institute of CertifiedPublic Accountants and other recent interpretations regarding certain operatinglease accounting issues and their application under accounting principlesgenerally accepted in the United States of America (“GAAP”).  As a result of the Company’s review, itdetermined that, with regard to its method of accounting for leases, itshistorical methods of accounting for rent holidays and tenant improvementallowances, and of determining the amortization period for leasehold improvementsfor certain leased properties, were not in accordance with GAAP.  As a result, on May 10, 2005, theCompany filed a Current Report on Form 8-K with the SEC announcing itsdecision to restate the previously issued consolidated financial statementscontained in its Annual Report on Form 10-K for the year ended September 30,2004 and the Quarterly Report on Form 10-Q for the quarterly period ended December 31,2004  (the “Restatement”).

 

A discussion ofeach of the aforementioned lease accounting matters is presented below:

 

*RentHoliday*. The Company has historically recognized rent holiday periods andscheduled rent increases on a straight-line basis over the lease term beginningwith the commencement date of the lease, which is typically the store openingdate.  The Company has determined thatthe lease term should commence on the date it takes possession of the leasedproperty, which is generally four to six weeks prior to a store’s opening date.

 

*TenantImprovement Allowances*.  The Company has historically accounted fortenant improvement allowances as reductions to the related leaseholdimprovements in its consolidated balance sheets and as reductions of capitalexpenditures in investing activities in its consolidated statements of cashflows.  The

 

F-7

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**2. RESTATEMENT OF CONSOLIDATED FINANCIALSTATEMENTS (Continued)**

 

Company has now determined that allowances should be recorded asdeferred rent liabilities in its consolidated balance sheets and as a componentof operating activities in its consolidated statements of cash flows.

 

*Amortizationof Leasehold Improvements.* Historically, the lifeused for certain leasehold improvements by the Company in some instances waslonger than the lease term for such related leases.  As part of the Company’s review associatedwith lease matters, the Company has determined that the amortization period forleasehold improvements should be consistent with the straight-line rent expenseperiod for each of its leases.  The livesfor all leasehold improvements have been reviewed to ensure that theamortization is now recorded based on the lesser of the estimated useful lifeof the asset or the lease term.

 

The primary effects of the corrections are:(i) to accelerate the rent expense on properties the Company occupied beforepayment of rents was required (rent holidays); (ii) to increase depreciationand amortization expense and decrease store occupancy expense (both of whichare components of selling, general and administrative expenses) to reflect theproper accounting for tenant improvement allowances; and (iii) to acceleratethe amortization of leasehold improvements on those leased properties where thelease term is shorter than the estimated useful economic life of thoseassets.  The cumulative effect of theseaccounting changes is a reduction to retained earnings of $1,409,000 as of thebeginning of fiscal 2002 and incremental decreases to retained earnings of$834,000, $736,000 and $388,000 for fiscal 2004, fiscal 2003 and fiscal 2002,respectively.  The Restatement decreasedreported diluted earnings per share by $0.15, $0.13 and $0.09, for fiscal 2004,fiscal 2003 and fiscal 2002, respectively. The restated consolidated financial statements reflect adjustments thathave no impact on the Company’s previously reported sales or the Company’scompliance with any financial covenant under its revolving credit facility orother debt instruments.

 

Theconsolidated financial statements included in this Form 10-K/A have beenrestated to reflect the adjustments described above.  The following is a summary of the impact ofthe Restatement on (i) the consolidated balance sheets as of September 30,2004 and 2003, (ii) the consolidated statements of operations for thethree years ended September 30, 2004, and (iii) the consolidatedstatements of cash flows for the three years ended September 30,2004.  In addition, for all periodsrestated, investments in auction rate securities have been reclassified fromcash and cash equivalents to short-term investments in the consolidated balancesheets.  The reclassification waseffected as the securities had stated maturities beyond three months but arepriced and traded as short-term investments due to the liquidity provisions atspecified interest rate reset dates, typically every 7, 28 or 35 days.

 

F-8

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**2. RESTATEMENT OF CONSOLIDATED FINANCIALSTATEMENTS (Continued)**

 

(in thousands, except per share amounts)

 

***CONSOLIDATED BALANCE SHEET****

 
| ** **                                      | ** ** | **September 30, 2004** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **As  Reported**            | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| Cash and cash equivalents                       |       | $                           | 12,867     |   | $ | (4,400 | ) | $ | 8,467 |   |
| Short-term investments                          |       | 2,000                       |       | 4,400 |   | 6,400 |   |
| Property, plant and equipment, net              |       | 60,288                      |       | 18,174 |   | 78,462 |   |
| Deferred income taxes – non-current        |       | 11,504                      |       | 1,813 |   | 13,317 |   |
| Total other assets                              |       | 67,499                      |       | 1,813 |   | 69,312 |   |
| Total assets                                    |       | 251,383                     |       | 19,987 |   | 271,370 |   |
|                                            |       |                        |       |   |   |   |   |
| Accrued expenses and other current liabilities  |       | 30,561                      |       | 3,935 |   | 34,496 |   |
| Total current liabilities                       |       | 50,628                      |       | 3,935 |   | 54,563 |   |
| Deferred rent and other non-current liabilities |       | 6,856                       |       | 19,419 |   | 26,275 |   |
| Total liabilities                               |       | 185,113                     |       | 23,354 |   | 208,467 |   |
| Retained earnings                               |       | 3,653                       |       | (3,367 | ) | 286 |   |
| Total stockholders’ equity                 |       | 66,270                      |       | (3,367 | ) | 62,903 |   |
| Total liabilities and stockholders’ equity |       | 251,383                     |       | 19,987 |   | 271,370 |   |
|                                                 |            |                             |            |  |  |  |  |  |  |  |

 
| ** **                                      | ** ** | **September 30,  2003** | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **As Reported**              | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| Cash and cash equivalents                       |       | $                            | 18,731     |   | $ | (3,000 | ) | $ | 15,731 |   |
| Short-term investments                          |       | 2,000                        |       | 3,000 |   | 5,000 |   |
| Property, plant and equipment, net              |       | 57,811                       |       | 15,569 |   | 73,380 |   |
| Deferred income taxes – non-current        |       | 13,586                       |       | 1,364 |   | 14,950 |   |
| Total other assets                              |       | 70,150                       |       | 1,364 |   | 71,514 |   |
| Total assets                                    |       | 246,603                      |       | 16,933 |   | 263,536 |   |
|                                            |       |                         |       |   |   |   |   |
| Accrued expenses and other current liabilities  |       | 31,346                       |       | 3,524 |   | 34,870 |   |
| Total current liabilities                       |       | 51,210                       |       | 3,524 |   | 54,734 |   |
| Deferred rent and other non-current liabilities |       | 6,234                        |       | 15,942 |   | 22,176 |   |
| Total liabilities                               |       | 185,212                      |       | 19,466 |   | 204,678 |   |
| Accumulated deficit                             |       | (2,220                       | )          | (2,533 | ) | (4,753 | ) |
| Total stockholders’ equity                 |       | 61,391                       |       | (2,533 | ) | 58,858 |   |
| Total liabilities and stockholders’ equity |       | 246,603                      |       | 16,933 |   | 263,536 |   |
|                                                 |            |                              |            |  |  |  |  |  |  |  |

 

F-9

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**2. RESTATEMENT OF CONSOLIDATED FINANCIALSTATEMENTS (Continued)**

 

***CONSOLIDATED STATEMENT OFOPERATIONS****

 
| ** **                                   | ** ** | **Year Ended  September 30, 2004** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **As  Reported**                        | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| Selling, general and administrative expenses |       | $                                       | 253,885    |   | $ | 1,283 |   | $ | 255,168 |   |
| Operating income                             |       | 24,553                                  |       | (1,283 | ) | 23,270 |   |
| Income before income taxes                   |       | 9,788                                   |       | (1,283 | ) | 8,505 |   |
| Income tax provision                         |       | 3,915                                   |       | (449 | ) | 3,466 |   |
| Net income                                   |       | 5,873                                   |       | (834 | ) | 5,039 |   |
| Net income available to common stockholders  |       | 5,873                                   |       | (834 | ) | 5,039 |   |
| Net income per share—Basic              |       | 1.13                                    |       | (0.16 | ) | 0.97 |   |
| Net income per share—Diluted            |       | 1.07                                    |       | (0.15 | ) | 0.92 |   |
|                                              |            |                                         |            |  |  |  |  |  |  |  |

 
| ** **                                   | ** ** | **Year Ended  September 30, 2003** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **As  Reported**                        | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| Selling, general and administrative expenses |       | $                                       | 230,104    |   | $ | 1,132 |   | $ | 231,236 |   |
| Operating income                             |       | 37,152                                  |       | (1,132 | ) | 36,020 |   |
| Income before income taxes                   |       | 22,683                                  |       | (1,132 | ) | 21,551 |   |
| Income tax provision                         |       | 8,733                                   |       | (396 | ) | 8,337 |   |
| Net income                                   |       | 13,950                                  |       | (736 | ) | 13,214 |   |
| Net income available to common stockholders  |       | 13,950                                  |       | (736 | ) | 13,214 |   |
| Net income per share—Basic              |       | 2.66                                    |       | (0.14 | ) | 2.52 |   |
| Net income per share—Diluted            |       | 2.47                                    |       | (0.13 | ) | 2.34 |   |
|                                              |            |                                         |            |  |  |  |  |  |  |  |

 
| ** **                                   | ** ** | **Year Ended  September 30, 2002** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **As  Reported**                        | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| Selling, general and administrative expenses |       | $                                       | 207,728    |   | $ | 597 |   | $ | 208,325 |   |
| Operating income                             |       | 33,742                                  |       | (597 | ) | 33,145 |   |
| Income before income taxes                   |       | 17,266                                  |       | (597 | ) | 16,669 |   |
| Income tax provision                         |       | 6,478                                   |       | (209 | ) | 6,269 |   |
| Net income                                   |       | 10,788                                  |       | (388 | ) | 10,400 |   |
| Net income available to common stockholders  |       | 6,846                                   |       | (388 | ) | 6,458 |   |
| Net income per share—Basic              |       | 1.75                                    |       | (0.10 | ) | 1.65 |   |
| Net income per share—Diluted            |       | 1.61                                    |       | (0.09 | ) | 1.52 |   |
|                                              |            |                                         |            |  |  |  |  |  |  |  |

 

F-10

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**2. RESTATEMENT OF CONSOLIDATED FINANCIALSTATEMENTS (Continued)**

 

***CONSOLIDATED STATEMENT OF CASHFLOWS****

 
| ** **                                                        | ** ** | **Year Ended  September 30, 2004** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                        | ** ** | **As  Reported**                        | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| **Cash Flows from Operating  Activities**                         | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                        |       | $                                       | 5,873      |   | $ | (834 | ) | $ | 5,039 |   |
| Depreciation and amortization                                     |       | 10,212                                  |       | 4,058 |   | 14,270 |   |
| Loss on impairment of long-lived assets                           |       | 1,545                                   |       | 271 |   | 1,816 |   |
| Loss on disposal of assets                                        |       | 1,285                                   |       | (62 | ) | 1,223 |   |
| Deferred income tax provision                                     |       | 2,778                                   |       | (449 | ) | 2,329 |   |
| Provision for deferred rent                                       |       | 606                                     |       | (606 | ) | — |   |
| Prepaid expenses and other assets                                 |       | (1,945                                  | )          | (86 | ) | (2,031 | ) |
| Accounts payable, accrued expenses and other current  liabilities |       | (1,280                                  | )          | 456 |   | (824 | ) |
| Deferred rent and other non-current liabilities                   |       | —                                  |       | 4,099 |   | 4,099 |   |
| Net cash provided by operating activities                         |       | 11,409                                  |       | 6,847 |   | 18,256 |   |
| **Cash Flows from Investing  Activities**                         |       |                                    |       |   |   |   |   |
| Purchase of short-term investments                                |       | (3,500                                  | )          | (50,575 | ) | (54,075 | ) |
| Proceeds from sale of short-term investments                      |       | 3,500                                   |       | 49,175 |   | 52,675 |   |
| Capital expenditures                                              |       | (14,693                                 | )          | (6,847 | ) | (21,540 | ) |
| Net cash used in investing activities                             |       | (14,773                                 | )          | (8,247 | ) | (23,020 | ) |
| **Net Decrease in Cash and Cash Equivalents**                     |       | (5,864                                  | )          | (1,400 | ) | (7,264 | ) |
|                                                                   |            |                                         |            |  |  |  |  |  |  |  |

 
| ** **                                                        | ** ** | **Year Ended  September 30, 2003** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                        | ** ** | **As  Reported**                        | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| **Cash Flows from Operating  Activities**                         | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                        |       | $                                       | 13,950     |   | $ | (736 | ) | $ | 13,214 |   |
| Depreciation and amortization                                     |       | 9,862                                   |       | 3,068 |   | 12,930 |   |
| Loss on impairment of long-lived assets                           |       | 545                                     |       | 71 |   | 616 |   |
| Loss on disposal of assets                                        |       | 700                                     |       | (53 | ) | 647 |   |
| Deferred income tax provision                                     |       | 2,529                                   |       | (396 | ) | 2,133 |   |
| Provision for deferred rent                                       |       | 604                                     |       | (604 | ) | — |   |
| Prepaid expenses and other assets                                 |       | (318                                    | )          | 316 |   | (2 | ) |
| Accounts payable, accrued expenses and other current  liabilities |       | 6,161                                   |       | 578 |   | 6,739 |   |
| Deferred rent and other non-current liabilities                   |       | —                                  |       | 3,886 |   | 3,886 |   |
| Net cash provided by operating activities                         |       | 30,009                                  |       | 6,130 |   | 36,139 |   |
| **Cash Flows from Investing  Activities**                         |       |                                    |       |   |   |   |   |
| Purchase of short-term investments                                |       | (4,200                                  | )          | (47,000 | ) | (51,200 | ) |
| Proceeds from sale of short-term investments                      |       | 2,200                                   |       | 52,350 |   | 54,550 |   |
| Capital expenditures                                              |       | (19,214                                 | )          | (6,130 | ) | (25,344 | ) |
| Net cash used in investing activities                             |       | (21,389                                 | )          | (780 | ) | (22,169 | ) |
| **Net Increase in Cash and Cash Equivalents**                     |       | 3,972                                   |       | 5,350 |   | 9,322 |   |
|                                                                   |            |                                         |            |  |  |  |  |  |  |  |

 

F-11

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**2. RESTATEMENT OF CONSOLIDATED FINANCIALSTATEMENTS (Continued)**

 
| ** **                                                        | ** ** | **Year Ended  September 30, 2002** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                        | ** ** | **As  Reported**                        | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| **Cash Flows from Operating  Activities**                         | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                        |       | $                                       | 10,788     |   | $ | (388 | ) | $ | 10,400 |   |
| Depreciation and amortization                                     |       | 9,496                                   |       | 2,293 |   | 11,789 |   |
| Loss on impairment of long-lived assets                           |       | 250                                     |       | 53 |   | 303 |   |
| Loss on disposal of assets                                        |       | —                                  |       | 185 |   | 185 |   |
| Deferred income tax provision                                     |       | 5,541                                   |       | (209 | ) | 5,332 |   |
| Provision for deferred rent                                       |       | 488                                     |       | (488 | ) | — |   |
| Prepaid expenses and other assets                                 |       | 627                                     |       | (1,383 | ) | (756 | ) |
| Accounts payable, accrued expenses and other current  liabilities |       | (5,589                                  | )          | 408 |   | (5,181 | ) |
| Deferred rent and other non-current liabilities                   |       | —                                  |       | 2,107 |   | 2,107 |   |
| Net cash provided by operating activities                         |       | 28,478                                  |       | 2,578 |   | 31,056 |   |
| **Cash Flows from Investing  Activities**                         |       |                                    |       |   |   |   |   |
| Purchase of short-term investments                                |       | —                                  |       | (11,900 | ) | (11,900 | ) |
| Proceeds from sale of short-term investments                      |       | —                                  |       | 3,550 |   | 3,550 |   |
| Capital expenditures                                              |       | (9,839                                  | )          | (2,403 | ) | (12,242 | ) |
| Proceeds from disposal of property, plant and  equipment          |       | 175                                     |       | (175 | ) | — |   |
| Net cash used in investing activities                             |       | (9,291                                  | )          | (10,928 | ) | (20,219 | ) |
| **Net Increase (Decrease) in Cash and Cash  Equivalents**         |       | 4,401                                   |       | (8,350 | ) | (3,949 | ) |
|                                                                   |            |                                         |            |  |  |  |  |  |  |  |

 

----

* The tables include only those line items that have changed as aresult of the Restatement and the reclassification related to auction ratesecurities.

 

Certainamounts in Notes 3, 5, 7,13, 15 and 19 have been restated to reflect therestatement adjustments described above.

 

**3.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***a.***                 Principlesof Consolidation

*** ***

Theaccompanying consolidated financial statements include the accounts of MothersWork, Inc. and, as of September 30, 2004 and 2003, its direct andindirect wholly-owned subsidiaries of Cave Springs, Inc., Mothers WorkCanada, Inc., Maternity Factory Warehouse Centre, Inc. (awholly-owned subsidiary of Mothers Work Canada, Inc.) and ConfeccionesAcona S.A.  As of September 30,2002, the Company’s direct and indirect wholly-owned subsidiaries includedeSpecialty Brands, LLC (including its wholly-owned subsidiaries Dan HowardIndustries, Inc., Mother’s Stores, Inc., Confecciones Acona S.A. andMaternity Factory Warehouse Centre, Inc.) and Cave Springs, Inc.  During the year ended September 30,2003, (i) the Canadian assets of eSpecialty Brands, LLC and itssubsidiaries were contributed to a newly-formed subsidiary, Mothers Work Canada, Inc.,(ii) Confecciones Acona S.A. became a wholly-owned subsidiary of MothersWork, Inc., and (iii) eSpecialty Brands, LLC, Dan Howard Industries, Inc.and Mother’s

 

F-12

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

Stores, Inc.were merged into Mothers Work, Inc. All significant intercompany transactions and accounts have beeneliminated in consolidation.

 

***b.***                 Fiscal Year-End

*** ***

TheCompany operates on a fiscal year ending September 30 of each year.  All references to fiscal years of the Companyrefer to the fiscal years ended on September 30 in those years.  For example, the Company’s “fiscal 2004”ended on September 30, 2004.

 

***c.***                  Use ofEstimates

*** ***

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make certainestimates and assumptions that may affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

***d.***                 Cash andCash Equivalents

*** ***

Cashand cash equivalents include cash on hand, cash in the bank and short-terminvestments with an original maturity of three months or less whenpurchased.  Cash overdrafts of $2,979,000and $2,295,000 were included in accounts payable at September 30, 2004 and2003, respectively.

 

TheCompany maintains cash accounts that, at times, may exceed federally insuredlimits.  The Company has not experiencedany losses from maintaining cash accounts in excess of such limits.  Management believes that it is not exposed toany significant credit risks on its cash accounts.

 

***e.***                  Short-TermInvestments

*** ***

TheCompany’s short-term investments may be classified as either held-to-maturityor available-for-sale.  Held-to-maturitysecurities represent those securities that the Company has both the intent andability to hold to maturity and are carried at amortized cost.  Interest on these securities, as well asamortization of discounts and premiums, is included in interest income.  Available-for-sale securities represent thosesecurities that do not meet the classification of held-to-maturity, are notactively traded and are carried at fair value, which approximates amortizedcost.  Unrealized gains and losses onthese securities are excluded from earnings and are reported as a separatecomponent of shareholders’ equity until realized.  When available-for-sale securities are sold,the cost of the securities is specifically identified and is used to determinethe realized gain or loss.

 

TheCompany’s short-term investments as of September 30, 2004 and 2003 wereclassified as available-for-sale and consist exclusively of auction ratesecurities with the cost equal to the fair value.  These securities have liquidity provisions atspecified interest rate reset dates, typically every 7, 28 or 35 days and theoriginal maturity of the securities is beyond three months.  There were no realized gains or lossesassociated with these available-for-sale investments in fiscal 2004, 2003 or2002.

 

F-13

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

***f.***                    Inventories

*** ***

Inventoriesare valued at the lower of cost or market. Cost is determined by the “first-in, first-out” (FIFO) method.Inventories of goods manufactured by the Company include the cost of materials,freight, direct labor, and manufacturing and distribution overhead.

 

***g.***                 AdvertisingCosts

*** ***

TheCompany expenses the costs of advertising when the advertising occurs, exceptfor the costs associated with catalogs and brochures.  The production costs for catalogs andbrochures are deferred and amortized over a three to six month period correspondingto the expected period in which these items will be mailed.  Advertising and catalog expenses were$9,922,000, $8,651,000 and $7,580,000 in fiscal 2004, 2003 and 2002,respectively.

 

***h.***                 Property,Plant and Equipment

*** ***

Property,plant and equipment are stated at cost. Depreciation and amortization are computed for financial reportingpurposes on a straight-line basis, using service lives ranging principally fromfive to ten years for furniture and equipment and forty years for thebuilding.  Leasehold improvements areamortized using the straight-line method over the shorter of the lease term ortheir useful life, generally ten years. The cost of assets sold or retired and the related accumulateddepreciation or amortization are removed from the accounts with any resultinggain or loss included in net income. Maintenance and repairs are expensed as incurred except for thecapitalization of major renewals and betterments that extend the life of theasset.  Long-lived assets are reviewedfor impairment whenever adverse events or changes in circumstances or businessclimate indicate that the carrying value may not be recoverable.  Factors used in the valuation include, butare not limited to, management’s plans for future operations, brandinitiatives, recent operating results and projected cash flows.  If the associated undiscounted cash flows areinsufficient to support the recorded asset, an impairment is recognized toreduce the carrying value of the asset. The amount of the impairment loss is determined by comparing thediscounted expected future cash flows with the carrying value.

 

Duringfiscal 2004, 2003 and 2002, the Company recorded write downs of long-livedassets totaling $1,816,000, $616,000 and $303,000, respectively, on a pre-taxbasis.

 

***i.***                    Goodwill,Intangible and Other Assets

*** ***

Goodwillrepresents the excess of cost over the fair value of net assets acquired inbusiness combinations. Prior to fiscal 2002, goodwill was amortized using thestraight-line method over a period of 20 years.  Effective October 1, 2001, the Companyadopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwilland Other Intangible Assets,” and no longer amortizes goodwill.  As of October 1, 2001, managementdetermined that the Company had one reporting unit for purposes of applyingSFAS No.142 based on its reporting structure.  The Company made its initial assessment ofimpairment for the transition period as of October 1, 2001 and again as ofSeptember 30 of each subsequent year. The fair value of the Company’s single reporting unit at each of thesedates was determined based on the then fair market value of the Company’soutstanding common stock on a control basis.

 

F-14

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

Basedon this assessment, no impairment loss was recognized at any of the measurementdates.  The Company plans to perform anannual assessment for goodwill impairment at the end of each fiscal year or asimpairment indicators arise.  If the fairmarket value of the Company’s outstanding common stock on a control basis wereto significantly decline in the future, the goodwill would likely becomeimpaired.

 

Asummary of changes in the carrying amount of goodwill for fiscal 2004 and 2003is as follows (in thousands):

 
| Goodwill  at September 30, 2002                                                    |   | $      | 52,677 |   |
|-----------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Less:  reduction of iMaternity acquisition reserves and acquired payables (see Note  5) |   | (2,288 | )      |
| Goodwill  at September 30, 2004 and 2003                                           |   | $      | 50,389 |   |

** **

Duringfiscal 2003, the iMaternity purchase accounting reserves were reduced by$1,784,000, less a related tax effect of $625,000, and acquired payables werereduced by $1,129,000, resulting in a reduction to goodwill of $2,288,000 (seeNote 6).

 

Intangibleassets with definite useful lives, which primarily consist of lease acquisitioncosts, are amortized over the lease term (estimated to be ten years).  Management reviews the carrying amount ofthese intangible assets as impairment indicators arise, to assess the continuedrecoverability based on future undiscounted cash flows and operating resultsfrom the related asset, future asset utilization and changes in marketconditions.  As of September 30,2004, management does not believe that there has been any impairment to thecarrying value of these intangible assets. The Company has not identified any unamortizable intangible assets.  Aggregate amortization expense of intangibleassets in fiscal 2004, 2003 and 2002 was $224,000**,**$267,000 and $279,000, respectively.

 

Estimatedamortization expense for the next five fiscal years is as follows (inthousands):

 

| **Fiscal Year** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|
| 2005                 |       | $          | 194        |   |
| 2006                 |       | 171        |       |
| 2007                 |       | 135        |       |
| 2008                 |       | 116        |       |
| 2009                 |       | 104        |       |
|                      |            |            |            |  |

 

F-15

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

***j.***                    DeferredFinancing Costs

*** ***

Deferredfinancing costs (see Note 9) are amortized to interest expense over theterm of the related debt using the effective interest method.  Amortization expense of deferred financingcosts in fiscal 2004, 2003 and 2002 was $415,000, $387,000 and $1,670,000, ofwhich $1,173,000 ($763,000 on an after-tax basis) of the fiscal 2002 figurerepresented accelerated amortization in connection with the repayment of seniornotes.  Estimated amortization expensefor the next five fiscal years of deferred financing costs as of September 30,2004 is as follows (in thousands):

 

| **Fiscal Year** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|
| 2005                 |       | $          | 464        |   |
| 2006                 |       | 519        |       |
| 2007                 |       | 580        |       |
| 2008                 |       | 649        |       |
| 2009                 |       | 726        |       |
|                      |            |            |            |  |

 

***k.***                 DeferredRent

*** ***

Rentexpense on operating leases is recorded on a straight-line basis over the termof the lease.  The net excess of rentexpense over the actual cash paid has been recorded as deferred rent in theaccompanying Consolidated Balance Sheets.

 

***l.***                    Treasury(Reacquired) Shares

*** ***

Sharesrepurchased are retired and treated as authorized but unissued shares, with thecost in excess of par value of the reacquired shares charged to additionalpaid-in capital and the par value charged to common stock.

 

***m.***              Fair Valueof Financial Instruments

*** ***

Thecarrying values of cash and cash equivalents, short-term investments, tradereceivables and accounts payable approximate fair value due to the short-termnature of those instruments.  Based upona valuation of the New Senior Notes by a third party, the fair value of thelong-term debt as of September 30, 2004 was approximately $126,716,000,which is slightly lower than its carrying value.

 

***n.***                 RevenueRecognition, Sales Returns and Allowances

*** ***

Revenueis recognized at the point of sale for retail store sales, including leaseddepartment sales, or when merchandise is shipped to customers for Internet andmail order sales.  Allowances for returnsare recorded as a reduction of revenue, based on the Company’s historicalexperience.

 

***o.***                 OtherRevenues

*** ***

Includedin net sales are revenues earned by the Company through a variety of marketingpartnership programs utilizing the Company’s extensive opt-in customer databaseand various in-store marketing initiatives, focused on baby and parent-relatedproduct and services.

 

***p.***                 Shipping andHandling Fees and Costs

*** ***

TheCompany includes shipping and handling revenue earned from its catalog ande-commerce activities in net sales. Shipping and handling costs, which are included in cost of goods sold inthe accompanying Consolidated Statements of Operations, include shippingsupplies, related labor costs and third-party shipping costs.

 

***q.***                 Income Taxes

*** ***

TheCompany utilizes the asset and liability method of accounting for income taxesas prescribed by SFAS No. 109, “Accounting for Income Taxes.”  Under this method, deferred tax assets andliabilities are recognized for the expected future tax consequences oftemporary differences between the carrying amounts and the tax bases of assetsand liabilities as well as from net operating loss carryforwards.  The effect on deferred tax assets andliabilities of a change in tax rates is recognized in operations in the periodthat includes the enactment date.

 

F-16

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

***r.***                   Accountingfor Stock-Based Compensation

*** ***

TheCompany accounts for stock-based compensation under the provisions ofAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretation.  The Company has adopted the disclosurerequirements of SFAS No. 123, “Accounting for Stock-BasedCompensation,” as amended by SFAS No. 148 “Accounting for Stock-BasedCompensation-Transition and Disclosure”, but has elected to continue to measurecompensation expense in accordance with APB Opinion No. 25.  Accordingly, no compensation expense forstock options has been recognized for stock option awards granted at fairmarket value.  Had the compensation costfor the Company’s stock-based compensation plans been determined based on thefair value at the grant dates for awards under those plans in accordance withthe provisions of SFAS No. 123, the Company’s net earnings andearnings per share would have been reduced to the pro forma amounts indicatedbelow.  The effect of applying SFAS No. 123in this pro forma disclosure is not indicative of future amounts.  SFAS No. 123 does not apply tooptions awarded prior to the fiscal year ended September 30, 1996.  Additional option awards are anticipated infuture years (see Note 12).

 
| ** **                                                                                                                  | ** ** | **Year Ended September 30,**                             | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2004**                                                                | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                                  | ** ** | **(in thousands, except  per share amounts) (Restated)** | ** ** |
| Net  income available to common stockholders:                                                                               |       |                                                                    |       |   |   |   |   |
| As restated                                                                                                                 |       | $                                                                       | 5,039      |   | $ | 13,214 |   | $ | 6,458 |   |
| Stock-based employee compensation expense  included in the determination of net income as reported, net of tax              |       | 116                                                                     |       | — |   | — |   |
| Deduct total stock-based employee compensation  expense determined under fair value-based method for all awards, net of tax |       | (1,525                                                                  | )          | (2,910 | ) | (950 | ) |
| Pro forma net income available to common  stockholders                                                                      |       | $                                                                       | 3,630      |   | $ | 10,304 |   | $ | 5,508 |   |
| Net  income available to common stockholders per share—Basic:                                                          |       |                                                                    |       |   |   |   |   |
| As restated                                                                                                                 |       | $                                                                       | 0.97       |   | $ | 2.52 |   | $ | 1.65 |   |
| Pro forma                                                                                                                   |       | 0.70                                                                    |       | 1.97 |   | 1.41 |   |
| Net  income net income available to common stockholders per   share—Diluted:                                           |       |                                                                    |       |   |   |   |   |
| As restated                                                                                                                 |       | $                                                                       | 0.92       |   | $ | 2.34 |   | $ | 1.52 |   |
| Pro forma                                                                                                                   |       | 0.66                                                                    |       | 1.86 |   | 1.29 |   |

 

***s.***                   Earnings perShare

*** ***

Basicearnings per share is computed by dividing net income available to commonstockholders by the weighted average number of outstanding common shares.  Diluted earnings per share is computed basedupon the weighted average number of outstanding common shares, after givingeffect to the potential dilutive effect from the assumed exercise of the commonstock equivalents including stock options and warrants, as well as the assumedconversion of dilutive securities of the Company, including any convertiblepreferred stock and debt (see Note 10).

 

F-17

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

Thefollowing summarizes those effects for the diluted earnings per sharecalculation (in thousands):

 
| ** **                                                                              | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Average  number of shares outstanding—Basic                                        |       | 5,212                                       |       | 5,236 |   | 3,914 |   |
| Incremental  shares from the assumed exercise of outstanding stock options and warrants |       | 289                                         |       | 410 |   | 347 |   |
| Average  number of shares outstanding—Diluted                                      |       | 5,501                                       |       | 5,646 |   | 4,261 |   |

 

Optionsto purchase 467,170, 202,850 and 10,000 shares of the Company’s common stockwere outstanding as of September 30, 2004, 2003 and 2002, respectively,but were not included in the computation of diluted earnings per share forfiscal 2004, 2003 and 2002, respectively, as their effect would have beenantidilutive.

 

***t.***                    Statementsof Cash Flows

*** ***

Infiscal 2004, 2003 and 2002, the Company paid interest of $14,415,000,$14,503,000 and $13,289,000, respectively, and made income tax payments of$3,258,000, $5,447,000 and $2,602,000, respectively.

 

***u.***                 Internal UseSoftware

*** ***

TheCompany records the costs of computer software, inclusive of websitedevelopment costs, in accordance with Statement of Position (“SOP”) 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use”issued by the Accounting Standards Executive Committee of the AmericanInstitute of Certified Public Accountants. SOP 98-1 requires that certaininternal-use computer software costs be capitalized and amortized over theuseful life of the asset.  In fiscal2004, 2003 and 2002, the Company capitalized $50,000, $84,000 and $104,000,respectively, of costs related to the development of internal-use software.

 

***v.***                  Business andCredit Risk

*** ***

Financialinstruments, primarily cash and cash equivalents, short-term investments andaccounts receivable, potentially subject the Company to concentrations ofcredit risk.  The Company limits itscredit risk associated with cash and cash equivalents and short-terminvestments by placing such investments in highly liquid funds andinstruments.  Receivables associated withthird party credit cards are processed by financial institutions, which aremonitored for financial stability.  TheCompany is dependent on key suppliers to provide sufficient quantities ofinventory at competitive prices.  Nosingle supplier represented 10% or more of net purchases in fiscal 2004, 2003or 2002.  A majority of the Company’spurchases during fiscal 2004 were imported. The Company imported from 27 countries during fiscal 2004.  Management believes that any event causing adisruption of imports from any specific country could be mitigated by movingproduction to readily available alternative sources.

 

***w.***               Insurance

*** ***

TheCompany is self-insured for workers’ compensation and employee-related healthcare benefits, up to certain stop-loss limits. Such costs are accrued based on known claims and an estimate of incurredbut

 

F-18

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

 

notreported claims.  Further, the Companyutilizes a cooperative arrangement with a number of other companies to assistin managing certain insurance risks.  TheCompany’s expenses associated with this relationship could be impacted by theloss history associated with the cooperative as a whole.  Liabilities associated with these risks areestimated by considering historical claims experience and other actuarialassumptions.

 

***x.***                 StorePreopening Costs

*** ***

Non-capitalexpenditures, such as payroll costs incurred prior to the opening of a newstore, are charged to expense in the period in which they were incurred.

 

***y.***                  Reclassifications

*** ***

Certainreclassifications have been made to the prior year consolidated financialstatements to conform to the current year presentation.

 

***z.***                   NewAccounting Pronouncements

*** ***

OnMarch 31, 2004, the Financial Accounting Standards Board (“FASB”) issuedits exposure draft, “Share-Based Payment,” which is a proposed amendment toSFAS No. 123.  Generally, theapproach in the exposure draft is similar to the approach described in SFAS No. 123.  However, the exposure draft would require allshare-based payments to employees, including grants of employee stock options,to be recognized in the Company’s statement of operations based on their fairvalues.  There are a number of issuesthat are not resolved in the exposure draft, including the final methodologyfor calculating fair value.  The FASBexpects to issue a final standard in the near future that would be effectivefor interim and annual periods beginning after June 15, 2005.  The pro forma impact of the adoption of SFAS No. 123on the Company’s historical financial statements is included in these notes toconsolidated financial statements.  TheCompany expects to continue to grant stock-based compensation toemployees.  The impact of the newstandard, when and if issued, may have a material adverse impact on the Company’sfuture results of operations.

 

**4.INVENTORIES**

** **

Inventoriesas of September 30 were comprised of the following (in thousands):

 
| ** **       | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------|------------|----------|------------|----------|------------|
| Finished  goods  |       | $        | 81,428     |     | $          | 73,583 |   |
| Work-in-progress |       | 3,317    |       | 2,778    |       |
| Raw  materials   |       | 7,998    |       | 8,144    |       |
|             |       | $        | 92,743     |     | $          | 84,505 |   |

 

F-19

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**5.PROPERTY, PLANT AND EQUIPMENT, NET**

** **

Property,plant and equipment as of September 30 was comprised of the following (inthousands):

 
| ** **                                       | ** ** | **2004**       | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------------|------------|----------|------------|
| ** **                                       | ** ** | **(Restated)** | ** ** |
| Land                                             |       | $              | 1,400      |     | $          | 1,400 |   |
| Building  and improvements                       |       | 12,062         |       | 11,549   |       |
| Furniture  and equipment                         |       | 47,748         |       | 42,349   |       |
| Leasehold  improvements                          |       | 100,682        |       | 95,454   |       |
|                                             |       | 161,892        |       | 150,752  |       |
| Less:  accumulated depreciation and amortization |       | (83,430        | )          | (77,372  | )          |
|                                             |       | $              | 78,462     |     | $          | 73,380 |   |

 

Duringfiscal 2004 and 2003, the Company recorded pre-tax charges under SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” of $1,816,000and $616,000, respectively, and during fiscal 2002, the Company recordedpre-tax charges under SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to Be Disposed Of,”**of $303,000, related to the impairment of leaseholdimprovements and furniture and equipment at certain of its retail locations.

 

Asof September 30, 2004, $1,200,000 of assets held for sale (not includedabove) relate to the manufacturing and warehouse facilities located in CostaRica that were acquired in the purchase of iMaternity (see Note 6).  These facilities, shut down during fiscal2002, are being marketed for sale, are not being depreciated and are separatelyreflected in the accompanying Consolidated Balance Sheets as “Assets Held forSale.”

 

**6.ACQUISITION**

** **

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

 

Basedon the allocation of purchase price, the application of the purchase method ofaccounting resulted in approximately $23,093,000 of excess purchase price overthe estimated fair value of the net tangible assets acquired of $22,145,000,less assumed liabilities of $16,553,000 and costs to exit certain operationsand locations of iMaternity of $8,937,000. In addition, in connection with the acquisition, the Company assumedcertain liabilities with trade creditors of $1,700,000 that were indispute.  During fiscal 2003, adetermination was made that a portion of these liabilities and certain otheracquired payables would not be paid.  TheCompany reduced the iMaternity purchase accounting reserves by $1,784,000,reflected a related reduction of deferred income tax assets of $625,000, andreduced the acquired payables by $1,129,000, resulting in a reduction to goodwillof $2,288,000.

 

F-20

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**6.ACQUISITION (Continued)**

 

At the Acquisition Date,iMaternity operated a total of 166 Dan Howard and Mothertime maternity clothingstores, including some under the iMaternity tradename, and the onlineiMaternity.com website.  The Companydeveloped a plan in conjunction with the acquisition to close 92 iMaternitystores and convert the remaining acquired locations to the Company’s existingstore concepts of Motherhood and Mimi. In fiscal 2003, the Company concluded that it would not close 12 of theoriginal stores that were intended to be closed, and the estimated leasetermination costs accrued for these anticipated closures of $1,519,000, less arelated tax effect of $532,000, was reversed against goodwill.  During fiscal 2004, the Company closed fouriMaternity stores which were part of the original 92 planned storeclosures.  Further, the plan included theshutdown of iMaternity’s corporate headquarters and warehouse operation inChicago, as well as its manufacturing and warehousing facilities in CostaRica.  In connection with the plan, theCompany originally recorded severance costs for involuntarily terminatedemployees of the acquired business of $2,587,000, lease termination fees andrelated legal costs of $4,200,000, and accrued for other costs to be incurredto complete the exit activities of the acquired business totaling$2,150,000.  Approximately 850 employeesof the acquired business were expected to be terminated as part of the plan,consisting of 528 corporate and 322 store employees.

 

As of September 30,2004, the Company has closed 110 acquired iMaternity stores, of which 82 wereincluded as part of the 92 planned store closures.  During fiscal 2002, the Company closed thecorporate headquarters and warehouse operation in Chicago, an internet-relateddevelopment center in San Diego, California and other domestic warehousingfacilities.  The iMaternity manufacturingand warehousing operations in Costa Rica have been shut down, are beingmarketed for sale and are expected to be sold during fiscal 2005.  The carrying values of the Costa Ricanfacilities were reduced by $200,000 during fiscal 2002 to their estimatedrealizable values as of the Acquisition Date, which were determined based on amarket survey received from an independent third party less estimated sellingcosts, and is classified as “Assets Held For Sale” in the accompanyingconsolidated balance sheets.  As ofSeptember 30, 2004, the remaining accrual for exit costs of $201,000 isprincipally for expected costs related to the Costa Rican properties.

 

In connection with thestore closures and the shutdown of the various facilities as described above,the Company terminated 820 employees (524 corporate and 296 store employees),to whom $1,687,000 in accrued severance was paid out and charged against theliability as of September 30, 2002. Included in the severance payouts are monthly installments made on thenon-compete covenant and severance arrangement with a former executive ofiMaternity.  During fiscal 2003, theremaining severance accrual was reduced by $97,000, less a related tax effectof $34,000, against goodwill.  Thebalance of the severance reserve reflects a non-compete and severancearrangement that is payable ratably on a monthly basis throughSeptember 30, 2006.

 

F-21

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**6. ACQUISITION (Continued)**

 

A summary of the chargesincurred and reserves recorded in connection with the iMaternity acquisitionexit/restructuring activities during fiscal 2004 is as follows (in thousands):

 
| ** **             | ** ** | **Reserves  Recorded in  Purchase  Accounting** | ** ** | **Balance as of  September 30, 2003** | ** ** | **Payments  During Fiscal  2004** | ** ** | **Balance as of  September 30, 2004** | ** ** |
|------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------|------------|
| Lease termination fees |       | $                                                    | 4,200      |                                                      | $          | 668                                    |       | $                                                         | (419       | ) | $ | 249 |   |
| Severance              |       | 2,587                                                |       | 600                                                       |       | (200                                   | )          | 400                                                       |       |
| Exit and other costs   |       | 2,150                                                |       | 325                                                       |       | (124                                   | )          | 201                                                       |       |
|                   |       | $                                                    | 8,937      |                                                      | $          | 1,593                                  |       | $                                                         | (743       | ) | $ | 850 |   |
|                        |            |                                                      |            |                                                           |            |                                        |            |                                                           |            |  |  |  |  |  |

 

The following tabledisplays the net non-cash assets that were acquired in conjunction with theiMaternity acquisition as adjusted for the above-mentioned changes to theacquired liabilities (in thousands):

 
| Non-cash assets (liabilities):                    |   |    |   |
|---------------------------------------------------|--------|---------|--------|
| Inventory                                         |   | $       | 6,168  |   |
| Property, plant and equipment                     |   | 3,412   |   |
| Deferred income taxes                             |   | 10,825  |   |
| Other current assets                              |   | 541     |   |
| Goodwill                                          |   | 20,805  |   |
| Current liabilities, including transaction  costs |   | (14,560 | )      |
| Debt                                              |   | (8,892  | )      |
| Net non-cash assets acquired                      |   | 18,299  |   |
| Less: Preferred stock issued                      |   | (17,999 | )      |
| Less: Warrants issued                             |   | (874    | )      |
| Cash acquired from the acquisition of  iMaternity |   | $       | (574   | ) |

 

F-22

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**7. ACCRUED EXPENSES ANDOTHER CURRENT LIABILITIES**

 

As of September 30,accrued expenses and other current liabilities were comprised of the following(in thousands):

 
| ** **                                                  | ** ** | **2004**       | ** ** | **2003** | ** ** |
|-------------------------------------------------------------|------------|----------------|------------|----------|------------|
| ** **                                                  | ** ** | **(Restated)** | ** ** |
| Salaries, wages and employee benefits                       |       | $              | 8,944      |     | $          | 8,089 |   |
| Income taxes payable                                        |       | 1,344          |       | 1,991    |       |
| Interest                                                    |       | 2,358          |       | 2,356    |       |
| Deferred rent                                               |       | 3,935          |       | 3,524    |       |
| Sales taxes                                                 |       | 2,458          |       | 2,306    |       |
| Insurance                                                   |       | 2,425          |       | 2,135    |       |
| Rent                                                        |       | 608            |       | 802      |       |
| Audit and legal                                             |       | 1,671          |       | 2,368    |       |
| Reserves recorded in iMaternity acquisition (Note 6)        |       | 850            |       | 1,593    |       |
| Remaining payout for redeemed Series A Preferred Stock |       | 1,052          |       | 2,414    |       |
| Accrued store construction costs                            |       | 1,514          |       | 1,991    |       |
| Gift certificates and store credits                         |       | 2,586          |       | 1,988    |       |
| Other                                                       |       | 4,751          |       | 3,313    |       |
|                                                        |       | $              | 34,496     |     | $          | 34,870 |   |

 

**8. LINE OF CREDIT**

 

On October 15,2004, the Company entered into a new five-year $60,000,000 senior securedrevolving credit facility (the “New Credit Facility”), which replaced theformer $60 million credit facility that included a $56,000,000 borrowing baserevolving line of credit.  The New CreditFacility will mature on October 15, 2009. Upon the Company’s request and with the consent of the lender, permittedborrowings under the New Credit Facility may be increased up to an additional$15,000,000, in increments of $2,500,000,****up to amaximum limit of $75,000,000.  Proceedsfrom advances under the New Credit Facility, with certain restrictions, may beused to provide financing for working capital, letters of credit, capitalexpenditures, debt prepayments, dividends, share repurchases and other generalcorporate purposes.  The Company paidcertain closing fees in connection with the negotiation and execution of theNew Credit Facility.  The Company alsopays an unused line fee under the New Credit Facility and certain earlytermination fees if the new credit facility is terminated prior to its thirdanniversary.  The New Credit Facilitycontains various affirmative and negative covenants and representations andwarranties.  There are no financial covenant requirements under the New CreditFacility unless either (i) ExcessAvailability (as defined in the agreement) falls below $10,000,000, or (ii) average Financial CovenantAdjusted Availability (as defined in the agreement) for any calendar month is less than$15,000,000.  If either of the events initem (i) or (ii) above occurs, the Company would be required to meeta certain minimum fixed charge coverage ratio (which increases from 1.00x duringthe first two years of the New Credit Facility to 1.10x during the fifth yearof the New Credit Facility).  The New Credit Facility is secured by a security interest in theCompany’s accounts receivable, inventory, real estate interests, letter ofcredit rights, cash, intangibles and certain other assets.  The interest rate on outstanding borrowingsis equal to, at the Company’s election, either the lender’s prime rate or thelender’s LIBOR rate plus the applicable margin. The applicable margin for LIBOR rate borrowings is variable, rangingfrom 1.25% to 1.75%, based upon

 

F-23

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**8. LINE OF CREDIT (Continued)**

 

theavailability calculation made in accordance with the New CreditFacility. Any amounts outstanding under the New Credit Facility may beaccelerated and become due and payable immediately and all loan and letter ofcredit commitments thereunder may be terminated upon an event of default andexpiration of any applicable cure period. Events of default include: (i) nonpayment of obligations due underthe New Credit Facility, (ii) failure to perform any covenant or agreementcontained in the New Credit Facility, (iii) material misrepresentations,(iv) failure to pay, or certain other defaults under, other materialindebtedness, (v) certain bankruptcy or insolvency events, (vi) achange of control, (vii) material uninsured losses,(viii) indictments of the Company or senior management in a materialforfeiture action, and (ix) customary ERISA defaults, among others.

 

Prior to entering intothe New Credit Facility, the Company had a $60 million credit facility maturingon September 15, 2005, which included a $56 million borrowing baserevolving line of credit and approximately $4 million to support a specialpurpose letter of credit facility. Amounts available for direct borrowings, net of letters of creditoutstanding, were limited to the lesser of (a) the unused portion of thecredit facility or (b) the Aggregate Adjusted Availability (“AAA”) asdefined in the agreement based on a percentage of eligible inventory,receivables and cash.  The creditfacility was secured by a security interest in the Company’s accounts receivable,inventory, equipment, fixtures, cash and other assets.  There were no financial covenant requirementsin the agreement unless the AAA falls below $10 million.  In such event, the Company would have had toachieve minimum cash flow, as defined in the agreement, of not less thanzero.  During fiscal 2004, 2003 and 2002,the Company always exceeded the minimum required AAA.

 

As of September 30,2004, outstanding borrowings under the credit facility consisted of no directborrowings and $3,700,000 in letters of credit with AAA and available borrowingsof $52,300,000, compared to no direct borrowings and $3,900,000 in letters ofcredit with AAA and available borrowings of $52,100,000 as ofSeptember 30, 2003.  In addition,pursuant to the special purpose letter of credit facility, as ofSeptember 30, 2004 and 2003, the Company had an outstanding standby letterof credit of $3,149,000 and $3,300,000, respectively, to collateralize anoutstanding industrial revenue bond.  Asof September 30, 2003, the Company had a $1,000,000 letter of credit tocollateralize a government mortgage note; this letter of credit wassubsequently cancelled during fiscal 2004. Borrowings under the credit facility as of September 30, 2004 wouldhave borne interest at the rate of between approximately 3.84% and 4.75% perannum.  The Company had no directborrowings under the credit facility during fiscal 2004 and 2003.

 

F-24

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**9. LONG-TERM DEBT**

 

The following tablesummarizes the Company’s long-term debt as of September 30 (in thousands):

 
| ** **                                                                                                                                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| 111⁄4% senior notes due August 1, 2010 (net of unamortized  discount)                                                                                                                      |       | $        | 123,701    |     | $          | 123,552 |   |
| Industrial Revenue Bond, interest is  variable (1.7% as of September 30, 2004), principal due annually through  September 1, 2020 (collateralized in full by a standby letter of credit) |       | 3,075    |       | 3,200    |       |
|                                                                                                                                                                                               |       |     |       |     |       |
| *Government Mortgage Notes:*                                                                                                                                                                       |       |     |       |     |       |
| * *                                                                                                                                                                                           |       |     |       |     |       |
| Interest at 3.0%, principal due monthly  until May 1, 2011 (collateralized by a second mortgage on certain  property and equipment at the Company’s headquarters)                        |       | 1,000    |       | 1,134    |       |
| Interest at 2.0%, principal due monthly  until March 1, 2011 (collateralized by certain equipment at the  Company’s headquarters)                                                        |       | 141      |       | 161      |       |
|                                                                                                                                                                                               |       | 127,917  |       | 128,047  |       |
| Less: current portion                                                                                                                                                                              |       | (288     | )          | (279     | )          |
|                                                                                                                                                                                               |       | $        | 127,629    |     | $          | 127,768 |   |

 

Long-term debtmaturities as of September 30, 2004 are as follows (in thousands): 

 
| **Fiscal Year**       | ** ** | ** ** | ** ** |
|----------------------------|------------|------------|------------|
| 2005                       |       | $          | 288        |   |
| 2006                       |       | 298        |       |
| 2007                       |       | 313        |       |
| 2008                       |       | 322        |       |
| 2009                       |       | 337        |       |
| 2010 and thereafter        |       | 127,658    |       |
|                       |       | 129,216    |       |
| Less: unamortized discount |       | (1,299     | )          |
|                       |       | $          | 127,917    |   |
|                            |            |            |            |  |  |

 

In August 2002, theCompany repurchased the outstanding $92,000,000 of 125/8% seniornotes (the “Old Senior Notes”) with a portion of the proceeds from the issuanceof $125,000,000 of 111⁄4% senior notes due 2010 (the “New Senior Notes”) and1,165,000 shares of common stock (see Note 10).  The Company received net proceeds from thedebt offering of approximately $118,900,000, net of issuance discount ofapproximately $1,600,000 and after deducting fees and expenses of theoffering.  The Company used approximately$92,700,000 of the net proceeds from the debt offering for the repurchase ofthe Old Senior Notes, including accrued and unpaid interest and related feesand expenses.  In addition, the Companyused approximately $2,600,000 of the net proceeds from the debt offering forthe repayment of subordinated notes that had been issued in lieu of cashdividends on shares of Series A Preferred Stock previously converted intocommon stock.

 

F-25

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**9. LONG-TERM DEBT (Continued)**

 

In connection with theissuance of the New Senior Notes in fiscal 2002, the Company incurred deferredfinancing costs of $4,497,000.  Thesedeferred financing costs, along with the debt discount, are being amortized andincluded in interest expense over the term of the New Senior Notes, using the effectiveinterest method.  In connection with therepurchase of the Old Senior Notes in fiscal 2002, the Company wrote off theremaining deferred financing costs of $1,173,000 related to the Old SeniorNotes.

 

The New Senior Notes aredue August 1, 2010 and were issued at 98.719% of their face amount,resulting in an annual effective interest rate of 11.50%.  Interest on the New Senior Notes is payablesemi-annually in cash on February 1 and August 1, commencing onFebruary 1, 2003.  The New SeniorNotes were issued by Mothers Work, are senior unsecured obligations of MothersWork, and are unconditionally guaranteed on a senior basis by all of theCompany’s domestic subsidiaries (see Note 15).  The New Senior Notes are redeemable at theCompany’s option, in whole or in part at any time on or after August 1,2006 at 105.625% of their face amount, plus accrued and unpaid interest,declining ratably to 100% of their face amount, plus accrued and unpaidinterest, on or after August 1, 2009. Additionally, prior to August 1, 2005, the Company may redeem, atits option, up to 35% of the aggregate principal amount of the New Senior Noteswith the proceeds from equity offerings at 111.25% of their principal amount,plus accrued and unpaid interest, in accordance with the terms of the indentureof the New Senior Notes.  The New SeniorNotes impose certain restrictions on the Company’s ability to, among otherthings, incur additional indebtedness, pay dividends, repurchase stock, andenter into other various types of transactions.

 

During fiscal 2001,certain holders of the Series A Preferred Stock elected to convert 2,591shares with a stated value of $727,000 into shares of common stock at aninitial conversion rate equal to ten shares of common stock for each share ofSeries A Preferred Stock.  TheCompany was restricted under the terms of the Old Senior Notes from paying cashdividends to the holders of the Series A Preferred Stock upon conversion.  Accordingly, the Company issued $331,000 ofsubordinated notes in fiscal 2001, with unpaid interest compounding annually atthe prime rate until paid.  During fiscal2002, a total of 11,496 shares of the Series A Preferred Stock with astated value of approximately $3,200,000 were converted into 114,955 shares ofcommon stock.  The Company was restrictedunder the terms of the Old Senior Notes from paying cash dividends to theholders of the Series A Preferred Stock upon conversion.  As a result, the Company issued subordinatednotes totaling $2,214,000 in fiscal 2002, with unpaid interest compoundingannually at the prime rate until paid. The subordinated notes were convertible after August 1, 2003 intocommon stock in accordance with the terms of those notes.  The subordinated notes, totalingapproximately $2,600,000 including accrued and unpaid interest, were repaid infull in August 2002 using a portion of the net proceeds from the debtoffering.

 

**10. COMMON AND PREFERREDSTOCK**

 

In connection with theMotherhood acquisition on August 1, 1995, the Company issued 41,000 sharesof Series A Preferred Stock with a stated value of $11,500,000.  The holders of the Series A PreferredStock were entitled to receive cash dividends, which were cumulative to theextent not paid, and compounded annually at 8.5% of the stated value.  In addition, the Series A PreferredStock was convertible into shares of common stock at specified conversion ratesdepending on the date of conversion. Pursuant to the optional redemption provisions of the Series APreferred Stock, the Company redeemed all of the outstanding Series APreferred Stock in August 2002 using a portion of the proceeds from thedebt and equity offerings.

 

F-26

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**10. COMMON AND PREFERRED STOCK (Continued)**

 

In connection with theRights Agreement dated March 17, 1997 (see Note 11), the Companyauthorized 10,000 shares of Series B Junior Participating Preferred Stock(the “Series B Preferred Stock”). In fiscal 2003, the Board of Directors of the Company authorized anadditional 290,000 shares of Series B Preferred Stock.  The Series B Preferred Stock can be purchasedin units equal to one one-thousandth of a share (the “Series B Units”)under the terms of the Rights Agreement. The holders of the Series B Units are entitled to receive dividendswhen and if declared on common stock. Series B Units are junior to thecommon stock for both dividends and liquidations.  Each Series B Unit votes as one share ofcommon stock.

 

In connection with theacquisition of iMaternity, the Company issued 302,619 shares of Series CPreferred Stock, having an aggregate stated value of $19,500,000 and valued atan estimated $59.48 per share, or $17,999,000, as determined by an independentthird party appraiser.  The excess bywhich the stated value of the Series C Preferred Stock exceeded itscarrying value was accreted to the earliest redemption date using the effectiveinterest method.  This accretion wasrecorded as dividends in the accompanying consolidated statements ofoperations.  Additionally, the holders ofthe Series C Preferred Stock were entitled to receive dividends at anannual rate of 8.625% of the stated value, compounded quarterly.  On August 6, 2002, the Company purchasedall outstanding shares of the Series C Preferred Stock for $20,890,000,which included accrued and unpaid dividends of $1,390,000.  As a result of the purchase of theSeries C Preferred Stock, the Company recognized the remaining unaccreteddiscount of $1,310,000 as additional dividends on preferred stock in fiscal2002.

 

The Company hasauthorization to issue up to 2,000,000 shares of preferred stock, par value$0.01.  There was no preferred stockissued or outstanding as of September 30, 2004 or 2003.

 

In August 2002, theCompany completed a public equity offering whereby the Company issued 1,165,000shares of common stock, including the full exercise of the over-allotmentoption by the underwriters.  In addition,as part of this offering, certain selling stockholders sold 100,000 shares ofthe Company’s common stock.  The Companyreceived net proceeds from the equity offering of approximately $28,400,000after deducting fees and expenses of the offering.

 

The Company used the netproceeds of the equity offering, along with the net proceeds of the$125,000,000 offering of New Senior Notes, to repay certain indebtedness, toredeem the Series A Preferred Stock, to repurchase the Series CPreferred Stock, to repay the outstanding borrowings under its credit facility,and for general corporate purposes.  TheCompany received net proceeds from the debt and equity offerings ofapproximately $147,900,000, after deducting fees and expenses of the offeringsand including approximately $600,000 of cash proceeds from the exercise ofstock options by certain selling stockholders in conjunction with the equityoffering.

 

The Company usedapproximately $92,700,000 of the net proceeds of the offerings for therepurchase of the Old Senior Notes, and used approximately $2,600,000 for therepayment of subordinated notes that had been issued in lieu of cash dividendson shares of Series A Preferred Stock previously converted into commonstock.  The Company used approximately$13,400,000 to redeem all of the outstanding Series A Preferred Stock,including accrued and unpaid dividends, of which approximately $12,400,000 hasbeen paid as of September 30, 2004 and approximately $1,000,000 will bepaid out upon submission of proper documentation from the remaining holders ofthe Series A Preferred Stock.

 

F-27

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**10. COMMON AND PREFERRED STOCK (Continued)**

 

Additionally, theCompany used approximately $20,900,000 of the net proceeds from the offeringsfor the repurchase of the Series C Preferred Stock issued to the sellersof iMaternity in October 2001, including accrued and unpaid dividends.  The remaining $18,300,000 of net proceedsfrom the offerings were used to repay all of the outstanding borrowings underthe Company’s credit facility, with the balance invested in short-terminvestments and available for general corporate purposes.

 

In March 2003, theCompany’s Board of Directors approved a share repurchase program, under whichit may repurchase up to $10,000,000 of the Company’s outstanding common stockfrom time to time until March 2005 (see Note 18).

 

**11. RIGHTS AGREEMENT**

 

In accordance with theCompany’s Rights Agreement, the Company provided and will provide one Rightoutstanding for each share of Mothers Work common stock now or hereafteroutstanding.  Under certain limitedconditions, as defined in the Rights Agreement, each Right entitles theregistered holder to purchase from the Company one Series B Unit at $85per share, subject to adjustment.  Therights expire on October 9, 2005 (the “Final Expiration Date”).

 

On March 17, 1997,the Company amended its Rights Agreement to provide the independent directorsof the Company with some discretion in determining when the Distribution Date(as defined in the Rights Agreement) shall occur and the date until which theRights may be redeemed.  In addition, theAmended and Restated Rights Agreement exempts from its operation any personthat acquires, obtains the right to acquire, or otherwise obtains beneficialownership of 10.0% or more of the then outstanding shares of the Company’scommon stock (an “Acquiring Person”) without any intention of changing orinfluencing control of the Company provided that such person, as promptly aspracticable, divests himself or itself of a sufficient number of shares ofcommon stock so that such person would no longer be an Acquiring Person.

 

The Rights are notexercisable until the Distribution Date, which will occur upon the earlier of(i) ten business days following a public announcement that an AcquiringPerson has acquired beneficial ownership of 10.0% or more of the Company’soutstanding common stock, and ten business days following the commencement of atender offer or exchange offer that would result in a person or group owning10.0% or more of the Company’s outstanding common stock, or (ii) suchlater date as may be determined by action of a majority of the independentdirectors.  The Rights have certainanti-takeover effects.  The Rights willcause substantial dilution to a person or group that attempts to acquire theCompany without conditioning the offer on the redemption of the Rights.

 

The Rights can bemandatorily redeemed by action of a majority of the independent directors atany time prior to the earlier of the Final Expiration Date and the DistributionDate for $.01 per Right.  Upon exerciseand the occurrence of certain events, as defined in the Rights Agreement, eachholder of a Right, except the Acquiring Person, will have the right to receiveSeries B Units, or common stock of the acquiring company, in each casehaving a value equal to two times the exercise price of the Right.

 

On October 14,2001, the Company amended its Rights Agreement to include Centre Partners andits affiliates as exempt persons under the terms of the Rights Agreement.  In addition, on June 4, 2002, theCompany further amended the Rights Agreement to (i) increase the number ofshares of Company

 

F-28

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**11. RIGHTS AGREEMENT (Continued)**

 

common stock that may bebeneficially owned by the Meridian Group, (ii) amend the definition ofBeneficial Ownership to exclude, under certain circumstances, any deemedattribution of beneficial ownership between the Meridian Group and a specifiedindividual who has served as a general partner of certain entities within theMeridian Group, (iii) amend the definition of Independent Director, and(iv) amend the definition of Meridian Group.

 

**12. STOCK OPTION PLANSAND WARRANTS**

 

The Company has twostock option plans: the Director Stock Option Plan and the Amended and Restated1987 Stock Option Plan.  Under theDirector Stock Option Plan, as of October 1, 2002, each outside directoris granted 3,000 fully vested options on an annual basis, at an exercise priceequal to the fair market value of the stock on the grant date.  Under the 1987 Stock Option Plan, as amendedand restated, officers and certain employees may be granted options to purchasethe Company’s common stock at exercise prices equal to the fair market value ofthe stock at the date of grant or at other prices as determined by the CompensationCommittee of the Board of Directors.  Nooptions have been granted by the Company at less than the fair market value ofthe Company’s common stock on the date of grant for any of the periodspresented.  In February 2003, thestockholders of the Company approved an amendment to increase the number ofshares of common stock available for issuance upon the exercise of optionsgranted under these plans by 500,000, up to a total of 2,175,000 options whichmay be issued (including up to a total of 200,000 options which may be issuedunder the Director Stock Option Plan) under the plans.  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.

 

As of September 30,2004, there were 350,137 options available for grant under the Amended andRestated 1987 Stock Option Plan and 98,000 options available for grant underthe Director Stock Option Plan.

 

Stock option activityfor all plans was as follows: 

 
| ** **                           | ** ** | **Outstanding  Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|--------------------------------------|------------|--------------------------|------------|------------------------------------------------|------------|
|                                 |       | **(in thousands)**  |       |                                           |       |
| Balance—September 30, 2001 |       | 1,016                    |       |                                           | $10.58     |   |   |
| Granted                              |       | 316                      |       |                                           | 12.09      |   |   |
| Exercised                            |       | (280                     | )          |                                           | 10.92      |   |   |
| Canceled                             |       | (97                      | )          |                                           | 11.04      |   |   |
| Balance—September 30, 2002 |       | 955                      |       |                                           | 10.85      |   |   |
|                                 |       |                     |       |                                           |       |   |   |
| Granted                              |       | 260                      |       |                                           | 34.71      |   |   |
| Exercised                            |       | (74                      | )          |                                           | 10.02      |   |   |
| Canceled                             |       | (48                      | )          |                                           | 15.95      |   |   |
| Balance—September 30, 2003 |       | 1,093                    |       |                                           | 16.36      |   |   |
|                                 |       |                     |       |                                           |       |   |   |
| Granted                              |       | 233                      |       |                                           | 23.41      |   |   |
| Exercised                            |       | (80                      | )          |                                           | 11.14      |   |   |
| Canceled                             |       | (56                      | )          |                                           | 25.29      |   |   |
| Balance—September 30, 2004 |       | 1,190                    |       |                                           | $17.67     |   |   |

 

F-29

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**12. STOCKOPTION PLANS AND WARRANTS (Continued)**

 

**During fiscal 2004, optionsto purchase 54,540 shares of common stock with an aggregate exercise price of$614,000 were exercised by the option holders tendering 28,438 shares of theCompany’s common stock, which were held by the option holders.**

** **

Options for 760,900,703,700, and 531,831 shares were exercisable as of September 30, 2004,2003 and 2002, respectively, and had a weighted-average exercise price of$16.19, $15.49 and $10.32, for those respective periods.

 

The weighted averagefair value of the stock options granted during 2004, 2003 and 2002 wasestimated to be $15.85, $23.35 and $8.41, respectively.  The weighted average fair value of eachoption granted is calculated on the date of grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions:

 
| ** **                | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|
| ** **                | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Dividend yield            |       | none                                        |       | none |   | none |   |
| Expected price volatility |       | 62                                          | %          | 61 | % | 60 | % |
| Risk-free interest rates  |       | 3.9                                         | %          | 3.8 | % | 4.6 | % |
| Expected lives            |       | 8.1 years                                   |       | 8.1 years |   | 8.1 years |   |

 

The following tablesummarizes information about stock options outstanding as of September 30,2004:

 
| ** **                                  | ** ** | **Options Outstanding** | ** ** | ** **                                 | ** ** | **Options Exercisable**               | ** ** |
|---------------------------------------------|------------|------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number  Outstanding**      | ** ** | **Weighted  Average  Remaining Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| ** **                                  | ** ** | **(in thousands)**      | ** ** | ** **                                 | ** ** | ** **                                 | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $                                           | 7.40       |                         | to         |                                       | $          | 7.88                                       |       |   | 128 |   |   | 7.1 |   | $ | 7.66 |   |   | 61 |   |   | $ | 7.68 |   |   |
| 7.89                                        |       | to                           |       | 8.98                                       |       |                                       | 44         |   |   | 5.4 |   | 8.44 |   |   | 27 |   |   | 8.40 |   |   |
| 8.99                                        |       | to                           |       | 9.98                                       |       |                                       | 287        |   |   | 4.9 |   | 9.27 |   |   | 276 |   |   | 9.27 |   |   |
| 9.99                                        |       | to                           |       | 10.98                                      |       |                                       | 129        |   |   | 6.5 |   | 10.24 |   |   | 78 |   |   | 10.24 |   |   |
| 10.99                                       |       | to                           |       | 12.98                                      |       |                                       | 50         |   |   | 2.4 |   | 11.34 |   |   | 48 |   |   | 11.34 |   |   |
| 12.99                                       |       | to                           |       | 17.98                                      |       |                                       | 81         |   |   | 2.7 |   | 14.21 |   |   | 67 |   |   | 13.56 |   |   |
| 17.99                                       |       | to                           |       | 22.98                                      |       |                                       | 38         |   |   | 9.5 |   | 21.34 |   |   | 2 |   |   | 22.27 |   |   |
| 22.99                                       |       | to                           |       | 27.98                                      |       |                                       | 199        |   |   | 9.1 |   | 24.14 |   |   | 42 |   |   | 24.03 |   |   |
| 27.99                                       |       | to                           |       | 31.98                                      |       |                                       | 40         |   |   | 8.2 |   | 20.32 |   |   | 24 |   |   | 30.90 |   |   |
| 31.99                                       |       | to                           |       | 38.57                                      |       |                                       | 194        |   |   | 8.2 |   | 36.84 |   |   | 136 |   |   | 36.96 |   |   |
| $                                           | 7.40       |                         | to         |                                       | $38.57     |                                       |       | 1,190 |   |   | 6.6 |   | $ | 17.67 |   |   | 761 |   |   | $ | 16.19 |   |   |

 

In conjunction with debtissued in the acquisition of A Pea in the Pod in 1995, the Company issued140,123 warrants for the purchase of the Company’s common stock at $.01 pershare.  These warrants were exercised onMarch 12, 2002.

 

In connection with theacquisition of iMaternity on October 17, 2001 (see Note 6), theCompany issued to the sellers warrants to purchase 350,000 shares of theCompany’s common stock at an exercise

 

F-30

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**12. STOCKOPTION PLANS AND WARRANTS (Continued)**

 

price of $22.50 pershare (the “Warrants”).  The Warrantswere immediately vested upon grant and are exercisable for seven years from thedate of grant.  During the year endedSeptember 30, 2002, the Company repurchased Warrants to purchase 125,000shares of the Company’s common stock for a purchase price of $4.50 perunderlying share, or a total of $562,500. In the first quarter of fiscal 2003, certain holders of the Warrantsturned in Warrants to purchase 100,000 shares of the Company’s common stock andwere issued 44,113 shares of the Company’s common stock pursuant to a cashlessexercise net issuance election.  As ofSeptember 30, 2004, Warrants to purchase 125,000 shares remainoutstanding.

 

**13. INCOME TAXES**

 

For the years endedSeptember 30, income tax provisions were comprised of the following (inthousands):

 
| ** **         | ** ** | **2004**       | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------|------------|----------------|------------|----------|------------|----------|------------|
| ** **         | ** ** | **(Restated)** | ** ** |
| Current provision  |       | $              | 1,137      |     | $          | 6,204    |       | $ | 937 |   |
| Deferred provision |       | 2,329          |       | 2,133    |       | 5,332    |       |
|               |       | $              | 3,466      |     | $          | 8,337    |       | $ | 6,269 |   |

 

The reconciliations ofthe statutory federal rate to the Company’s effective income tax rates for theyears ended September 30, were as follows:

 
| ** **                          | ** ** | **2004**       | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------|------------|----------------|------------|----------|------------|----------|------------|
| ** **                          | ** ** | **(Restated)** | ** ** |
| Statutory federal tax rate          |       | 34.0           | %          | 35.0     | %          | 35.0     | %          |
| State taxes, net of federal benefit |       | 4.2            |       | 3.2      |       | 2.2      |       |
| Other                               |       | 2.6            |       | 0.5      |       | 0.4      |       |
|                                |       | 40.8           | %          | 38.7     | %          | 37.6     | %          |

 

F-31

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**13. INCOMETAXES (Continued)**

 

The deferred tax effectsof temporary differences giving rise to the Company’s net deferred tax assetsas of September 30, were as follows (in thousands):

 
| ** **                                  | ** ** | **2004**       | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------------|------------|----------|------------|
| ** **                                  | ** ** | **(Restated)** | ** ** |
| *Deferred tax assets:*                      |       |           |       |     |       |
| Net operating losses carryforwards          |       | $              | 1,919      |     | $          | 2,242 |   |
| Depreciation                                |       | 1,241          |       | 4,113    |       |
| Deferred rent                               |       | 10,480         |       | 8,908    |       |
| Inventory reserves                          |       | 672            |       | 550      |       |
| Employee benefit accruals                   |       | 1,823          |       | 1,722    |       |
| Reserves recorded in iMaternity acquisition |       | 298            |       | 558      |       |
| Tax benefit on stock option exercises       |       | 291            |       | 256      |       |
| Other accruals                              |       | 705            |       | 1,042    |       |
| Other                                       |       | 561            |       | 327      |       |
|                                        |       | 17,990         |       | 19,718   |       |
| *Deferred tax liability:*                   |       |           |       |     |       |
| Prepaid expenses                            |       | (13            | )          | (113     | )          |
|                                        |       | $              | 17,977     |     | $          | 19,605 |   |

 

Asof September 30, 2004, the Company has net operating loss carryforwardsfor federal tax purposes of $5,484,000, which were acquired in the acquisitionof iMaternity and begin to expire in 2021. While the acquired net operating loss carryforwards are subject tocertain annual limitations due to the change in ownership, the Company does notexpect the limitations to reduce its ability to ultimately use suchcarryforwards.  The tax benefit of theacquired net operating loss carryforwards was recorded under the purchasemethod of accounting.

 

The above deferred taxassets reflect only the federal tax benefit associated with the temporarydifferences given the historical uncertainty related to realizing state taxbenefits.  Had the state tax benefitsbeen reflected, the deferred tax assets would be approximately $1,400,000higher.

 

No valuation allowancehas been provided for the net federal deferred tax assets.  Based on the Company’s historical levels oftaxable income, management believes it is more likely than not that the Companywill realize the federal net deferred tax assets as of September 30,2004.  There can be no assurance that theCompany will generate taxable earnings or any specific level of earnings in thefuture.

 

**14. COMMITMENTS ANDCONTINGENCIES**

 

The Company leases itsretail facilities and certain equipment under various non-cancelable operatingleases. Certain of these leases have renewal options.  Total rent expense under operating leasesamounted to $73,690,000, $65,327,000 and $59,582,000 in fiscal 2004, 2003 and2002, respectively.  Such amounts includecontingent rentals based upon a percentage of sales totaling $388,000, $740,000and $688,000 in fiscal 2004, 2003 and 2002, respectively.

 

F-32

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**14.COMMITMENTS AND CONTINGENCIES (Continued)**

 

Store operating leasesand warehouse leases generally provide for payment of direct operating costs inaddition to rent.  Future annual minimumoperating lease payments, excluding such direct operating costs, as well asleases for equipment rental as of September 30, 2004 are as follows (inthousands):

 
| **Fiscal Year** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|
| 2005                 |       | $          | 52,618     |       |
| 2006                 |       | 48,468     |       |
| 2007                 |       | 45,022     |       |
| 2008                 |       | 40,518     |       |
| 2009                 |       | 36,361     |       |
| 2010 and thereafter  |       | 96,378     |       |
|                 |       | $          | 319,365    |       |

 

The Company was a partyto an action filed against the Company alleging that certain former and currentemployees should have received overtime compensation under Washington law inSpokane County Superior Court.  Theplaintiffs in this action sought unspecified actual damages, penalties andattorneys’ fees.  On or aboutApril 23, 2003, one purported subclass of the plaintiffs accepted asettlement arrangement in the amount of $50,000, plus attorney’s fees and costsincurred through such date.  After atrial with the remaining purported subclass, in May 2003, the jury foundfor the Company on all but one claim, for which it awarded the remainingplaintiffs damages in the amount of $106,000. The parties are currently contesting costs and expenses being sought bythe plaintiffs in the amount of approximately $390,000. The Company recordedexpenses during fiscal 2004 and 2003 of $78,000 and $546,000, respectively, forthe estimated legal fees and settlement costs of this case, including thecontested costs and expenses noted above.

 

Inaddition, from time to time, the Company is named as a defendant in legalactions arising from its normal business activities.  Although the amount of any liability thatcould arise with respect to currently pending cannot be accurately predicted,the Company does not believe that the resolution of any pending action willhave a material adverse effect on its financial position, results of operationsor liquidity.

 

**15. GUARANTORSUBSIDIARIES**

 

Pursuant to the terms ofthe indenture relating to the New Senior Notes, each of the domesticsubsidiaries of Mothers Work, Inc. (the “Guarantor Subsidiaries”) hasjointly and severally provided an unconditional guarantee of the obligations ofMothers Work with respect to the New Senior Notes.  There are no restrictions on any of theassets of the Guarantor Subsidiaries which would limit their ability totransfer funds to Mothers Work in the form of loans, advances or cashdividends, except as provided by applicable law.  None of the Company’s foreign subsidiaries(the “Non-Guarantor Subsidiaries”) have guaranteed the New Senior Notes.  The condensed consolidating financialinformation for the Company, the Guarantor Subsidiaries, and the Company’sNon-Guarantor Subsidiaries as of and for the fiscal year endedSeptember 30, 2004 as presented below has been prepared from the books andrecords maintained by the Guarantor Subsidiaries and the Company.  The condensed financial information may notnecessarily be indicative of the results of operations or financial positionhad the Guarantor Subsidiaries operated as independent entities.  Certain intercompany revenues and expensesincluded in the subsidiary records are eliminated in consolidation.  As a result of this activity, an amount dueto/due from parent will exist at any time.

 

F-33

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**15.GUARANTOR SUBSIDIARIES (Continued)**

 

**Mothers Work, Inc.Condensed Consolidating Balance Sheet (Restated)September 30, 2004(in thousands)**

 
| ** **                                        | ** ** | **Mothers  Work (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Operations)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|---------------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **ASSETS**                                        |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Current Assets:                                   |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Cash and cash equivalents                         |       | $                                        | 7,426      |                        | $          | 44                                                     |       | $                               | 997        |                                | $          | — |   | $ | 8,467 |   |
| Short-term investments                            |       | 6,400                                    |       | —                      |       | —                                                 |       | —                          |       | 6,400                               |       |
| Trade receivables                                 |       | 2,866                                    |       | —                      |       | 45                                                     |       | —                          |       | 2,911                               |       |
| Inventories                                       |       | 91,029                                   |       | —                      |       | 1,714                                                  |       | —                          |       | 92,743                              |       |
| Deferred income taxes                             |       | 4,660                                    |       | —                      |       | —                                                 |       | —                          |       | 4,660                               |       |
| Prepaid expenses and other current assets         |       | 7,001                                    |       | —                      |       | 214                                                    |       | —                          |       | 7,215                               |       |
| Total Current Assets                              |       | 119,382                                  |       | 44                          |       | 2,970                                                  |       | —                          |       | 122,396                             |       |
| Property, Plant and Equipment, net                |       | 76,507                                   |       | —                      |       | 1,955                                                  |       | —                          |       | 78,462                              |       |
| Assets Held for Sale                              |       | —                                   |       | —                      |       | 1,200                                                  |       | —                          |       | 1,200                               |       |
| Other Assets                                      |       | 69,149                                   |       | 3                           |       | 160                                                    |       | —                          |       | 69,312                              |       |
| Investments in and Advances to (from)  Affiliates |       | (1,085                                   | )          | 215,150                     |       | (4,823                                                 | )          | (209,242                        | )          | —                              |       |
| Total Assets                                      |       | $                                        | 263,953    |                        | $          | 215,197                                                |       | $                               | 1,462      |                                | $          | (209,242 | ) | $ | 271,370 |   |
|                                              |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**     |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Current Liabilities:                              |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Line of credit borrowings                         |       | $                                        | —     |                        | $          | —                                                 |       | $                               | —     |                                | $          | — |   | $ | — |   |
| Current portion of long-term debt                 |       | 288                                      |       | —                      |       | —                                                 |       | —                          |       | 288                                 |       |
| Accounts payable                                  |       | 19,760                                   |       | 19                          |       | —                                                 |       | —                          |       | 19,779                              |       |
| Accrued expenses and other current  liabilities   |       | 27,814                                   |       | 6,319                       |       | 363                                                    |       | —                          |       | 34,496                              |       |
| Total Current Liabilities                         |       | 47,862                                   |       | 6,338                       |       | 363                                                    |       | —                          |       | 54,563                              |       |
| Long-Term Debt                                    |       | 127,629                                  |       | —                      |       | —                                                 |       | —                          |       | 127,629                             |       |
| Deferred Rent and Other Non-Current  Liabilities  |       | 25,559                                   |       | —                      |       | 716                                                    |       | —                          |       | 26,275                              |       |
| Total Liabilities                                 |       | 201,050                                  |       | 6,338                       |       | 1,079                                                  |       | —                          |       | 208,467                             |       |
| Total Stockholders’ Equity                   |       | 62,903                                   |       | 208,859                     |       | 383                                                    |       | (209,242                        | )          | 62,903                              |       |
| Total Liabilities and Stockholders’ Equity   |       | $                                        | 263,953    |                        | $          | 215,197                                                |       | $                               | 1,462      |                                | $          | (209,242 | ) | $ | 271,370 |   |

 

F-34

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**15. GUARANTOR SUBSIDIARIES (Continued)**

 

**MothersWork, Inc.Condensed Consolidating Statement of Operations (Restated)For the Year Ended September 30, 2004(in thousands)**

 
| ** **                                   | ** ** | **Mothers  Work (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Operations)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| Net sales                                    |       | $                                        | 510,751    |                        | $          | 27,245                                                 |       | $                               | 7,300      |                                | $          | (27,245 | ) | $ | 518,051 |   |
| Cost of goods sold                           |       | 236,167                                  |       | —                      |       | 3,446                                                  |       | —                          |       | 239,613                             |       |
| Gross profit                                 |       | 274,584                                  |       | 27,245                      |       | 3,854                                                  |       | (27,245                         | )          | 278,438                             |       |
| Selling, general and administrative expenses |       | 278,702                                  |       | 165                         |       | 3,546                                                  |       | (27,245                         | )          | 255,168                             |       |
| Operating income (loss)                      |       | (4,118                                   | )          | 27,080                      |       | 308                                                    |       | —                          |       | 23,270                              |       |
| Interest income (expense), net               |       | (24,564                                  | )          | 9,799                       |       | —                                                 |       | —                          |       | (14,765                             | )          |
| Equity in earnings of subsidiaries           |       | 37,187                                   |       | —                      |       | —                                                 |       | (37,187                         | )          | —                              |       |
| Income before income taxes                   |       | 8,505                                    |       | 36,879                      |       | 308                                                    |       | (37,187                         | )          | 8,505                               |       |
| Income tax provision                         |       | 3,466                                    |       | 12,908                      |       | 128                                                    |       | (13,036                         | )          | 3,466                               |       |
| Net income                                   |       | $                                        | 5,039      |                        | $          | 23,971                                                 |       | $                               | 180        |                                | $          | (24,151 | ) | $ | 5,039 |   |

 

F-35

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**15. GUARANTOR SUBSIDIARIES (Continued)**

 

**Mothers Work, Inc.****Condensed Consolidating Cash Flow Statement(Restated)****For the Year Ended September 30, 2004****(in thousands)**

 
| ** **                                                                         | ** ** | **Mothers Work  (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Operations)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **Cash Flows from Operating Activities:**                                          | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                             | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Net income                                                                         |       | $                                        | 5,039      |                        | $          | 23,971                                                 |       | $                               | 180        |                                | $          | (24,151 | ) | $ | 5,039 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Depreciation and amortization                                                      |       | 14,067                                   |       | —                      |       | 203                                                    |       | —                          |       | 14,270                              |       |
| Loss on impairment of long-lived assets                                            |       | 1,816                                    |       | —                      |       | —                                                 |       | —                          |       | 1,816                               |       |
| Loss on disposal of assets                                                         |       | 1,223                                    |       | —                      |       | —                                                 |       | —                          |       | 1,223                               |       |
| Accretion of discount on notes                                                     |       | 149                                      |       | —                      |       | —                                                 |       | —                          |       | 149                                 |       |
| Deferred income tax provision                                                      |       | 2,329                                    |       | —                      |       | —                                                 |       | —                          |       | 2,329                               |       |
| Tax benefit of stock option exercises                                              |       | 311                                      |       | —                      |       | —                                                 |       | —                          |       | 311                                 |       |
| Amortization of deferred financing costs                                           |       | 415                                      |       | —                      |       | —                                                 |       | —                          |       | 415                                 |       |
| Other                                                                              |       | 224                                      |       | —                      |       | —                                                 |       | —                          |       | 224                                 |       |
| Changes in assets and liabilities:                                                 |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Decrease (increase) in—                                                       |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Trade receivables                                                                  |       | (489                                     | )          | —                      |       | (37                                                    | )          | —                          |       | (526                                | )          |
| Inventories                                                                        |       | (7,808                                   | )          | —                      |       | (430                                                   | )          | —                          |       | (8,238                              | )          |
| Prepaid expenses and other assets                                                  |       | (1,817                                   | )          | —                      |       | (214                                                   | )          | —                          |       | (2,031                              | )          |
| Investments in and advances to (from)  affiliates                                  |       | (9,417                                   | )          | (16,173                     | )          | 1,439                                                  |       | 24,151                          |       | —                              |       |
| Increase (decrease) in—                                                       |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Accounts payable, accrued expenses and  other current liabilities                  |       | 6,857                                    |       | (7,787                      | )          | 106                                                    |       | —                          |       | (824                                | )          |
| Deferred rent and other non-current  liabilities                                   |       | 3,539                                    |       | —                      |       | 560                                                    |       | —                          |       | 4,099                               |       |
| Net cash provided by operating activities                                          |       | 16,438                                   |       | 11                          |       | 1,807                                                  |       | —                          |       | 18,256                              |       |
| **Cash Flows from Investing Activities:**                                          | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                             | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Purchase of short-term investments                                                 |       | (54,075                                  | )          | —                      |       | —                                                 |       | —                          |       | (54,075                             | )          |
| Proceeds from sale of short-term  investments                                      |       | 52,675                                   |       | —                      |       | —                                                 |       | —                          |       | 52,675                              |       |
| Capital expenditures                                                               |       | (20,317                                  | )          | —                      |       | (1,223                                                 | )          | —                          |       | (21,540                             | )          |
| Purchase of intangible assets                                                      |       | (30                                      | )          | —                      |       | (50                                                    | )          | —                          |       | (80                                 | )          |
| Net cash used in investing activities                                              |       | (21,747                                  | )          | —                      |       | (1,273                                                 | )          | —                          |       | (23,020                             | )          |
| **Cash Flows from Financing Activities:**                                          | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                             | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Increase in cash overdrafts                                                        |       | 684                                      |       | —                      |       | —                                                 |       | —                          |       | 684                                 |       |
| Repayment of long-term debt                                                        |       | (279                                     | )          | —                      |       | —                                                 |       | —                          |       | (279                                | )          |
| Repurchase of common stock                                                         |       | (1,775                                   | )          | —                      |       | —                                                 |       | —                          |       | (1,775                              | )          |
| Payout for redeemed Series A Preferred  Stock                                 |       | (1,362                                   | )          | —                      |       | —                                                 |       | —                          |       | (1,362                              | )          |
| Deferred financing costs                                                           |       | (44                                      | )          | —                      |       | —                                                 |       | —                          |       | (44                                 | )          |
| Proceeds from exercise of stock options and  warrants                              |       | 276                                      |       | —                      |       | —                                                 |       | —                          |       | 276                                 |       |
| Net cash used in financing activities                                              |       | (2,500                                   | )          | —                      |       | —                                                 |       | —                          |       | (2,500                              | )          |
| **Net  Increase (Decrease) in Cash and Cash Equivalents**                          |       | (7,809                                   | )          | 11                          |       | 534                                                    |       | —                          |       | (7,264                              | )          |
| **Cash and  Cash Equivalents, Beginning of Year**                                  |       | 15,235                                   |       | 33                          |       | 463                                                    |       | —                          |       | 15,731                              |       |
| **Cash and Cash Equivalents, End of Year**                                         |       | $                                        | 7,426      |                        | $          | 44                                                     |       | $                               | 997        |                                | $          | — |   | $ | 8,467 |   |
|                                                                                    |            |                                          |            |                             |            |                                                        |            |                                 |            |                                     |            |  |  |  |  |  |  |  |  |

 

F-36

----

 

**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**16. EMPLOYMENTAGREEMENTS**

 

The Company has employment agreements with itsChairman of the Board/Chief Executive Officer (“CEO”) and its President/ChiefOperating Officer (“COO”).  Theseagreements, as amended, provided for base compensation of $477,405, $463,500and $450,000 for fiscal 2004, 2003 and 2002, respectively, increasing annuallythereafter in an amount to be determined by the Compensation Committee of theBoard of Directors, and salary continuation and severance payments shouldemployment of the executives be terminated under specified conditions, asdefined therein.  The agreements, whichexpire on September 30, 2007, automatically extend for successive one-yearperiods extending the expiration date to three years from the date of theextension, unless either the Company or the executive gives written notice tothe other party that the term will not be further extended.  Additionally, the CEO and COO are eligiblefor an annual cash bonus and stock options based on performance, as specifiedby the Compensation Committee.

 

The Company also has an employment agreement with its Executive VicePresident—Chief Financial Officer.  Thisagreement provided for base compensation of $360,000 for fiscal 2004, which issubject to potential increase in the future by the Company.  The agreement also provides for salarycontinuation and severance payments should employment of the executive beterminated under specified conditions, as defined therein.  The agreement, which expires onSeptember 30, 2006, automatically extends for successive one-year periodsextending the expiration date to two years from the date of the extension,unless either the Company or the executive gives written notice to the otherparty that the term will not be further extended.

 

**17. EMPLOYEE BENEFITPLANS**

** **

The Company has a 401(k) savings plan for allemployees who have at least six months of service and are at least18 years of age.  Employees cancontribute up to 20% of their annual salary. Employees who meet certain criteria are eligible for a matchingcontribution from the Company based on a sliding scale.  Company matches are made in the first quarterof the succeeding calendar year.  Companymatches vest over a period of approximately six years from each employee’scommencement of employment with the Company. Company matching contributionstotaling $82,000, $76,000 and $65,000 were made in fiscal 2004, 2003 and 2002,respectively.  In addition the Companymay make discretionary contributions to the plan, which vest over a period ofapproximately six years from each employee’s commencement of employment withthe Company.  The Company has not madeany discretionary contributions.

 

**18. STOCK REPURCHASE**

 

During fiscal 2003, the Board of Directors approved ashare repurchase program under which the Company may repurchase up to$10,000,000 of its outstanding common stock from time to time in privatetransactions or on the open market until March 2005.  As of September 30, 2004, the Company hadpurchased and retired 142,269 shares in the aggregate under the repurchaseprogram at a total cost of $3,242,000, at an average cost of $22.79 per share,of which 75,715 shares were repurchased in fiscal 2004, at an average cost of$23.44 per share.  The indenturegoverning the New Senior Notes and the terms of both the Company’s New CreditFacility and previous credit facility contain restrictions that place limits oncertain payments by the Company, including payments to repurchase shares of itscommon stock.  The Company’s repurchasesof common stock have been made in compliance with all restrictions under theindenture governing the New Senior Notes and the terms of its New CreditFacility and previous credit facility.

 

F-37

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**19. QUARTERLY FINANCIALINFORMATION (UNAUDITED) (RESTATED)**

** **

Quarterly financial results for the years endedSeptember 30, 2004 and 2003 are as follows (in thousands, except per shareamounts): 

 
| ** **                                         | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| **Fiscal 2004**                               | ** ** | **9/30/04**            | ** ** | **6/30/04** | ** ** | **3/31/04** | ** ** | **12/31/03** | ** ** |
| ** **                                         | ** ** | **(As Reported)**      | ** ** |
| Net sales                                          |       | $                      | 120,995    |   | $ | 139,558 |   | $ | 125,803 |   | $ | 131,695 |   |
| Gross profit                                       |       | 63,571                 |       | 78,760 |   | 66,077 |   | 70,030 |   |
| Net income (loss) available to common stockholders |       | (3,616                 | )          | 6,991 |   | 444 |   | 2,054 |   |
| Net income (loss) per share—Basic             |       | (0.70                  | )          | 1.34 |   | 0.09 |   | 0.39 |   |
| Net income (loss) per share—Diluted           |       | (0.70                  | )          | 1.28 |   | 0.08 |   | 0.37 |   |
|                                                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                  | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| **Fiscal 2003**                        | ** ** | **9/30/03**            | ** ** | **6/30/03** | ** ** | **3/31/03** | ** ** | **12/31/02** | ** ** |
| ** **                                  | ** ** | **(As Reported)**      | ** ** |
| Net sales                                   |       | $                      | 122,400    |   | $ | 132,403 |   | $ | 111,304 |   | $ | 126,340 |   |
| Gross profit                                |       | 65,936                 |       | 75,697 |   | 58,980 |   | 66,643 |   |
| Net income available to common stockholders |       | 1,638                  |       | 8,369 |   | 331 |   | 3,612 |   |
| Net income per share—Basic             |       | 0.31                   |       | 1.60 |   | 0.06 |   | 0.69 |   |
| Net income per share—Diluted           |       | 0.29                   |       | 1.50 |   | 0.06 |   | 0.63 |   |
|                                             |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| **Fiscal 2004**                              | ** ** | **9/30/04**            | ** ** | **6/30/04** | ** ** | **3/31/04** | ** ** | **12/31/03** | ** ** |
| ** **                                        | ** ** | **(As Restated)**      | ** ** |
| Net sales                                         |       | $                      | 120,995    |   | $ | 139,558 |   | $ | 125,803 |   | $ | 131,695 |   |
| Gross profit                                      |       | 63,571                 |       | 78,760 |   | 66,077 |   | 70,030 |   |
| Net income(loss) available to common stockholders |       | (3,945                 | )          | 6,818 |   | 251 |   | 1,915 |   |
| Net income (loss) per share—Basic            |       | (0.76                  | )          | 1.31 |   | 0.05 |   | 0.37 |   |
| Net income (loss) per share—Diluted          |       | (0.76                  | )          | 1.24 |   | 0.05 |   | 0.34 |   |
|                                                   |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                  | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| **Fiscal 2003**                        | ** ** | **9/30/03**            | ** ** | **6/30/03** | ** ** | **3/31/03** | ** ** | **12/31/02** | ** ** |
| ** **                                  | ** ** | **(As Restated)**      | ** ** |
| Net sales                                   |       | $                      | 122,400    |   | $ | 132,403 |   | $ | 111,304 |   | $ | 126,340 |   |
| Gross profit                                |       | 65,936                 |       | 75,697 |   | 58,980 |   | 66,643 |   |
| Net income available to common stockholders |       | 1,339                  |       | 8,243 |   | 137 |   | 3,495 |   |
| Net income per share—Basic             |       | 0.26                   |       | 1.57 |   | 0.03 |   | 0.67 |   |
| Net income per share—Diluted           |       | 0.24                   |       | 1.48 |   | 0.02 |   | 0.61 |   |
|                                             |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

The Company’s business, like that of other retailers, is seasonal.  The Company’s quarterly net sales havehistorically been highest in its third fiscal quarter, corresponding to theSpring selling season, followed by its first fiscal quarter, corresponding tothe Fall/holiday selling season.  Giventhe typically higher gross margin experienced in the third fiscal quartercompared to other quarters, the relatively fixed nature of most of theCompany’s operating expenses and interest expense, and the historically highersales level in the third quarter, the Company has typically generated a verysignificant percentage of its full year operating income and net income duringthe third quarter.

 

F-38

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**MOTHERSWORK, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)**

 

**20. RELATED PARTYTRANSACTIONS**

 

Other than the husband and wife relationship betweenthe CEO and COO, there are no other family relationships among any otherexecutive officers of the Company.

 

The Company paid a former director on the Board of Directors of theCompany $77,500 in fiscal 2002 for merchandising consulting fees (none infiscal 2004 or 2003).  The consultingarrangement was cancelled during fiscal 2002. In addition, another director was re-elected, effective January 1,2001, to the partnership at Pepper Hamilton LLP, which provides legal servicesto the Company.  This director iscurrently Of Counsel at Pepper Hamilton LLP. The Company incurred legal fees to this law firm of $147,000, $348,000and $1,510,000 in fiscal 2004, 2003 and 2002, respectively. As ofSeptember 30, 2004, the Company had amounts outstanding to this law firmof $41,000, which are included in accounts payable in the accompanyingconsolidated balance sheets.

 

During fiscal 2004, the Company repurchased an aggregate 14,954 sharesof common stock from both the Company’s CEO and COO as part of the sharerepurchase program.

 

F-39

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**Reportof Independent Registered Public Accounting Firm on Financial StatementSchedule**

** **

The Board of Directorsand StockholdersMothers Work, Inc.:

 

Under date ofNovember 17, 2004, except as to Note 2, which is as of September 28,2005, we reported on the consolidated balance sheets of Mothers Work, Inc.and subsidiaries as of September 30, 2004 and 2003, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows foreach of the years in the three-year period ended September 30, 2004.  In connection with our audits of theaforementioned consolidated financial statements, we also audited the relatedfinancial statement schedule as listed in the accompanying index.  This financial statement schedule is theresponsibility of the Company’s management. Our responsibility is to express an opinion on this financial statementschedule based on our audits.

 

Inour opinion, such financial statement schedule, when considered in relation tothe basic consolidated financial statements taken as a whole, presents fairly,in all material respects, the information set forth therein.

 

Asdiscussed in Note 2 to the consolidated financial statements, the Company hasrestated its consolidated financial statements as of September 30, 2004and 2003 and for each of the years in the three-year period endedSeptember 30, 2004.

 

 
| /s/  KPMG LLP                  |   |
|--------------------------------|--------|
|                           |
| **Philadelphia, Pennsylvania** |
| **November 17, 2004**     |

 

F-40

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**MOTHERS WORK, INC.AND SUBSIDIARIESSCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS(in thousands)**

 
| ** **                                                  | ** ** | **Balance at  beginning  of period** | ** ** | **Additions  Charged to  costs and  expenses** | ** ** | **Deductions** | ** ** | **Balance at  end of  period** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|----------------|------------|------------------------------------------|------------|
| Year Ended September 30, 2004   Product return reserve |       | $400                                           |       |                                                     | $          | 38             |       |                                     | —     |   |   | $438 |   |   |
| Year Ended September 30, 2003   Product return reserve |       | —                                         |       |                                                     | $          | 400            |       |                                     | —     |   |   | $400 |   |   |
| Year Ended September 30, 2002   Product return reserve |       | —                                         |       |                                                     | —     |           |       | —                                   |       |   | — |   |   |

 

F-41

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