**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**Washington, D.C.20549

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FORM 10-K

| **(Mark One)**                                         | ** ** |
|--------------------------------------------------------|------------|
| **x**                                                  | ** ** | **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 period from                 to                   Commission file number 0-21196**

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MothersWork, Inc.

(Exact name of Registrantas 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)

Securities registeredpursuant to Section 12(b) of the Act:

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

 

Securities registered pursuant to Section 12(g) ofthe Act:

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

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes xNo o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein and will not be contained, to the best of Registrant’s knowledge,in definitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2of the Act).  Yes xNo o

The aggregate market valueof the voting and non-voting common equity held by non-affiliates computed byreference to $26.65, the price at which the common equity was last sold as of March 31,2004 (the last business day of the Registrant’s most recently completed secondfiscal quarter), was approximately $124,000,000.

On December 10,2004, there were 5,225,495 shares of the Registrant’scommon stock, $.01 par value, outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the Registrant’sProxy Statement to be filed with the Commission in connection with the AnnualMeeting of Stockholders scheduled to be held on January 21, 2005 areincorporated by reference into Part III of this Form 10-K.

 

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**PART I.**

**Item1.    Business**

**General**

We are the leading designer and retailer of maternityapparel in the United States, operating 1,115 retail locations, including 883stores in all 50 states, Puerto Rico and Canada, and 232 leased departments. Wedesign and contract manufacture approximately 90% of the merchandise we sell inour 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:Motherhood Maternity,Mimi Maternity,A Pea in the Pod and Destination MaternityTM and also sell our merchandise onthe Internet at our MaternityMall.comTM and our chain-specific websites.Our strategy is to fulfill, in a high-service store environment, all of anexpectant mother’s clothing needs, including casual and career wear, formalattire, lingerie, sportswear and outerwear. We use a vertically integratedbusiness model to ensure that we offer the broadest assortment of in-stock,fashionable merchandise. Our three retail brands collectively target all of theprice points in maternity apparel, ranging from Motherhood at value prices to APea in the Pod at luxury prices. In addition to our 883 stores, our retaillocations include 232 leased departments located within department andspecialty stores, which sell primarily Motherhood and Two HeartsTM Maternitybranded apparel. We have achieved 11.6% compounded annual sales growth over thepast 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 toour fiscal years refer to the fiscal year ended on September 30 in theyear mentioned. For example, our fiscal 2004 ended on September 30, 2004.

We plan to open approximately 30-40 new retailstores during fiscal 2005, of which approximately 15-20 will be newmulti-brand stores, including Destination Maternity superstores, with thebalance primarily under the Motherhood brand. We plan to close approximately 48-60stores, with approximately 30-40 of these planned store closings relatedto the opening of new multi-brand stores.

In addition, based on the success of the initiallaunch in April 2004 of our Two Hearts Maternitycollection, which is available exclusively at selected Sears® locations, wewill be expanding the distribution of our Two Hearts Maternity collection fromthe current 71 Sears locations to a total of approximately 645 Sears locationsbeginning in March 2005. This proprietary brand will replace the existingmaternity apparel lines in those locations and will become the exclusivematernity apparel offering in Sears stores.

In February 2005, we will launch our Oh Baby! byMotherhoodTM collection at Kohl’s® stores throughout the United States and onKohls.com. The Oh Baby! by Motherhood collection, available exclusively at Kohl’sunder a licensed arrangement, will replace the existing maternity apparel linesat Kohl’s and will become their exclusive maternity apparel line. As of October 31,2004, Kohl’s operates approximately 637 stores in 40 states.

Mothers Work was foundedby Dan and Rebecca Matthias in 1982 as a mail-order maternity apparel catalog.We began operating retail stores in 1985 and completed our initial publicoffering in 1993. To address multiple price points in maternity apparel andimprove operating productivity, we acquired Motherhood and A Pea in the Pod in1995 and eSpecialty Brands, LLC (“iMaternity”) in October 2001. Since theacquisitions of Motherhood and A Pea in the Pod, we have developed and grownthese brands along with our Mimi brand. In connection with each of ouracquisitions, we have consolidated some overlapping locations and closed under-performingstores, resulting in increased operating efficiency through reductions ofacquired store expenses and improved inventory utilization.

**Retail Concepts and Product Distribution**

***MotherhoodMaternity.******  ***MotherhoodMaternity serves the value-pricedportion of the maternity apparelindustry with the greatest number of customers and is our largest chain with717 stores as of 

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September 30, 2004.Motherhood is positioned with everyday low prices, broad assortment, fashionand 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 locatedprimarily in enclosed malls, strip and power centers and central city businessdistricts. Motherhood stores include 106 outlet locations that carry predominantlyMotherhood-branded product, includingsome closeout merchandise. In addition, as of September 30, 2004, weoperate 131 Motherhood leased departments in department and specialty storessuch as Macy’s®, Babies “R” Us®, Lazarus® and Rich’s®. Between 1998 and 2000,we successfully broadened Motherhood’s customer base by lowering price pointsapproximately 40% to 45%. This new price position significantly expanded thebrand’s target market, increased revenues per store and increased unit volumesduring this period. In fiscal 2004, we opened 29 new Motherhood stores and outlets, excluding leaseddepartments and net of store closings and store conversions. As of September 30,2004, we operate 26 Motherhood stores in Canada and believe that marketopportunities may permit us to open additional stores in Canada in the future.We may also have the opportunity to grow the number of our Motherhood leaseddepartments in the United States.

***Mimi Maternity.******  ***As of September 30,2004, we had 121 Mimi Maternity storesthat serve the middle market priced portion of the maternity apparel industry.The brand is positioned as trendy, contemporary, fun and affordable. We believethat the Mimi customer shops at department stores and specialty apparel chainswhen she is not expecting. Mimi stores average approximately 2,000 square feetand are located primarily in regional malls, lifestyle centers and centralbusiness districts.

*Single-Brand Mimi Stores.*   As of September 30,2004, 91 of our Mimi stores predominantly  carry Mimi-branded product, as well as a smallselection of maternity merchandise developed by contemporary vendorsexclusively for Mimi, and average approximately1,600 square feet. As of September 30, 2004, we alsooperate 29 Mimi leased departments in Marshall Field’s® and Bloomingdale’s®.Mimi was historically price positioned just below A Pea in the Pod. WhenMotherhood’s prices were lowered, there was an opportunity for Mimi to broadenits customer base by including lower price points. Mimi was, therefore,repositioned during fiscal 2002 and its merchandise price points now range fromjust above Motherhood to the lower end of A Pea in the Pod. This repositioning resulted in an expansion of Mimi’starget customer base,and providedus the opportunity to increase the number of Mimi stores over time.

*Multi-Brand Mimi Stores.*   We are continuing to test, develop andexpand our multi-brand store concepts. Our current multi-brand store conceptsoperated under the Mimi name include two-brandstores (which carry both the Mimi and Motherhood brands) and triplex stores(which carry the Mimi, Motherhood and A Pea in the Pod brands). Thesemulti-brand stores are larger (average of approximately 3,000 square feet) andhave higher average sales volume than our average store, and provide theopportunity to lower our store operating expense percentage and improve storeoperating profit margins over time. Opening these multi-brand stores willtypically involve closing two smallerstores and consolidating their business into one store, and frequently willinvolve one-time store closing costs resulting primarily from early leaseterminations. As of September 30, 2004, 30 of our stores are multi-brandstores using the Mimi name, consisting of 28two-brand Mimicombo stores and 2 Mimi triplex stores. We plan to continue toopen additional multi-brand stores carrying both Mimi and Motherhoodproduct, using the Mimi store name.

In fiscal 2004, at MimiMaternity, we opened four single-brand stores, 16 two-brand combo stores, two triplexstores and an additional four stores as a result of net store conversions,excluding leased departments, and closed 24 stores.

***A Pea in the Pod.******  ***A Pea in the Pod is theleading luxury maternity brand in the United States, with 41 store locations asof September 30, 2004. The brand is positioned as exclusive, designer andluxury. A Pea in the Pod stores average approximately 2,400 square feet and arelocated in upscale venues, including Madison Avenue, Oak Street, Beverly Hills,South Coast Plaza and Bal Harbor. We also operate one A 

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Pea in the Pod leaseddepartment in Macy’s flagship Herald Square store in New York City. Duringfiscal 2004, we opened two stores and closed five stores. In addition tooffering a wide selection of both A Pea in the Pod and Mimi branded products inalmost all A Pea in the Pod stores, we seek out designer and contemporarybrands and assist them in developing maternity versions of select stylesexclusively for our A Pea in the Pod stores. Publicity, including celebritieswearing our clothes, is an important part of the marketing and positioning ofthe brand. As scarcity is part of the concept’s luxury image, we have chosen tofurther develop the brand primarily by optimizing our customers’ in-storeexperience rather than by opening new stores. We therefore continuously upgradethe quality of the locations, our store designs, the product styling and ourpublicity to enhance our brand image.

***DestinationMaternity superstores.******  ***OnMarch 4, 2004, we opened our first Destination Maternity superstore inDanbury, Connecticut, a nearly 4,000 square foot test store carrying all threeof our brands plus a greatly expanded line of nursing accessories,fertility-related products and maternity-related exercise gear, books, and bodyand nutritional products. This store also has a dedicated “learning center”area for maternity-related classes, as well as a “relax area” for husbands andshoppers alike, and an inside play area for the pregnant mom’s toddlers andyoung children. These elements combine to give our Destination Maternitysuperstore not only by far the largest assortment of maternity apparel andaccessories available, but also a new and engaging atmosphere and experiencefor the maternity customer. Our superstore format is highly differentiated fromthe stores of our maternity competitors, which do not even carry the breadth ofselection we carry in one of our three brands presented in the superstore.Opening these superstores will typically involve closing two or more smallerstores and consolidating their business into one store, and frequently willinvolve one-time store closing costs resulting primarily from early leaseterminations. We believe the superstore model will improve store profitabilitymargins by reducing store operating expense percentages and may increaseoverall sales in the geographical markets they serve. We are actively workingto continue to refine our maternity superstore concept and to find additionalsuitable new locations for the concept. We opened three additional DestinationMaternity superstores during August 2004, for a total of four stores openas of September 30, 2004, with four additional superstores scheduled toopen during the first six months of fiscal 2005. We may open additionalsuperstores in fiscal 2005 as we find and evaluate additional potentiallocations and obtain additional results and insights from our existingsuperstores. As the only national retailer that is solely focused on maternity,we are further differentiating ourselves as the ultimate maternity destinationwith these large, well-assorted, “must visit” superstores.

***Two HeartsMaternity.******  ***TwoHearts Maternity launched in selected Sears stores in April 2004 and, as of September 30, 2004,  is carried in leaseddepartments in 71 Sears stores. Based on the success of the initial launch, theTwo Hearts Maternity collection is expanding to a totalof approximately 645 Sears stores beginning in March 2005.This proprietary brand will become the exclusive maternity apparel offering inSears stores. Two Hearts Maternity is a new fashionable collection includingcareer and casual sportswear as well as dresses, lingerie, swimwear and nursingsleepwear, with most items priced under $40. The average Two Hearts Maternityleased department retail space covers approximately400 square feet.

***Oh Baby! by Motherhood.***   OhBaby! by Motherhood collection willlaunch in February 2005 at Kohl’s stores throughout the United States andon Kohls.com. Availableexclusively at Kohl’s under a productand license agreement, the collection will feature a modernand complete assortment of sportswear, intimate apparel and sleepwear, withmost items priced under $40.

**Our Competitive Strengths**

***We are the leaderin maternity apparel.******  ***Weare the leading designer and retailer of maternity apparel in the United Statesand are the only nationwide chain of maternity specialty stores in the UnitedStates. We believe that our brands are the most recognized in maternityapparel. We have established a broad distribution network, with stores in awide range of geographic areas and retailing venues. In addition, we 

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have a leading position atevery price point of maternity apparel through our three distinct brands. Ourleadership position enables us to gain a unique understanding of the needs ofour maternity customers, as well as keep abreast of fashion and productdevelopments. We enhance our leadership position, increase market penetrationand further build our brands by operating leased departments in department andbaby specialty stores.

***We offer a wide product assortment.******  ***A primary consideration forexpectant mothers shopping for maternity clothes is product assortment, aspregnant women need to replace almost their entire wardrobe. We believe that weoffer the widest selection of merchandise in the maternity apparel industry. Wealso offer product for multiple seasons, as pregnant women’s clothing needsvary 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.

***We are vertically integrated.******  ***We design and contractmanufacture approximately 90% of the merchandise we sell in our stores. Webelieve that vertical integration enables us to offer the widest productselection in maternity apparel, to respond quickly to fashion trends and toensure industry-leading in-stock levels. We combine our in-house designexpertise, domestic and international sourcing capabilities, a rapid inventoryreplenishment process and extensive proprietary systems to enhance operationaland financial results.

***We utilize a rapid inventory replenishment system.******  ***Since maternity apparel is aniche industry, store profitability is usually optimized in smaller storeformats. We are able to offer a wide selection of merchandise in our stores,which average approximately 1,800 square feet, due, in large part, to our rapidinventory replenishment system. Our proprietary system enables us to offer morethan 3,000 stock keeping units, or SKUs, per store without dedicating retailspace to storage. We coordinate the rapid replenishment of inventory for all ofour stores through our Philadelphia and Canadian distribution centers, which send individually tailored selectionsto specific store locations between two and six times per week.

***We have proprietary systems that support our business******.  ***In order to support ourvertically integrated business model, we have developed a fully integrated,proprietary enterprise resource planning (ERP) system. This system includespoint-of-sale (POS) systems, our TrendTrackTM merchandise analysis and planningsystem, our materials requirement planning (MRP) system and our web-based,global sourcing and logistics systems. These systems also support our automatedpicking and sorting systems and other aspects of our logistics infrastructure.We believe that our proprietary systems are critical to our competitivestrengths of offering a broad product assortment, responding quickly to fashiontrends, helping to reduce product costs and rapidlyreplenishing inventory in our stores.

***We are able to obtain prime real estate locations.******  ***We believe that we are ableto obtain attractive real estate locations due to the brand awareness of ourconcepts, our multiple price point approach and our sought after maternitycustomer. We are the only maternity apparel retailer to provide mall operatorswith the ability to choose from three differently priced concepts, depending onthe mall’s target demographics. We are also able to provide multiple stores or a multi-brand storefor malls that want to offer their maternity customers a rangeof price alternatives. In addition, in the case of multi-mall operators, wehave the flexibility to provide several stores across multiple malls. As aresult, we have been able to locate stores in many of what we believe are the mostdesirable shopping malls in the country and are able to obtain attractivelocations within these malls.

***We have a highly experienced management team.******  ***Dan Matthias, our Chairmanand Chief Executive Officer, and Rebecca Matthias, our President and Chief OperatingOfficer, founded the Company over 20 years ago and are leaders inmaternity apparel retailing. In recent years, we have added to our managementteam and have a management team with significant experience in all aspects ofthe retail and apparel business.

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**The Maternity Apparel Industry**

We are unaware of any dataon the size of the maternity apparel industry. However, based on our ownanalysis, we believe there are approximately $1.2 billion of maternityclothes sold each year in the United States. In addition, we believe that thereis an opportunity to grow the market by selling maternity clothes to pregnantwomen who currently purchase loose-fitting or larger-sizednon-maternity clothing as a substitute for maternity wear. We also believe thatthe market can grow by reducing the amount of “hand-me-down” and “borrowing”associated with maternity apparel, particularly in the value-pricedmarket where low-priced, fashionable newly-purchased maternity apparelcould provide an economical alternative to secondhand maternity wear. Further,we believe that the demand for maternity apparel is relatively stable whencompared to non-maternity apparel. Expectant mothers continue to need toreplace their clothes and the current steady rate of approximately four millionU.S. births per year has remained stable over the last decade. We believe thatmaternity apparel is also less fashion sensitive than specialty apparel ingeneral, as demand is driven by the need to replace wardrobe basics as opposedto current fashion trends.

**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 positioned our four retail concepts and threeprimary apparel brands to target the entire spectrum of pregnant women, servinga smaller customer base at the highest price points and broadening the marketas 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 averagestore 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)          Our single-brand Mimi stores average 1,600 squarefeet and our multi-brand Mimi stores average 3,000 squarefeet.

We also have four DestinationMaternity superstores open as of September 30, 2004. Thesesuperstores are located in or near regional malls and shoppingcenters, generally include the brands of Motherhood, Mimi and A Pea in the Pod,as well as products unique to the superstore, with dress price rangesindicative of the brands represented. The average size of these fourDestination Maternity superstores is approximately 4,500 square feet. We expectfuture superstores will typically be 6,000 square feet or more.

Major regional malls withseveral department stores and a wide range of price points may be able toaccommodate a multi-brand store, or morethan one maternity store. We have the ability to address 

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multipleprice alternatives at a given mall, with Motherhood as our value-orientedbrand, Mimi as our mid-priced brand and A Pea in the Pod as our luxury brand.As of September 30, 2004, we had at least two of our store concepts in 47 majorregional malls. In addition, almost all 41 of our A Pea in the Pod stores and23 of our Motherhood stores carry Mimi-branded merchandise, and 30of our Mimi stores carry Motherhood-branded merchandise.

**InternetOperations**

We believe that manypregnant women turn to the Internet for maternity-related information andproducts, including on-line purchases of maternity clothes. Our websites aretherefore important tools for educating existing and potential customers aboutour brands and driving traffic to our stores. Our websites sell merchandise andprovide 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 and portal, MaternityMall.com, is anotherlikely way for a consumer to reach one of our brand-specific websites. Inaddition to providing links to all of our websites, MaternityMall.com containsmaternity advice and information, related baby product information andeditorial content. We also operate the iMaternity.com website, which sellsMotherhood merchandise. Our marketing andtechnology capabilities, and the replenishment capabilities ofour distribution center and stores enable us to incorporate Internet design,operations and fulfillment into our existing operations.

**Marketing Partnerships**

We expand and leverage therelationship we have with our customers and earn incremental revenues through avariety of marketing partnership programs utilizing our extensive opt-incustomer database and various in-store marketing initiatives, focused on babyand parent-related products and services.

**Brand-Specific Operations Teams**

To obtain maximumefficiencies, we are organized primarily along functional lines, such asmerchandising, store operations, design and production. Since our businessconsists of three separate brands requiring decisions on a brand-specificbasis, we have built business teams by brand where the functional leaderswithin each brand work together. Each brand team is led by the head merchantand includes the director of stores for that brand, the head designer, the headplanner and distributor and the key production manager. These teams alsoinclude visual, fabric purchasing and other necessary professionals.

**StoreOperations**

The typical maternity customer, especially thefirst-time mother, seeks more advice and assistance than the typicalnon-maternity customer does. Therefore, we aim to employ skilled, motivatedstore team members who are trained to provide the high level of service andreassurance 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. Our centralized merchandising and storeoperations also enable our store team members to focus primarily on selling andmaintaining the appearance of the stores. In addition, visual merchantscoordinate with the merchandising department to develop floor-sets, designstore display windows and define and enhance the product presentation.

Each of our three primarystore 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 to its smaller number of stores, thedistrict managers report to the director of stores. Our store, district andregional managers are eligible to receive incentive-based compensationrelated to store, district and regional-level performance.

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**Merchandising,Design and Inventory Planning**

***Merchandising.******  ***We strive to maintain anappropriate balance between new merchandise and proven styles, as well asbetween basic and fashion items. Our merchandising decisions are based oncurrent fashion trends, as well as input from our designers and outsidevendors. This information is used in conjunction with the item-specific salesdata provided by our proprietary merchandising and replenishment system. Eachbrand has its own team of merchants, designers and planners. These teams areled by the head merchant of the brand.

***Design.******  ***Our design department createsand produces samples and patterns for our contract-manufacturedproducts under the guidance of the merchandising department. This capabilitydifferentiates us from many of our competitors, who source their products froma limited number of maternity wear vendors. The design of our products beginswith a review of European and New York runway trends, current non-maternityretail trends, fashion reporting service slides and fabric samples. Thedesigners review our best selling items from prior seasons and integratecurrent fashion ideas from the non-maternity apparel market.

***Inventory Planning and Allocation.******  ***Our planning and allocationdepartment is responsible for planning future inventory purchases andmarkdowns, as well as targeting overall inventory levels and turnover. Weestablish target inventories for each store using our inventory planning systemwith the goals of optimizing our merchandise assortment and turnover,maintaining adequate depth of merchandise by style and managing closeout andend-of-season merchandise consolidation. Our proprietary capabilities enable usto continually monitor and respond quickly to consumer demand and are integralto our inventory management program. These capabilities are facilitated by ourTrendTrack system, which provides daily product sell-through data andmerchandising information.

**Production and Distribution**

We design and contract for the production forapproximately 90% of our merchandise. We contract our sewing to factoriesthroughout the world, including domestic facilities, and we continue to seekadditional contractors for our sourcing needs. No individual contractorrepresents a material portion of our sewing. A majority of our merchandise ispurchased “full package” as finished product made to our specifications,typically utilizing our designs. Fabric, trim and other supplies are obtainedfrom a variety of sources. As we have expanded our stores and increased volumesover the past several years, we have generally been able to reduce our productcosts, thereby increasing gross margins. However, our most recent fiscal year’sgross margin decreased by about one-half percent, primarily driven by increasedmarkdowns recognized.

Our production and quality assurance personnel monitorproduction at contractor facilities in the United States and work with ouragents abroad to ensure quality control, compliance with our designspecifications and timely delivery of finished goods. This quality controleffort is enhanced by our worldwide Internet-based contracting andlogistics systems, which include advanced features such as measurementspecifications and digital photography. We also use a third party consultingfirm to help monitor working conditions at our contractors’ facilities on aworldwide basis.

Finished garments from contractors and othermanufacturers are received at our United States distribution facility in Philadelphia,Pennsylvania, and our Canadian distribution center. Garments are inspectedusing statistical sampling methods and stored for picking. Our distributionfacility utilizes the latest fulfillment technology to serve as a replenishmentcenter, as opposed to solely a distribution center. The facility sends anindividually tailored selection from our approximately 24,000 SKUs to our storelocations two to six times per week. Store replenishment decisions are madeautomatically based upon target inventories established by the allocationdepartment and individual store sales data. The distribution 

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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.

Shipments to stores are tracked by our proprietarydelivery 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.

In November 2003, wewere certified to participate in Customs-Trade Partnership AgainstTerrorism, or C-TPAT, a United States Department of Homeland Security sponsoredprogram that enhances our standing with United States Customs and BorderProtection through our implementation and monitoring of procedures to managethe security of our supply chain as part of the effort to protect the UnitedStates against potential acts of terrorism.

**Management Information and Control Systems**

We believe that our proprietary systems areinstrumental to our ability to offer the broadest assortment of maternitymerchandise and accomplish rapid replenishment of inventory. We continuouslydevelop, maintain and upgrade our systems and currently employ an in-house teamof programmers. Our stores have point-of-sale terminals that provideinformation used in our customized TrendTrack merchandise analysis and planningsystem. This system provides daily financial and merchandising information thatis integral to monitoring trends and making merchandising decisions. TheTrendTrack system has numerous features designed to integrate our retailoperations with our design, manufacturing and financial functions. Thesefeatures include custom merchandise profiles for each store, rapid inventoryreplenishment, item-tracking providing daily updated selling information forevery style, classification open-to-buy and inventory control, as well as thedaily collection of customer payment data,including cash, check and credit card sales data.

As part of our proprietary ERP system, we employ acomprehensive MRP system to manage our production inventories, documentation,work orders and scheduling. This system provides a perpetual inventory of rawmaterials, actual job costing, scheduling and bill of materials capabilities.The foundation of our ERP system is a perpetual inventory of finished goods bylocation across all of our retail stores, which interfaces directly with ourdistribution facility.

In fiscal 2003, we rolled out a proprietary,upgraded point-of-sale system to our stores andintegrated this system with our existing systems. This Internet-basedsystem provides real-time access to financial and merchandising information inaddition to rapid credit authorization. This upgraded point-of-sale system hassignificantly reduced the amount of training required for new sales associatesand store managers. In addition, we plan tocontinue to add new features and functionality to the system, andanticipate that the system will improve our customer relationship managementcapabilities by allowing the creation of customized promotional and marketingstrategies.

Given the importance ofour management information systems, we have taken extensive measures to ensuretheir 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 ourPhiladelphia facility, is duplicated by a fully mirrored system in a separatepart of the building with a separate power source that is designed to assumefull operations should disruption in the primary system occur. In addition, oursoftware programs and data are backed up and stored off-site. Ourcommunications links come from two telephone frame rooms and are deliveredthrough underground and aboveground feeds.

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**Pricing**

Each of our brands targets customers at differentprice points of the maternity apparel industry. Our Motherhood brand ispositioned primarily on everyday low prices, Mimi employs middle-marketpricing and A Pea in the Pod employs luxury pricing. None of our conceptsrelies on point-of-sale high/low promotional strategies to drive traffic intothe stores. Our price reductions are done at the individual style level and areused to accelerate the sale of slower selling merchandise. Merchandise that isselling slowly is quickly marked down, moved to another store where the item isselling faster, or moved to a Motherhood Outlet store.

**Advertising andMarketing**

We believe that the power of our brands, customerreferrals and our convenient mall locations drive traffic into our stores.Therefore, we have modest advertising and marketing expenditures. Ouradvertising and publicity efforts include in-store marketing, prenatal consumer-targetedadvertising and our Internet websites. We also run full-page ads for allof our brands in pregnancy-targeted publications, as well as prenatalissues of leading baby and parenting magazines. We advertise in several keyprenatal magazines, including *American Baby, Pregnancy,ePregnancy, Healthy Pregnancy* and *Shape FitPregnancy*. A Pea in the Pod, Mimi and Motherhood are also advertisedin fashion and broad-reach magazines, such as *Vogue*,*In Style, Lucky, People* and *Glamour*. We also utilize our publicity efforts to generatefree editorial coverage in broadcast television, magazines, radio and selectednewspapers for all of our brands.

**Competition**

Our business is highlycompetitive, characterized by low barriers to entry. The following are severalimportant factors in competing successfully in the retail apparel industry: breadth ofselection in sizes; colors and styles of merchandise; product procurement andpricing; ability to anticipate fashion trends and customer preferences;inventory control; reputation; quality of merchandise; store design andlocation; visual presentation and advertising and customer service. We facecompetition in our maternity apparel lines from various sources, includingdepartment stores, specialty retail chains, discount stores, independent retailstores and catalog and Internet-based retailers, from both new andexisting competitors. Many of our competitors are larger and have substantiallygreater financial and other resources than us. 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-pricedmerchandise faces a highly fragmented competitive landscape that includeslocally based, single unit retailers, as well as a handful of multi-unitmaternity operations, none of which we believe has more than 15 storesnationwide. In the value-priced maternity apparel business, we currentlyface competition on a nationwide basis from retailers such as Fashion Bug®,GAP®, JC Penney®, Kmart®, Kohl’s®, Old Navy®, Target®, Sears® and Wal-Mart®. Severalof these competitors, including Gap® and Old Navy®, also sell maternity apparelon their websites. We believe there has been increased competition in thematernity apparel industry, from both new and existing competitors. Wecurrently face maternity competition in over 1,000 more competitive locationsthan a year ago. Our market share and results of operations may be materiallyand adversely affected by this competition, including the potential forincreased 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 willbe expanding our Two Hearts Maternity collection to a total of approximately 645 Searsstores in March 2005 under a leased department arrangement. In February 2005,we will launch our Oh Baby! by Motherhood collection at Kohl’sstores throughout the United States and on Kohls.com,available exclusively at Kohl’sunder a product and licenseagreement.

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**Employees**

As of September 30,2004, we had 2,624 full-time and 2,401 part-time employees. None of ouremployees are covered by a collective bargaining agreement. We consider ouremployee relations to be good.

**Executive Officers 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 |

 

*DanW. Matthias***co-foundedMothers Work in 1982 (along with Rebecca C. Matthias) and has served asChairman of the Board since our inception. From 1983 to 1993, Mr. Matthiasserved as our Executive Vice President, and since January 1993, Mr. Matthiashas been our Chief Executive Officer. 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.

*RebeccaC. Matthias***co-foundedMothers Work in 1982 (along with Dan W. Matthias) and has served as a directorand our President since our inception. Since January 1993, Ms. Matthiashas also served as our Chief Operating Officer. In 1992, Ms. Matthias waschosen as “Regional Entrepreneur of the Year” by *Inc*.magazine and Merrill Lynch Corporation, and in September 2003, Ms. Matthiaswas recognized as a top woman entrepreneur by the United States Small BusinessAdministration. Prior to 1982, Ms. Matthias was a construction engineerfor 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.

*EdwardM. Krell***has served asExecutive Vice President-Chief Financial Officer since November 2003,having served as Senior Vice President-Chief Financial Officer from thetime he joined Mothers Work in January 2002 until November 2003.Prior to joining Mothers Work, Mr. Krell served as Executive VicePresident and Chief Financial Officer of Mammoth Sports Group, Inc., anInternet and catalog retailer of golf equipment and accessories, from December 1999to July 2000 and as an independent financial consultant from July 2000to January 2002. From 1995 to 1999, Mr. Krell served as ExecutiveVice 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.

*DavidMangini***has served asExecutive Vice President-General Merchandise Manager since August 2001.Prior to joining Mothers Work, Mr. Mangini served as Today’s Man’s ChiefMerchandising Officer from 1999 to 2000. From 1998 to 1999, Mr. Manginiserved as Chief Operating Officer of Gadzooks. From 1987 to 1997, Mr. Manginiwas an officer at Limited, Inc., including President and Chief ExecutiveOfficer of its Structure brand.

Our executive officers areelected annually by the Board of Directors and serve at the discretion of theBoard. Other than the husband and wife relationship between Dan and RebeccaMatthias, there are no family relationships among any of our other executiveofficers.

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**Trademarks**

We own trademark andservice mark rights that we believe are sufficient to conduct our business ascurrently operated. We own several trademarks, including Mothers Work®, A Peain the Pod®, Mimi Maternity®, Motherhood®, Motherhood Maternity®, DestinationMaternityTM, Two Hearts MaternityTM, Oh Baby!TM, Oh Baby! byMotherhoodTM, Motherhood Maternity Outlet®, Steena® and MaternityMall.com®. As aresult of the iMaternity acquisition, we also own the iMaternity®, Dan Howard®and iMaternity.comTM marks. Additionally, we own the marks futuretrustTM, RealTime Retailing®, What’s Showing is Your Style®, Motherhood: It’s Hot!TM,Motherhood is Everything GoodTM, Motherhood Baby® and Maternity Redefined®. Weare 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 or Canada.

**Seasonality**

Our business, like that ofmany 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 typically higher gross margin we experience in thethird fiscal quarter compared to other quarters, the relatively fixed nature ofmost of our operating expenses and interest expense, and the historicallyhigher sales level in the third quarter, we have typically generated a verysignificant percentage of our full year operating income and net income duringthe third quarter. Results for any quarter are not necessarily indicative ofthe results that may be achieved for a full fiscal year. Quarterly results mayfluctuate materially depending upon, among other things, the timing of newstore openings, net sales and profitability contributed by new stores,increases or decreases in comparable store sales, adverse weather conditions,shifts in the timing of certain holidays and promotions, changes in inventory andproduction levels and the timing of deliveries of inventory, and changes in ourmerchandise mix.

**Securities and Exchange Commission Filings**

Securities and ExchangeCommission (“SEC”) filings are available free of charge on our website,www.motherswork.com. Our annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K andamendments to those reports are posted on our website as soon as practicableafter we furnish such materials to the SEC.

**Item2.    Properties**

We own our principal executive offices anddistribution facility, which is located at 456 North Fifth Street,Philadelphia, Pennsylvania, subject to a mortgage under the terms of which weowe approximately $3.1 million as of September 30, 2004. Thisfacility consists of approximately 318,000 square feet, of which 45,000square feet is dedicated to office space and the remaining square footage tofinished goods warehousing and distribution. On August 26, 2002, weentered into a 10-year lease for a facility located at 2001 Kitty Hawk Avenue,Philadelphia, Pennsylvania in the Philadelphia Naval Business Center. The arealeased at this facility, which we use for raw material cutting and warehousing,consists of 64,000 square feet of space.To facilitate our store growth in Canada, we entered intoa three-year lease commencing November 1, 2002 for 12,000 square feet of finished goods warehouse and distribution space in Mississauga,Ontario in Canada. We believe that these facilities will be adequate to supportour anticipated distribution needs for the near term and, potentially, longer.In the event we need additional space to meet our future distribution needs, webelieve that such space would be readily available. Our facilities are subjectto state and local regulations that range from building codes to health andsafety.

We lease our store premises for terms averaging fromseven to ten years. Certain leases allow us to terminate our obligations at specified points in time in theevent that the applicable store does not achieve 

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a specified sales volume.Some of our store leases also provide forcontingent payments based on sales volume, escalations of the base rent, aswell as increases in operating costs, marketing costs and real estate taxes.

As of September 30,2004, the following number of store leases are set to expire as listed in thetable below. We do not expect the expiration of any leases to have a materialadverse impact on our 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        |                       |       |

 

In addition, we havearrangements with department and specialty stores, including Babies “R” Us®,Bloomingdale’s®, Burdine’s®,  Lazarus®,Macy’s®, Marshall Field’s®, Rich’s®and Sears® to operate maternitydepartments in their stores. These leased departments typically involve thelease partner collecting all of the revenue from the leased department andremitting all but a fixed percentage to us. Weprovide at least some amount of staffing for each of the leased departments, with the amount varying depending on the specificarrangement.

**Item 3.    LegalProceedings**

We were a party to an action filed against us allegingthat certain former and current employees should have received overtimecompensation under Washington law in Spokane County Superior Court. Theplaintiffs in this action sought unspecified actual damages, penalties andattorneys’ fees. On or about April 23, 2003, one purported subclass of theplaintiffs accepted a settlement arrangement in the amount of $50,000, plusattorney’s fees and costs incurred through such date. After a trial with theremaining purported subclass, in May 2003, the jury found for us on allbut one claim, for which it awarded the remaining plaintiffs damages in theamount of $106,000. The parties are currently contesting fees, costs andexpenses being sought by the plaintiffs in the amount of approximately$390,000. We recorded expenses during fiscal 2004 and 2003 of $78,000 and$546,000, respectively, for the estimated legal fees and settlement costs ofthis case, including the contested costs and expenses noted above.

In addition, from time totime, we are named as a defendant in legal actions arising from our normalbusiness activities. Although the amount of any liability that could arise withrespect to currently pending actions cannot be accurately predicted, we do notbelieve that the resolution of any pending action will have a material adverseeffect on our financial position, results of operations or liquidity.

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

Not applicable.

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**PART II.**

**Item 5.  Market for Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities**

Ourcommon stock is traded on the Nasdaq National Market under the symbol “MWRK.”The following table sets forth for the periods indicated below the reportedhigh and low sales prices of our common stock as reported on the NasdaqNational 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   |       |

 

As of December 1, 2004, there were 837holders of record and 2,030 estimated beneficial holders of our common stock.

We have not paid any cash dividends on our commonstock since our initial public offering and do not anticipate paying cashdividends on our common stock in the foreseeable future. In addition, the termsof our senior notes and our credit facility significantlyrestrict our ability to declare or pay dividends on our common stock. Even ifwe were not restricted under the terms of our $125.0 million of 111¤4%senior notes due 2010 (the “New Senior Notes”) or ourcredit facility from being able to pay dividends, any futurepayment of dividends would still be at the discretion of our Board of Directorsand would be based upon certain restrictive financial covenants, earnings,capital requirements and our financial condition, among other factors, at thetime any such dividend is considered.

Up to a total of 1,975,000 options may be issued underour1987 Stock Option Plan and up to a total of 200,000 options may be issued underour separate Director Stock Option Plan.

In March 2003, our Board of Directors approved ashare repurchase program under which we may repurchase up to $10.0 million ofour outstanding common stock from time to time in private transactions or onthe 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 ourNew Senior Notes and the terms of our credit facility contain restrictions thatplace limits on certain payments by us, including payments to repurchase sharesof our common stock. Our repurchases of common stock have been made incompliance with all restrictions under the indenture governing the New SeniorNotes 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:

**Issuer Purchases ofEquity 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 142,269 shares at a total cost ofapproximately $3.2 million pursuant to the repurchase program that we publiclyannounced in March 2003, of which 75,715 shares were repurchased duringfiscal 2004, at an average cost of $23.44 per share.

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**Item 6.    SelectedConsolidated Financial and Operating Data**

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. Theselected consolidated statement of operations and balance sheet data for eachof the five fiscal years presented below are derived from our auditedconsolidated financial statements. You should read this information in conjunctionwith the “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and our consolidated financial statements and therelated notes included elsewhere in this report.
| ** **                                           | ** ** | **Year Ended September 30,**                           | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **2002 (1)** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                           | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Statement  of Operations Data:**                   |       |                                                                  |       |   |   |   |   |   |   |   |   |
| 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         |       | 253,885                                                               |       | 230,104 |   | 207,728 |   | 172,795 |   | 157,809 |   |
| Operating income                                     |       | 24,553                                                                |       | 37,152 |   | 33,742 |   | 21,191 |   | 25,174 |   |
| Interest expense, net (2)                       |       | 14,765                                                                |            | 14,469 |  | 16,476 |  | 14,867 |  | 15,877 |  |
| Other income                                         |       | —                                                                |       | — |   | — |   | 594 |   | — |   |
| Income before income taxes                           |       | 9,788                                                                 |       | 22,683 |   | 17,266 |   | 6,918 |   | 9,297 |   |
| Income tax provision (2)                        |       | 3,915                                                                 |       | 8,733 |   | 6,478 |   | 3,456 |   | 4,249 |   |
| Net income                                           |       | 5,873                                                                 |       | 13,950 |   | 10,788 |   | 3,462 |   | 5,048 |   |
| Dividends on preferred stock                         |       | —                                                                |       | — |   | 3,942 |   | 1,491 |   | 1,389 |   |
| Net income available to common stockholders (1) |       | $                                                                     | 5,873      |   | $ | 13,950 |   | $ | 6,846 |   | $ | 1,971 |   | $ | 3,659 |   |
| Net income per share—Basic (1)             |       | $                                                                     | 1.13       |   | $ | 2.66 |   | $ | 1.75 |   | $ | 0.57 |   | $ | 1.06 |   |
| Average shares outstanding—Basic                |       | 5,212                                                                 |       | 5,236 |   | 3,914 |   | 3,456 |   | 3,443 |   |
| Net income per share—Diluted (1)           |       | $                                                                     | 1.07       |   | $ | 2.47 |   | $ | 1.61 |   | $ | 0.55 |   | $ | 1.01 |   |
| 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 (1)** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                              | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Pro  Forma Statement of Operations Data (3):**                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Net income available to common stockholders                                             |       | $                                                                     | 5,873      |   | $ | 13,950 |   | $ | 6,846 |   | $ | 1,971 |   | $ | 3,659 |   |
| Add back goodwill amortization                                                          |       | —                                                                |       | — |   | — |   | 2,207 |   | 2,216 |   |
| Pro forma net income available to common  stockholders, excluding goodwill amortization |       | $                                                                     | 5,873      |   | $ | 13,950 |   | $ | 6,846 |   | $ | 4,178 |   | $ | 5,875 |   |
| Pro forma net income per share—Basic                                               |       | $                                                                     | 1.13       |   | $ | 2.66 |   | $ | 1.75 |   | $ | 1.21 |   | $ | 1.71 |   |
| Pro forma net  income per share—Diluted                                            |       | $                                                                     | 1.07       |   | $ | 2.47 |   | $ | 1.61 |   | $ | 1.16 |   | $ | 1.61 |   |

 

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(1)          In August 2002, aspart of a refinancing, we repurchased our existing 125¤8% senior notesand 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 ofthe $3.0 million of one-time charges, fiscal 2002 net income available tocommon stockholders would have been approximately $9.9 million, or $2.32per share(diluted). We have presented this adjusted earnings figure because managementbelieves it enhances the reader’s understanding of our operating results byadjusting for the one-time charges related to the refinancing. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”

(2)          In fiscal 2003, weadopted the provisions of Financial Accounting Standards Board (“FASB”)Statement of Financial Accounting Standards (“SFAS”) No. 145. Theprovisions of this statement require, effective in fiscal years beginning afterMay 15, 2002, the reclassification of certain gains or losses onextinguishment of debt that were previously classified as an extraordinary itemin 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 the adoption of SFAS No. 145, we hadreported interest expense for fiscal 2002 of $14.0 million.

(3)          As a result of ouradoption of SFAS No. 142 on October 1, 2001, we no longeramortize goodwill. The pro forma statement of operations data reflects anadjustment to exclude amortization expense recognized in the prior periods aspresented. 

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| ** **                                                  | ** ** | **Year Ended September 30,**                                                        | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2004**                                                                                           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                  | ** ** | **(unaudited; in thousands, except operating data and ratios)** | ** ** |
| **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)       |       | $                                                                                                  | 319        |   | $ | 359 |   | $ | 363 |   | $ | 365 |   | $ | 390 |   |
| Average net sales per store (3)                        |       | $                                                                                                  | 544,000    |   | $ | 592,000 |   | $ | 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:**                               |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| EBITDA (5)                                             |       | $                                                                                                  | 34,765     |   | $ | 47,014 |   | $ | 43,238 |   | $ | 33,700 |   | $ | 37,125 |   |
| Cash flows provided by operating activities            |       | 11,409                                                                                             |       | 30,009 |   | 28,478 |   | 19,507 |   | 18,623 |   |
| Cash flows used in investing activities                     |       | (14,773                                                                                            | )          | (21,389 | ) | (9,291 | ) | (12,127 | ) | (13,828 | ) |
| Cash flows used in financing activities                     |       | (2,500                                                                                             | )          | (4,648 | ) | (14,786 | ) | (98 | ) | (2,859 | ) |
| Capital expenditures                                        |       | 14,693                                                                                             |       | 19,214 |   | 9,839 |   | 12,212 |   | 13,619 |   |
| Ratio of total debt to EBITDA                               |       | 3.7x                                                                                               |       | 2.7x |   | 3.0x |   | 3.8x |   | 3.4x |   |
| Ratio of EBITDA to interest expense (6)                |       | 2.4x                                                                                               |       | 3.2x |   | 2.6x |   | 2.3x |   | 2.3x |   |
| **Balance Sheet Data (at end of period):**                  |       |                                                                                               |       |   |   |   |   |   |   |   |   |
| Working capital                                             |       | $                                                                                                  | 71,768     |   | $ | 66,232 |   | $ | 57,918 |   | $ | 32,509 |   | $ | 29,684 |   |
| Total assets                                                |       | 251,383                                                                                            |       | 246,603 |   | 233,285 |   | 185,177 |   | 179,586 |   |
| 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 (7)                      |       | $                                                                                                  | —     |   | $ | — |   | $ | — |   | $ | 10,773 |   | $ | 11,500 |   |
| Common stockholders’  equity                      |       | 66,270                                                                                             |       | 61,391 |   | 47,505 |   | 3,968 |   | 1,250 |   |
| Total  stockholders’ equity                            |       | $                                                                                                  | 66,270     |   | $ | 61,391 |   | $ | 47,505 |   | $ | 14,741 |   | $ | 12,750 |   |

 

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(1)          Same store sales figuresrepresent sales at retail locations that have been in operation by Mothers Workfor at least twelve full months at the beginning of the period for which suchdata is presented. As used in this Form 10-K, “retail locations” includestores and leased departments.

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

(3)          Based on stores inoperation by Mothers Work during the entire twelve-month period.

(4)          Based on all retaillocations in operation at the end of the period.

(5)          EBITDA represents incomebefore interest expense, income tax provision, and depreciation andamortization expense. We have presented EBITDA to enhance your understanding ofour operating results. EBITDA is provided because management believes it is animportant measure of financial performance commonly used in the retail industryto determine the value of companies within the industry and to define standardsfor 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 

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accordance with generallyaccepted accounting principles. We may calculate EBITDA differently than othercompanies.

(6)          Ratio of EBITDA tointerest expense for fiscal 2002 reflects the inclusion in interest expense ofan approximately $2.5 million loss on early extinguishment of debt relatedto our fiscal 2002 refinancing.

(7)   Wehave redeemed 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 our consolidated balance sheet as of September 30,2004 in accrued expenses and other current liabilities.

**Reconciliation of Operating Income to EBITDA**(in thousands)(unaudited)
| ** **                                  | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Operating income                            |       | $                                           | 24,553     |   | $ | 37,152 |   | $ | 33,742 |   | $ | 21,191 |   | $ | 25,174 |   |
| Add: depreciation  and amortization expense |       | 10,212                                      |       | 9,862 |   | 9,496 |   | 11,915 |   | 11,951 |   |
| Add: other income                           |       | —                                      |       | — |   | — |   | 594 |   | — |   |
| EBITDA                                      |       | $                                           | 34,765     |   | $ | 47,014 |   | $ | 43,238 |   | $ | 33,700 |   | $ | 37,125 |   |

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****

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

**Overview**

The following discussion should be read in conjunctionwith the consolidated financial statements and their related notes includedelsewhere in this report.

We are the leadingdesigner and retailer of maternity apparel in the United States with 1,115retail locations, including 883 stores in all 50 states, Puerto Rico and Canadaand 232 leased departments. We operate our stores under the MotherhoodMaternity, Mimi Maternity,  A Pea in the Pod and DestinationMaternity brands and also sell our merchandise on the Internetat our MaternityMall.com and our brand-specific websites. In addition toour 883 stores, our retail locations include 232 leased departments, primarilyMotherhood-branded, within department and specialty stores. We design andcontract manufacture approximately 90% of the merchandise we sell in our retaillocations.

**Critical Accounting Policies and Estimates**

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

Our significant accounting policies are described inNote 2 of “Notes to Consolidated Financial Statements.” We believe thatthe following discussion addresses our critical accounting policies, which arethose that are most important to the portrayal of our financial condition and resultsof operations and require management’s most difficult, subjective and complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. If actual results were to differsignificantly from estimates made, future reported results could be materiallyaffected. However, we are not currently aware of any reasonably likely eventsor circumstances that would result in materially different results.

Our senior management has reviewed these critical accountingpolicies and estimates and the related Management’s Discussion and Analysis ofFinancial Condition and Results of Operations with the Audit Committee of ourBoard of Directors.

*Inventories.**  *We valueour inventories, which consist primarily of maternity apparel, at the lower ofcost or market. Cost is determined on the first-in, first-out method (FIFO) andincludes the cost of merchandise, freight, duty and broker fees. A periodicreview of inventory quantities on hand is performed in order to determine ifinventory is properly valued at the lower of cost or market. Factors related tocurrent inventories such as future consumer demand and fashion trends, currentaging, current analysis of merchandise based on receipt date, current andanticipated retail markdowns or wholesale discounts, and class or type ofinventory are analyzed to determine estimated net realizable values. Criteriautilized by us to quantify aging trends include factors such as the amount ofmerchandise received within the past twelve months, merchandise received morethan one year before with quantities on-hand in excess of 12 months ofsales, and merchandise currently selling below cost. A provision is recorded toreduce the cost of inventories to the estimated net realizable values, ifrequired. Inventories as of September 30, 2004 and 2003 totaled$92.7 million and $84.5 million, respectively, representingapproximately 36.9% and 34.3% of total assets, respectively. Given thesignificance of inventories to our consolidated financial statements, thedetermination of net realizable values is considered to be a criticalaccounting estimate. Any significant unanticipated changes in the factors notedabove could have a significant impact on the value of our inventories and ourreported operating results.

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*Long-LivedAssets.**  *Ourlong-lived assets consist principally of store leasehold improvements and areincluded in the “Property, Plant and Equipment, net” line item in ourconsolidated balance sheets. These long-lived assets are recorded at cost andare amortized using the straight-line method over the shorter of the lease termor their useful life, generally ten years. Net property, plant and equipment asof September 30, 2004 and 2003 totaled $60.3 million and$57.8 million, respectively, representing approximately 24.0% and 23.4% oftotal assets, respectively.

In assessing potential impairment of these assets, weperiodically evaluate the historical and forecasted operating results and cashflows on a store-by-store basis. Newly-opened stores may take time togenerate positive operating and cash flow results. Factors such as (i) storetype, 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 aresubstantially different from our expectations, the carrying value of certain ofour long-lived assets may become impaired. As a result of our impairmentassessment, we recorded write-downs of long-lived assets of$1.5 million and $0.5 million during fiscal 2004 and fiscal 2003,respectively.

*Goodwill.**  *The purchase method of accounting for businesscombinations requires the use of estimates and judgments to allocate thepurchase price paid for acquisitions to the fair value of the net tangible andidentifiable intangible assets. Goodwill represents the excess of the aggregatepurchase price over the fair value of net assets acquired in businesscombinations and is separately disclosed in our consolidated balance sheets. Asof both September 30, 2004 and 2003, goodwill totaled $50.4 million,representing 20.0% and 20.4% of total assets, respectively. In June 2001,the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.”SFAS No. 142 requires that goodwill no longer be amortized, butinstead be tested for impairment at least annually or as impairment indicatorsarise. Prior to our adoption of SFAS No. 142 on October 1, 2001,goodwill was amortized using the straight-line method over a period of20 years.

The impairment test requires us to compare the fairvalue of business reporting units to their carrying value, including assignedgoodwill. In assessing potential impairment of goodwill, we have determinedthat we have one reporting unit for purposes of applying SFAS No. 142based 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 into account in determining the fair marketvalue of our outstanding common stock on a control basis are: (i) thetrading value of our outstanding common stock on an established public market,and (ii) the premium over the trading price of our outstanding commonstock that an investor would pay for a control ownership interest in thecompany, as determined through a third party evaluation. The carrying value ofour single reporting unit, expressed on a per share basis, is represented byour book value per share of outstanding common stock. We performed the initialadoption impairment test in early fiscal 2002. The results of the initial impairmenttest 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 $12.73 per shareof outstanding common stock and the closing tradingprice of our common stock was$14.50 per share. If the fair value of our outstanding common stock on acontrol basis were less than $12.73 per share on September 30, 2004, ourgoodwill would have become impaired.

*Accountingfor Income Taxes.**  *As partof the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. This process requires us to estimate our actual current tax exposuretogether with assessing temporary differences resulting from differingtreatment of items, such as depreciation of property and equipment 

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and valuation ofinventories, for tax and accounting purposes. 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 currentlyproposed by certain of the states in which we operate, if enacted, couldincrease our transactions or activities subject to tax. Any such legislationthat becomes law could result in an increase in our state income tax expenseand our state income taxes paid, which could have a material and adverse effecton our net income.

The temporary differences between the book and tax treatment of income and expenses resultin deferred tax assets and liabilities, which are included within ourconsolidated balance sheets. We must then assess the likelihood that ourdeferred tax assets will be recovered from future taxable income. Actualresults could differ from this assessment if adequate taxable income is notgenerated in future periods. Net deferred tax assets as of September 30,2004 and 2003 totaled $16.2 million and $18.2 million, respectively,representing approximately 6.4% and 7.4% of total assets, respectively. To theextent we believe that recovery is not more likely than not, we must establisha valuation allowance. To the extent we establish a valuation allowance orchange the allowance in a future period, income tax expense will be impacted.

*Accounting forContingencies.**  *Fromtime to time, we are named as a defendant in legal actions arising from ournormal business activities. We account for contingencies such as these inaccordance with SFAS No. 5, “Accounting for Contingencies.” SFAS No. 5requires us to record an estimated loss contingency when information availableprior to issuance of our financial statements indicates that it is probablethat an asset has been impaired or a liability has been incurred at the date ofthe financial statements and the amount of the loss can be reasonablyestimated. An interpretation of SFAS No. 5 further states that when thereis a range of loss and no amount within that range is a better estimate thanany other, then the minimum amount of the range shall be accrued. Accountingfor contingencies arising from contractual or legal proceedings requirescompany management, after consultation with outside legal counsel, to use itsbest judgment when estimating an accrual related 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 actual loss arising from a loss contingencywhich significantly exceeds the amount accrued for in our financial statementscould have a material adverse impact on our operating results for the period inwhich such actual loss becomes known.

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**Results of 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** | ** ** |
| 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 |       | 49.0                                       |       | 46.8                                    |       | 45.8 |   |   | 10.3 |   |   | 10.8 |   |
| Operating income                              |       | 4.7                                        |       | 7.5                                     |       | 7.5 |   |   | (33.9 | ) |   | 10.1 |   |
| Interest expense,  net                        |       | 2.9                                        |            | 2.9                                     |            | 3.7 |  |   | 2.0 |   |   | (12.2 | ) |
| Income before income taxes                    |       | 1.9                                        |       | 4.6                                     |       | 3.8 |   |   | (56.8 | ) |   | 31.4 |   |
| Income tax  provision                         |       | 0.8                                        |       | 1.8                                     |       | 1.4 |   |   | (55.2 | ) |   | 34.8 |   |
| Net income                                    |       | 1.1                                        |       | 2.8                                     |       | 2.4 |   |   | (57.9 | ) |   | 29.3 |   |
| Dividends on  preferred stock                 |       | —                                     |       | —                                  |       | 0.9 |   |   | — |   |   | (100.0 | ) |
| Net income  available to common stockholders  |       | 1.1                                        | %          | 2.8                                     | %          | 1.5 | % |   | (57.9 | )% |   | 103.8 | % |

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(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 |   |   |
|                                                         |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Year Ended September 30,2004 and 2003**

*NetSales.**  *Our netsales for fiscal 2004 increased by 5.2%, or $25.6 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 store sales.Comparable store sales decreased by 4.9% during fiscal 2004, based on 765retail locations, versus a comparable store sales increase of 0.3% duringfiscal 2003, based on 702 retail locations. The decrease in comparable storesales in fiscal 2004 reflected the impact of increased competition in thematernity apparel market and some weakness in the fashion portion of our productline earlier in the year. We estimate that there are over 1,000 more competitorlocations at the end of fiscal 2004 compared to the end of fiscal 2003. Webelieve this increased competition caused an oversupply of maternity apparel inthe market and that the increasingly deep markdowns taken by our competitors tostimulate sales and clear seasonal inventories further adversely affected ournet sales for the second half of fiscal 2004.

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As of September 30, 2004, we operated a total of883 stores and 1,115 total retail locations: 717 Motherhood Maternity stores(including 106 Motherhood Maternity Outlet stores), 121 Mimi Maternity stores,41 A Pea in the Pod stores, four Destination Maternity superstores,and 232 leased maternity departments, of which 71 were in Sears® stores and thebalance were primarily under the Motherhood brand. In comparison, as of September 30,2003, we had 1,006 total retaillocations: 688 Motherhood Maternity stores(including 104 Motherhood Maternity Outlet stores), 113 Mimi Maternity stores, 44 A Pea inthe Pod stores and 155 leased departments. As of September 30, 2004,our store total included 35 multi-brand stores, including four DestinationMaternity superstores, with the remaining multi-brand stores predominantlyunder the Mimi Maternity brand. In comparison, as of September 30, 2003,we operated 6 multi-brand stores. Thesemulti-brand store figures for fiscal 2004 and fiscal 2003 exclude our A Pea in the Pod stores, which have traditionallycarried a full line of both A Pea in the Pod and Mimi branded merchandise. Duringfiscal2004, 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. Inaddition, during fiscal 2004, the Company opened 81 leased department locationsand closed four leased department locations, with the openings predominantlycoming from the exclusive introduction of our new Two Hearts Maternitycollection in 71 Sears® stores to replace the existing maternity lines in thesestores.

*GrossProfit.**  *Ourgross profit for fiscal 2004 increased by 4.2%, or $11.2 million, to$278.4 million compared to $267.3 million for fiscal 2003, reflectingthe increase in net sales, partially offset by a decrease in gross profitmargin. Gross profit as a percentage of net sales was 53.7% for fiscal 2004,compared to 54.3% for fiscal 2003. 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 and Administrative Expenses.**  *Our selling, general and administrative expenses forfiscal 2004 increased by 10.3%, or $23.8 million, to $253.9 millionfrom $230.1 million for fiscal 2003. Compared to fiscal 2003, store rentand related expenses increased by $11.0 million and store wages andrelated benefits costs increased by $7.1 million, primarily resulting fromour new store openings. As a percentage of net sales, selling, general andadministrative expenses increased to approximately 49.0% for fiscal 2004compared to 46.8% for fiscal 2003, primarily reflecting an increased storeoccupancy expense ratio and, to a lesser extent, increased store payrollexpense ratios resulting from the 4.9% decrease in comparable store sales forthe year, partially offset by a lower legal expense and employee benefits expense ratios. In addition, weincurred charges relating to store closings of $1.8 million for the full yearof fiscal 2004 versus $0.3 million for fiscal 2003.

*OperatingIncome.**  *Ouroperating income for fiscal 2004 decreased by 33.9%, or $12.6 million, to$24.6 million from $37.2 million for fiscal 2003, due to our higherselling, general and administrative expenses, and lower gross margin, which more than offset theimpact of increased sales volume. Operating income as a percentage of net salesfor fiscal 2004 decreased to 4.7% from 7.5% for fiscal 2003, reflecting theincreased selling, general and administrative expense ratio and, to a muchlesser extent, decreased gross margin.

*InterestExpense, 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 ininterest expense for fiscal 2004 is primarily related to the impact in fiscal2003 of a $0.3 million non-recurring interest expense credit related to ourcredit facility. During fiscal 2004 and fiscal 2003, we did not have any directborrowings under our credit facility.

*IncomeTaxes.**  *Oureffective tax rate was a provision of 40.0% in fiscal 2004, compared to 38.5%in fiscal 2003, reflecting an increase in our composite estimated effectivestate income tax rate. See Note 12 

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of “Notes to ConsolidatedFinancial Statements” for the reconciliation of the statutory federal incometax rate to our effective tax rate.

*NetIncome Available to Common Stockholders.**  *Net income available to common stockholders forfiscal 2004 was $5.9 million, or $1.07 per share (diluted), compared to$14.0 million for fiscal 2003, or $2.47 per share (diluted), representinga 57.9% decrease in net income and a 56.7% decrease in diluted earnings pershare.

The average diluted sharesoutstanding of 5,501,000 shares for fiscal 2004 was 2.6% lower than the5,646,000 shares outstanding in fiscal 2003. The decrease in average dilutedshares outstanding 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 142,269shares of our common stock pursuant to our share repurchase program, of which75,715 shares were repurchased during fiscal 2004.

**Year Ended September 30,2003 and 2002**

*NetSales.**  *Our netsales for fiscal 2003 increased by 8.7%, or $39.2 million, to$492.4 million from $453.2 million for fiscal 2002. Comparable storesales increased by 0.3% during fiscal 2003, based on 702 retail locations,versus a comparable store sales increase of 2.2% during fiscal 2002, based on653 retail locations. The increase in sales for fiscal 2003 resulted primarilyfrom the incremental revenues generated by the 97 net retail locations addedduring fiscal 2003, as well as the full year sales impact in fiscal 2003 of the138 net retail locations added during fiscal 2002. The relatively flat comparablestore sales in fiscal 2003 reflected the continued difficult retail environmentduring the period, some cannibalization impact on our existing stores by ournew stores opened in the same geographic markets and, perhaps, the effect ofincreased competitive pressures in the maternity apparel market.

As of September 30, 2003, we operated a total of851 stores and 1,006 total retail locations: 688 Motherhood Maternity stores (including 104Motherhood Maternity Outlet stores), 119 MimiMaternity stores, 44 A Pea in the Pod and 155 leasedmaternity departments, primarily under the Motherhood brand. In comparison, asof September 30, 2002, we had 763 stores and 909 total retail locations:616 Motherhood Maternitystores (including 92 Motherhood Maternity Outlet stores), 104 Mimi Maternity stores, 43 A Peain the Pod stores, and 146 leased departments, primarily under theMotherhood brand. For the year ended September 30,2003, we opened 108 new stores and closed 20 stores, including eight iMaternitystores closed in connection with the consolidation of that acquired storechain. As of September 30, 2003, we had closed a total of 96 of the166 acquired iMaternity stores where we believed we could transfer a sufficientportion of the sales to our existing stores within the same area whileeliminating acquired store expenses and improving inventory utilization.In addition, during fiscal 2003, we opened 13 leased department locations andclosed four leased department locations.

*GrossProfit.**  *Ourgross profit 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 apercentage of net sales for fiscal 2003 increased by 99 basis points (0.99percentage 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 and Administrative Expenses.**  *Our selling, general and administrative expenses forfiscal 2003 increased by 10.8%, or $22.4 million, to $230.1 millionfrom $207.7 million for fiscal 2002. Compared to fiscal 2002, store wagesand related benefits costs increased by $7.9 million and store rent andrelated expenses increased by $8.3 million, primarily resulting from ournew store openings and increased medical benefits expenses. As a percentage ofnet sales, operating expenses increased to 46.8% 

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for fiscal 2003 comparedto 45.8% 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, and increasesin 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.

*OperatingIncome.**  *Ouroperating income for fiscal 2003 increased by 10.1%, or $3.5 million, to$37.2 million from $33.7 million for fiscal 2002, due to our highersales volume and improved gross margin and additional revenue generated by ouropt-in customer database and related marketing partnership programs, partiallyoffset by higher operating expenses. Operating income as a percentage of netsales remained relatively constant at 7.5% for both fiscal 2003 and 2002, withour increased gross margin offset by a higher operating expense ratio.

*InterestExpense, Net.**  *Our netinterest expense for fiscal 2003 decreased by 12.2%, or $2.0 million, to$14.5 million from $16.5 million in fiscal 2002. The decrease ininterest expense for fiscal 2003 is due to the $2.5 million loss on earlyextinguishment of debt included in interest expense for fiscal 2002, related toour fiscal 2002 refinancing, partially offset by a somewhat higher overall debtbalance compared to the prior year due to the net impact of the refinancing. In fiscal 2003,we adopted the provisions of SFAS No. 145, which require, effectivein fiscal years beginning after May 15, 2002, the reclassification ofcertain gains or losses on extinguishment of debt that were previouslyclassified as an extraordinary item in 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. In fiscal 2002, prior to the adoption ofSFAS No. 145, we had reported interest expense for fiscal 2002 of$14.0 million. During fiscal 2003, we did not have any direct borrowingsunder our credit facility.

*IncomeTaxes.**  *Oureffective tax rate increased to 38.5% in fiscal 2003 from 37.5% in fiscal 2002primarily due to an increase in our composite estimated effective state incometax rate.  See Note 12 of “Notes toConsolidated Financial Statements” for the reconciliation of the statutoryfederal income tax rate to our effective tax rate.

*Dividendson Preferred Stock.**  *Wehad no preferred stock dividendsduring fiscal 2003, compared to $3.9 million for fiscal 2002, reflectingthe redemption of our Series A Preferred Stock and repurchase of our Series CPreferred Stock in the fourth quarter of fiscal 2002 using the proceeds of ourdebt and common equity offerings.

*NetIncome Available to Common Stockholders.**  *Net income available to common stockholders forfiscal 2003 was $14.0 million, or $2.47 per share (diluted), compared to $6.8million for fiscal 2002, or $1.61 per share (diluted), representing a 103.8%increase in net income available to common stockholders and a 53.4% increase indiluted earnings per share.

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During the fourth quarterof fiscal 2002, we repurchased our outstanding 125¤8% senior notesand our Series A and Series C Preferred Stock with the proceeds fromthe issuance of new 111¤4%senior notes and 1,165,000 new shares of common stock. In connection with thisrefinancing, we incurred certain one-time charges, related to the earlyrepayment of the 125¤8%senior notes and the repurchase of the Series A and Series CPreferred Stock. These one-time charges totaled approximately$3.0 million, which included approximately $2.6 million of non-cashcharges and reduced diluted earnings per common share for fiscal 2002 byapproximately $0.71. On a pro forma basis, excluding the impact of the$3.0 million of one-time charges, fiscal 2002 net income available tocommon stockholders was $9.9 million, or $2.32 per common share (diluted).We have presented this pro forma earnings figure because we believe it enhancesthe reader’s understanding of our fiscal 2002 operating results by adjustingfor the one-time charges related to the refinancing.

**Reconciliation of Fiscal 2002 Earnings Per Share andPro Forma Earnings Per Share(in thousands, except per share data)(unaudited)**
| ** **                                                                                     | ** ** | **Fiscal Year Ended  September 30, 2002** | ** ** |
|------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **Net Income**                                           | ** ** | **Average   Shares  Outstanding** | ** ** | **Diluted  Income Per  Share** | ** ** |
| **Pro Forma Adjusted for One-Time  Charges Related to Fourth Quarter Fiscal 2002 Refinancing** |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| As  reported—Diluted                                                                      |       |                                                          | $          | 6,846 |   |   |   | 4,261 |   |   |   | $ | 1.61 |   |   |
| 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                            |       |                                                          | $          | 9,894 |   |   |   | 4,261 |   |   |   | $ | 2.32 |   |   |

 

Net income for fiscal 2002was favorably impacted by our adoption, as of October 1, 2001, of theprovisions of SFAS No. 142 which requires that goodwill no longer beamortized. Through the application of the provisions of this statement, weshowed improved earnings as a result of not recognizing any goodwillamortization in fiscal 2002, compared to recognizing $2.2 million ($0.61per diluted common share) of goodwill amortization in fiscal 2001.

**Liquidity and Capital Resources**

Our cash needs have primarily been for (i) debtservice, (ii) capital expenditures, including leasehold improvements,fixtures and equipment for new stores; store relocations and expansions of ourexisting stores as well as improvements and new equipment for our distributionand corporate facilities and information systems, and (iii) workingcapital, including inventory to support our new stores and our existing stores.We have historically financed these capital requirements from cash flows fromoperations, borrowings under our credit facility or available cash balances.

In August 2002, we completed debt and equity offeringswhereby we issued $125.0 million of 111⁄4%senior notes due 2010 (the “New Senior Notes”) and 1,165,000 new shares ofcommon stock (including the full exercise of the over-allotment option by theunderwriters of our common stock offering), and used the net proceedstherefrom: (i) to repay the existing 125¤8% senior notes(the “Old Senior Notes”), plus accrued and unpaid interest and related fees andexpenses; (ii) to repay our subordinated notes issued to 

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former holders of sharesof our Series A Preferred Stock in lieu of accrued and unpaid dividends; (iii) toredeem all of the outstanding shares of our Series A Preferred Stock andto purchase, through an offer to purchase, all of the outstanding shares of ourSeries C Preferred Stock, in each case, for a price which included allaccrued and unpaid dividends; (iv) to repay the outstanding borrowingsunder our credit facility and (v) for general corporate purposes.

We received net proceeds from these debt and equityofferings of approximately $147.9 million after deducting fees andexpenses of the offerings. We used approximately $92.7 million of the netproceeds of the offerings for the repurchase of our Old Senior Notes, includingaccrued and unpaid interest and related fees and expenses. We used approximately$2.6 million for the repayment of subordinated notes that had been issuedin lieu of cash dividends on shares of Series A Preferred Stock previouslyconverted into common stock. We used approximately $13.4 million to redeemall of the outstanding Series A Preferred Stock, including accrued andunpaid 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 properdocumentation from the remaining holders of the Series A Preferred Stock.The remaining $1.0 million amount is reflected in our consolidated balancesheet as of September 30, 2004 in accrued expenses and other currentliabilities. We used approximately $20.9 million of the net proceeds fromthe offerings for the repurchase of the Series C Preferred Stock issued tothe sellers of iMaternity in October 2001, including accrued and unpaiddividends. The remaining $18.3 million of net proceeds from the offeringswere used to repay all of the outstanding borrowings under our credit facility,with the balance invested in short-term investments and available for generalcorporate purposes. The net proceeds of approximately $147.9 million fromthe debt and equity offerings includes approximately $0.6 million of cashproceeds from the exercise of stock options by certain selling stockholders inconjunction with the equity offering.

The New Senior Notes were issued at 98.719% of theirface amount, resulting in an annual effective interest rate of 11.50%. Intereston the New Senior Notes is payable semi-annually in cash on February 1 andAugust 1, commencing on February 1, 2003. The New Senior Notes wereissued by Mothers Work, are senior unsecured obligations of Mothers Work andare unconditionally guaranteed on a senior basis by all of our domesticsubsidiaries. See Note 14 of “Notes to Consolidated Financial Statements.”The New Senior Notes are redeemable at our option, in whole or in part at anytime on or after August 1, 2006 at 105.625% of their face amount, plusaccrued and unpaid interest, declining ratably to 100% of their face amount,plus accrued and unpaid interest, on or after August 1, 2009.Additionally, before August 1, 2005, we may redeem, at our option, up to35% of the aggregate principal amount of the New Senior Notes with the proceedsfrom equity offerings at 111.25% of their principal amount, plus accrued andunpaid interest. The New Senior Notes impose certain restrictions on ourability to, among other things, incur additional indebtedness, pay dividends,repurchase stock, and enter into other various types of transactions.

Cash and cash equivalents decreased by$5.9 million during fiscal 2004 compared to an increase of$4.0 million during fiscal 2003. Cash provided by operations of $11.4million for fiscal 2004 decreased by $18.6 million from $30.0 millionfor fiscal 2003. This decrease was primarily the result of decreased netincome, as well as greater use of cash for operating working capital comparedto fiscal 2003. During fiscal 2004, we utilized our cash flow from operationsto pay for the predominant portion of our capital expenditures. During fiscal2003, we utilized our cash flow from operations primarily to pay for ourcapital expenditures and to increase our cash and cash equivalents.

For fiscal 2004, we spent $14.7 million oncapital expenditures, including $11.3 million for leasehold improvements,fixtures and equipment principally for new store facilities, as well asimprovements to existing stores, and $3.4 million for our distribution andcorporate facilities and information systems. This compares to$19.2 million in capital expenditures for fiscal 2003, of which$13.6 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 incapital expenditures was due to reduced expenditures for store remodeling,relocations and expansions, compared to last year, and the completion 

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last year of severalprojects relating to expanding the capacity and throughput of our distributioncenter and the rollout of our new proprietary point-of-sale system to ourstores.

In March 2003, our Board of Directors approved ashare repurchase program under which we may repurchase up to $10.0 millionof our outstanding common stock from time to time in private transactions oropen market purchases until March 2005. As of September 30, 2004, wehave repurchased and retired 142,269 shares in the aggregate pursuant to thisprogram at a total cost of approximately $3.2 million, at an average costof $22.79 per share, including repurchases during fiscal 2004 of 75,515 sharesof common stock at a cost of $1.8 million. The indenture governing the NewSenior Notes and the terms of both our new and previous credit facilitiescontain restrictions that place limits on certain payments by us, includingpayments to repurchase shares of our common stock. Our repurchases of commonstock have been made in compliance with all restrictions under the indenturegoverning the New Senior Notes and the terms of both our new and old creditfacilities.

On October 15, 2004, we entered into a newfive-year $60.0 million senior secured revolving credit facility (the “NewCredit Facility”) which replaced our former $60 million credit facility. TheNew Credit Facility will mature on October 15, 2009. Upon our request andwith the consent of the lender, permitted borrowings under the New CreditFacility may be increased up to an additional $15.0 million, in increments of$2.5 million,****up to a maximum limit of $75.0million. Proceeds from advances under the New Credit Facility, with certainrestrictions, may be used to provide financing for working capital, letters ofcredit, capital expenditures, debt prepayments, dividends, share repurchasesand other general corporate purposes. We paid certain closing fees inconnection with the negotiation and execution of the New Credit Facility. Wealso pay 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 Facility contains various affirmative and negativecovenants and representations and warranties. There are no financial covenant requirements under the  New Credit Facility unless either (i) Excess Availability (asdefined in the agreement) falls below $10 million, or (ii) averageFinancial Covenant Adjusted Availability (as defined in the agreement) for anycalendar month is less than $15 million. If either of the events in item (i) or(ii) above occurs, we would be required to meet a certain minimum fixedcharge coverage ratio (which increases from 1.00x during the first two years ofthe New Credit Facility to 1.10x during the fifth year of the New CreditFacility). 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 outstandingborrowings is equal to, at our election, either the lender’s prime rate or thelender’s LIBOR rate plus the applicable margin. The applicable margin for LIBORrate borrowings is variable, ranging from 1.25% to 1.75%, based upon theavailability calculation made in accordance with the agreement. Anyamounts outstanding under the New Credit Facility may be accelerated and becomedue and payable immediately and all loan and letter of credit commitmentsthereunder may be terminated upon an event of default and expiration of anyapplicable cure period. Events of default include: (i) nonpayment ofobligations due under the New Credit Facility; (ii) failure to perform anycovenant 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.

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

Prior to entering into the New Credit Facility, we hada $60 million credit facility maturing on September 15, 2005, whichincluded a $56.0 million borrowing base revolving line of credit andapproximately $4 million to support a special purpose letter of creditfacility. Amounts available for direct borrowings, net of letters of creditoutstanding, were limited to the lesser of (a) the unused portion of the 

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credit facility or (b) theAggregate Adjusted Availability (“AAA”) as defined in the agreement based on apercentage of eligible inventory, receivables and cash. The credit facility wassecured by a security interest in our accounts receivable, inventory,equipment, fixtures, cash and other assets. There were no financial covenantrequirements in the agreement unless the AAA fell below $10 million. Insuch event, we would have had to achieve minimum cash flow, as defined in theagreement, of not less than zero. During fiscal 2004, 2003 and 2002, we alwaysexceeded the minimum required AAA.

As of September 30, 2004, outstanding borrowingsunder the credit facility consisted of no direct borrowings and$3.7 million in letters of credit with AAA and available borrowings of$52.3 million, compared to no direct borrowings and $3.9 million inletters of credit with AAA and available borrowings of $52.1 million as ofSeptember 30, 2003. In addition, pursuant to the special purpose letter ofcredit facility, as of September 30, 2004 and 2003, we had an outstandingstandby letter of credit of $3.1 million and $3.3 million,respectively, to collateralize an outstanding industrial revenue 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 cancelledduring fiscal 2004. Borrowings under the credit facility as of September 30,2004 would have borne interest at the rate of between approximately 3.9% and4.8% per annum. We had no direct borrowings under the credit facility during fiscal2004 or 2003. We expect that we may have borrowings under our New CreditFacility during certain periods of fiscal 2005, reflecting seasonalfluctuations in cash flow.

Our management believesthat our current cash and working capital positions, expected operating cashflows and available borrowing capacity under our credit facility, will besufficient to fund our working capital, capital expenditures and debt repaymentrequirements and to fund stock and/or debt repurchases, if any, for at leastthe next twelve months.

**Contractual Obligations and Commercial Commitments**

Wehave entered into agreements that create contractual obligations and commercialcommitments. These obligations and commitments will have an impact on futureliquidity and the availability of capital resources. The tables below set fortha summary of these obligations and commitments as of September 30, 2004(in thousands):

*Contractual Obligations:*
| ** **                          | ** ** | ** ** | ** ** | **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                |       |       | —     |                                      |       |   | — |   |   | — |   | — |   | — |   |
| 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 amounts reflected include future minimum leasepayments and exclude such direct operating costs.

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*Commercial Commitments  (1):*
| ** **                       | ** ** | ** ** | ** ** | ** **             | ** ** | **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 (2)         |       |       | $          | 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)          Excludespurchase orders for merchandise and supplies in the normal course of business,which are liquidated within 12 months.

(2)          Consistsof outstanding letter of credit commitments.

**New Accounting Pronouncements**

*FASB Exposure Draft*

On March 31, 2004,the FASB issuedits exposure draft, “Share-Based Payment,” which is a proposed amendment to SFAS No. 123, “Accounting forStock-Based Compensation.” Generally, the approach in the exposure draft issimilar to the approach described in SFAS No. 123. However, the exposuredraft would require all share-based payments to employees, including grants ofemployee stock options, to berecognized in our statementof operations based on their fairvalues. There are a number of issues that are not resolved in the exposuredraft, including the final methodology for calculating fair value. The FASBexpects to issue a final standard in the near futurethat would be effective for interim and annual periods beginning after June 15,2005. The pro forma impact of the adoption of SFAS No. 123 on ourhistorical financial statements is included in Note 2 ofNotesToConsolidatedFinancialStatements.We expect to continue to grant stock-based compensation to employees. Theimpact of the new standard, when and if issued, may have a material adverseimpact on our future results of operations.

**Inflation**

We do not believe that therelatively moderate levels of inflation which have been experienced in theUnited States in recent years have had a significant effect on our net sales orprofitability. However, there can be no assurance that our business will not beaffected by inflation in the future.

**Forward-Looking Statements**

Some of the information in this report, including theinformation incorporated by reference (as well as information included in oralstatements or other written statements made or to be made by us), containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”). The forward-lookingstatements involve a number of risks and uncertainties. A number of factorscould cause our actual results, performance, achievements or industry resultsto be materially different from any future results, performance or achievementsexpressed or implied by these forward-looking statements. These factorsinclude, but are not limited to: the success of our new business 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 

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of terrorism and otherfactors referenced in this report, including those set forth under the caption “RiskFactors.”

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

**RiskFactors**

***We may not be successful in expanding our business andopening new stores.***

Any future growth depends significantly on our abilityto successfully open and operate new stores (including combination stores andsuperstores) on a profitable basis. This expansion, if it occurs, will placeincreased demands on our management, operational and administrative resources.These increased demands and operating complexities could cause us to operateour business less effectively, which, in turn, could cause a deterioration inthe financial performance of our stores and slow our new store growth. Ourplanned expansion will also require that we continually monitor and upgrade ourmanagement information and other systems, as well as our distributioninfrastructure.

Our ability to openand operate new stores successfully depends on many factors, including, amongothers, our ability to:

·       identifyand obtain suitable store locations, including mall locations, the availabilityof which 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,train and retain a sufficient number of qualified store personnel.

There can be no assurancethat we will be able to achieve our store expansion goals. Even if we succeedin opening new stores as planned, we cannot assure you that our newly openedstores will achieve planned revenue or profitability levels in the time periodsestimated by us, or at all. If our stores fail to achieve or are unable tosustain acceptable revenue and profitability levels, we may incur significantcosts associated with operating or closing those stores.

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***Our comparable store sales and quarterly operatingresults have fluctuated in the past and can be expected to continue tofluctuate in the future.***

Our comparablestore sales and quarterly results of operations have fluctuated in the past andcan be expected to continue to fluctuate in the future and are affected by avariety of factors, including: 

·                    theopening of new stores, the relative proportion of new stores to mature storesand the expansion of stores; 

·                    thetiming of new store openings; 

·                    theextent of cannibalization of sales volume of some of our existing stores by ournew stores opened in the same geographic markets; 

·                    changesin our merchandise mix; 

·                    theprice repositioning 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; 

·                    actionsof competitors;

·                    mallanchor tenants; 

·                    fashiontrends; and 

·                    weatherconditions. 

If, at any time, ourcomparable store sales or quarterly results of operations decline or do notmeet the expectations of Wall Street research analysts, the price of our commonstock could decline substantially.

***Our market share may be adversely impacted at any timeby a significant number of competitors.***

We operate in a highlycompetitive environment characterized by low barriers to entry. We competeagainst department stores, specialty retail chains, discount stores,independent retail stores and catalog and Internet-based retailers,including both new and existing competitors. Many of our competitors are largerand have substantially greater financial and other resources than us. Further,we do not typically advertise using television and radio media and thus do notreach customers through means our competitors may use. Our mid- and luxury-pricedmerchandise faces a highly fragmented competitive landscape that includeslocally based, single unit retailers, as well as a handful of multi-unitmaternity operations, none of which we believe have more than 15 storesnationwide. In the value-priced maternity apparel business, we facecompetition on a nationwide basis from retailers such as Fashion Bug®, GAP®, JC Penney®, Kmart®, Kohl’s®, Old Navy®, Target®, Sears® and Wal-Mart®. Several of these competitors, includingGap® and Old Navy®, also sell maternityapparel on their websites. There has been increased competition in thematernity apparel industry, from both new and existing competition. Wecurrently face maternity competition in over 1,000 more competitor locationsthan a year ago.  Our market share andresults of operations may be materially and adversely affected by thiscompetition, including the potential for increased competition in thefuture.  While we have competed with bothSears and Kohl’s in the past, our relationship with both of them is nowchanging.  We will be expanding our TwoHearts Maternity collection to a totalof approximately 645 Sears stores in March 2005under a leased department arrangement. In February 2005, we will launch our Oh Baby! by Motherhoodcollection at Kohl’s stores 

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throughoutthe United States and on Kohls.com,available exclusively at Kohl’sunder a product and licenseagreement.

***The expansion of our leased/licensed relationshipswith third-party retailers may not be successful.***

An unsuccessful expansionof our leased department and licensed brand businesses with third-partyretailers such as Sears® and Kohl’s® (which expansion is set to occur duringthe upcoming fiscal year) would have a material adverse effect on our resultsof operations. This expansion will place increased demands on our management,operational and administrative resources. These increased demands and operatingcomplexities could cause us to operate our business less effectively, which, inturn, could slow or terminate the growth of our leased department and licensedbrand businesses. Our planned expansion will also require that we continuallymonitor and upgrade our management information and other systems, as well asour distribution infrastructure.  Ourfailure to properly manage our leased departments and licensed brand businesses(including any failure by us in timely delivering goods to any third partyretailer) would have a direct impact on the profitability and continuation ofthese relationships.  

***We require a significant amount of cash to service ourindebtedness, which reduces the cash available to finance any growth.***

We have a significant amount of indebtedness. As ofSeptember 30, 2004, our total indebtedness, including current maturities,was $129.2 million, and we had theability to borrow an additional $52.3 million under our then existingcredit facility. Our required interest payments under our New Senior Notes areexpected to be approximately $14.1 million for each of fiscal 2005 and2006. 

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

Our indebtednesscould, among other things: 

·                    makeus more vulnerable to unfavorable economic conditions; 

·                    makeit more difficult for us to open new stores or improve or expand existingstores; 

·                    restrictour ability to pay dividends or make distributions to our stockholders; 

·                    restrictour ability to incur additional indebtedness; 

·                    requireus to pledge all or substantially all of our assets as collateral to secureindebtedness; 

·                    makeit more difficult for us to pursue strategic acquisitions, alliances andpartnerships; and 

·                    require us todedicate or reserve a large portion of our cash flow from operations to makingpayments on our indebtedness, which would prevent us from using cash flow forother purposes. 

***We are heavily dependent on our management informationsystems and our ability to maintain and upgrade these systems from time totime.***

The efficient operation of our business is heavilydependent on our fully integrated, internally developed management informationsystems. In particular, we rely on point-of-sale terminals, which provideinformation to our customized TrendTrack merchandise analysis and planningsystem used to track sales and inventory. The TrendTrack system helps integrateour design, manufacturing, distribution and financial functions, and alsoprovides daily financial and merchandising information. As a result, ourbusiness and operations could be materially and adversely affected if oursystems were inoperable or inaccessible. 

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From time to time, weimprove and upgrade our management information systems. We have rolled out aproprietary, upgraded Internet-based point-of-sale system and integratedthis system with our current systems. If we are unable to maintain and upgradeour systems or to integrate new and updated systems in an efficient and timelymanner, our business and results of operations could be materially andadversely affected.

***We rely significantly on foreign sources ofproduction.***

We receive apparel andother merchandise from foreign sources, both purchased directly in foreignmarkets and indirectly through domestic vendors with foreign sources. To theextent that any of our vendors are located overseas or rely on overseas sourcesfor a large portion of their products, any event causing a disruption ofimports, including the imposition of import restrictions, could harm ourability to source product. This disruption could materially limit themerchandise that we would have available for sale and reduce our revenues andearnings. The flow of merchandise from our vendors could also be adverselyaffected by financial or political instability, or war, in or affecting any ofthe countries in which the goods we purchase are manufactured or through whichthey flow. Trade restrictions in the form of tariffs or quotas, or both, thatare applicable to the products that we sell also could affect the import ofthose products and could increase the cost and reduce the supply of productsavailable to us. Any material increase in tariff levels, or any materialdecrease in quota levels or available quota allocation, could negatively impactour business. Further, changes in tariffs or quotas for merchandise importedfrom individual foreign countries could lead us to shift our sources of supplyamong various countries. Any such shift we undertake in the future could resultin a disruption of our sources of supply and lead to a reduction in ourrevenues and earnings. Supply chain security initiatives undertaken by the U.S.government that impede the normal flow of product could also negatively impactour business. In addition, decreases in the value of the U.S. dollar againstforeign currencies could increase the cost of products that we purchase fromoverseas vendors. 

***We could be materially and adversely affected if ourdistribution operations were disrupted.***

To support our retailoperations in the United States and Canada, we operate our main distributionfacility in Philadelphia, Pennsylvania and a significantly smaller Canadiandistribution facility in Mississauga, Ontario, respectively. Finished garmentsfrom contractors and other manufacturers are inspected and stored fordistribution to our stores. We do not have other distribution facilities tosupport 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 withthe distribution of our products to our stores during the time it takes toreopen or replace this facility. In light of our strategic emphasis on rapidreplenishment as a key competitive advantage, a distribution disruption mighthave a disproportionately adverse effect on our operations and profitabilityrelative to other retailers. In addition, the loss or material disruption ofservice 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. 

***We could be materially and adversely affected if weare unable to obtain sufficient raw materials or maintain satisfactorymanufacturing arrangements.***

We do not own any manufacturing facilities andtherefore depend on third parties to manufacture our products. We place ourorders for production of merchandise and raw materials by purchase order and donot have any long-term contracts with any manufacturer or supplier. We competewith many other companies for production facilities and raw materials.Furthermore, we have received in the past, and may receive in the future,shipments of products from manufacturers that fail to conform to our qualitycontrol standards. In such event, unless we are able to obtain replacementproducts in a timely manner, we may 

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losesales. If we fail to maintain favorable relationships with these third parties,or if we cannot obtain an adequate supply of quality raw materials oncommercially reasonable terms, it could harm our business and results ofoperations. 

***Our stores are heavily dependent on the customertraffic generated by shopping malls.***

We depend heavily on locating our stores in prominentlocations within successful shopping malls in order to generate customertraffic. We cannot control the development of new shopping malls, theavailability or cost of appropriate locations within existing or new shoppingmalls or the success of existing or new mall stores. 

The success of all of our mall stores will depend, inpart, on the ability of each mall's anchor tenants, such as large departmentstores, other tenants and area attractions to generate consumer traffic in thevicinity of our stores, and the continuing popularity of malls as shoppingdestinations. Sales volume and mall traffic may be adversely affected byeconomic downturns in a particular area, the closing of anchor tenants orcompetition from non-mall retailers and other malls where we do not havestores.

***Our success depends on our ability to identify andrapidly respond to fashion trends.***

The apparel industry issubject to rapidly changing fashion trends and shifting consumer demands.Accordingly, our success depends on the priority that our target customersplace on fashion and our ability to anticipate, identify and capitalize uponemerging fashion trends. Our failure to anticipate, identify or react appropriatelyto changes in styles or trends could lead to, among other things, excessinventories and higher markdowns, as well as the decreased appeal of ourbrands.

***The failure to retain our existing senior managementteam or to attract and retain highly skilled and qualified personnel couldadversely affect our business.***

Our business requires disciplined execution at alllevels of our organization in order to timely deliver and display fashionablemerchandise in appropriate quantities in our stores. This execution requiresexperienced and talented management. We currently have a management team with agreat deal of experience with us and in apparel retailing. If we were to losethe benefit of this experience and, in particular, if we were to lose theservices of Dan Matthias, our Chairman and Chief Executive Officer, or RebeccaMatthias, our President and Chief Operating Officer, our business could bematerially and adversely affected.

In addition, as ourbusiness expands, we believe that our success will depend greatly on ourcontinued ability to attract and retain highly skilled and qualified personnel.There is a high level of competition for personnel in the retail industry. Theinability to meet our staffing requirements in the future at costs that arefavorable to us, or at all, could impair our ability to increase revenue andcould otherwise harm our business.

***Our quarterly operating results and inventory levelsmay fluctuate significantly as a result of seasonality in our business.***

Our business, like that of other retailers, isseasonal. Results for any quarter are not necessarily indicative of the resultsthat may be achieved for a full fiscal year. Our quarterly net sales havehistorically been highest in our third fiscal quarter, corresponding to theSpring selling season, followed by our first fiscal quarter, corresponding tothe Fall/holiday selling season. Given the typically higher gross margin weexperience in the third fiscal quarter compared to other quarters, therelatively fixed nature of most of our operating expenses and interest expense,and the historically higher sales level in the third quarter, we have typicallygenerated a very significant percentage of our full year operating income andnet income during 

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thethird quarter. Thus, any factors which result in a material reduction of oursales for the third quarter could have a material adverse effect on our resultsof operations for the fiscal year as a whole. Seasonal fluctuations in salesalso affect our inventory levels, as we usually order merchandise in advance ofpeak selling periods and sometimes before new fashion trends are confirmed bycustomer purchases. We must carry a significant amount of inventory, especiallybefore the holiday and Spring selling periods. If we are not successful inselling our inventory during this period, we may be forced to rely on markdownsor promotional sales to dispose of the excess inventory or we may not be ableto sell the inventory at all, which could have a material adverse effect on ourbusiness and results of operations.

***Our business depends on sustained demand for maternityclothing and is sensitive to economic conditions and consumer spending.***

Our business depends uponsustained demand for maternity clothing. Our future performance will be subjectto a number of factors beyond our control, including demographic changes. Ifdemand for maternity clothing were to decline for any reason, such as adecrease in the number of pregnancies, our operating results could be adverselyaffected. In addition, the specialty apparel retail business historically hasbeen subject to cyclical variations. Consumer purchases of specialty apparelproducts, including maternity wear, may decline during recessionary periods andat other times when disposable income is lower. A prolonged economic downturncould have a material adverse impact on our business and results of operations.

***If an independent manufacturer violates labor or otherlaws, or is accused of violating any such laws, or if their labor practicesdiverge from those generally accepted as ethical, it could harm our businessand brand image.***

While we maintain policiesand guidelines with respect to labor practices that independent manufacturersthat produce goods for us are contractually required to follow, and while wehave an independent firm and company employees inspect certain manufacturingsites to monitor compliance, we cannot control the actions of suchmanufacturers or the public’s perceptions of them, nor can we assure that thesemanufacturers will conduct their businesses using ethical or legal laborpractices. Apparel companies can be held jointly liable for the wrongdoings ofthe manufacturers of their products. 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.

***Our earnings would decline if our goodwill becomesimpaired.***

As a result of purchaseaccounting for our various acquisitions, we have accumulated a substantialamount of goodwill, amounting to $50.4 million as of September 30,2004. Effective October 1, 2001, goodwill and other intangible assets withindefinite lives are not amortized, but rather tested for impairment annually.The impairment test requires us to compare the fair value of business reportingunits to their carrying value, including assigned goodwill. The fair value ofour single reporting unit is determined based on the fair market value of ouroutstanding common stock on a control basis. The factors taken into account indetermining the fair market value of our outstanding common stock on a controlbasis are: (i) the trading value of the outstanding common stock on anestablished public market, and (ii) the premium over the trading pricethat an investor would pay for a control ownership interest in the company, asdetermined through a third party evaluation. The carrying value of our singlereporting unit, expressed on a per share basis, is represented by our bookvalue per share of outstanding common stock. The results of the annualimpairment test performed as of September 30, 2004 indicated the fairvalue of the reporting unit exceeded its carrying value. At September 30,2004, our book value was $12.73 

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pershare of outstanding common stock and the closing trading price of our common stock was $14.50 pershare. If the fair value of our outstanding common stock on acontrol basis were less than $12.73 per share on September 30, 2004, ourgoodwill would have become impaired. If the fair value of our outstandingcommon stock on a control basis were to decline in the future below the thenapplicable book value of our outstanding common stock, our goodwill wouldbecome impaired. If we determine in the future that an impairment has occurred,we would be required to write off the impaired portion of goodwill, which couldsubstantially reduce our earnings and result in a substantial decline in theprice of our outstanding common stock.

***We may be unable to protect our trademarks and otherintellectual property.***

We believe that ourtrademarks and service marks are important to our continued success and ourcompetitive position due to their recognition with our customers. We devotesubstantial resources to the establishment and protection of our trademarks andservice marks. We are not aware of any material pending claims of infringementor challenges to our right to use any of our trademarks and service marks in theUnited States or Canada.Although we actively protect our intellectual property, there can be noassurance that the actions that we have taken to establish and protect ourtrademarks, service marks and other intellectual property, including our rightsin our management information systems, will be adequate to prevent imitation ofour marks, products or services by others or to prevent others from seeking toblock sales of our products as a violation of their trademarks, service marksor other proprietary rights. Also, others may assert rights in, or ownershipof, our trademarks and other proprietary rights and we may not be able tosuccessfully resolve these types of conflicts. In addition, the laws of certainforeign countries may not protect our trademarks and proprietary rights to thesame extent as do the laws of the United States.

***War or acts of terrorism or the threat of either maynegatively impact availability of merchandise and otherwise adversely impactour business.***

In the event of war oracts of terrorism, or if either is threatened, our ability to obtainmerchandise available for sale in our stores may be negatively affected. Asubstantial portion of our merchandise is imported from other countries. Ifgoods become difficult or impossible to import into the United States, and ifwe cannot obtain such merchandise from other sources at similar costs, oursales and profit margins may be adversely affected. In the event thatcommercial transportation is curtailed or substantially delayed, our business maybe adversely impacted, as we may have difficulty shipping merchandise to ourmain distribution facility and stores, as well as fulfilling catalog andwebsite orders.

***Our substantial indebtedness could adversely affectour financial health, which would prevent us from fulfilling our obligationsunder our senior notes.***

We have a significant amount of indebtedness and wehave the ability to incur substantial additional indebtedness in the future. Asof September 30, 2004, we had $129.2 million of debtoutstanding, including $4.2 million of secured debt. Our $60 millioncredit facility, 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 theprevious credit facility.

Our substantialindebtedness could have important consequences. For example, it could:

·       increaseour vulnerability to general adverse economic and industry conditions;

·       requireus to dedicate a substantial portion of our cash flow from operations topayments on our indebtedness, thereby reducing the availability of our cashflow to implement our growth strategy, or to fund working capital, capitalexpenditures and other general corporate needs;

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·       limitour flexibility in planning for, or reacting to, changes in our business andthe industry in which we operate;

·       resultin higher interest expense in the event of increases in interest rates as someof our 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;

·       placeus at a competitive disadvantage compared to our competitors that have lessdebt, or debt at lower interest rates;

·       limitour ability to borrow additional funds;

·       makeit more difficult for us to open new stores or improve or expand existingstores;

·       restrictour ability to pay dividends or make distributions to our stockholders;

·       requireus to pledge all or substantially all of our assets as collateral to secureindebtedness; and

·       makeit more difficult for us to pursue strategic acquisitions, alliances andpartnerships.

If we are unable to meetour expenses and debt obligations, we may need to refinance all or a portion ofour indebtedness before the scheduled maturity dates of such debt, sell assetsor raise equity. On such maturity dates, we may need to refinance ourindebtedness if our operations do not generate enough cash to pay suchindebtedness in full and if we do not raise additional capital. Our ability torefinance will depend on the capital markets and our financial condition atsuch time. We cannot assure you that we would be able to refinance any of ourindebtedness, sell assets or raise equity on commercially reasonable terms orat all, which could cause us to default on our obligations and impair ourliquidity.

***The terms of our debt instruments impose financial andoperating restrictions.***

Each of our NewCredit Facility and the indenture governing the New Senior Notes containrestrictive covenants that limit our ability to engage in activities that maybe in our long-term best interests. These covenants limit or restrict, amongother 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;

·       haveour subsidiaries pay dividends, make loans or transfer assets to us;

·       sellassets, including the capital stock of our subsidiaries;

·       enterinto any transactions with our affiliates;

·       transferany capital stock of any subsidiary or permit any subsidiary to issue capitalstock;

·       createliens;

·       enterinto certain sale/leaseback transactions; and

·       effecta consolidation or merger or transfer of all or substantially all of ourassets.

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These limitations andrestrictions may adversely affect our ability to finance our future operationsor capital needs or engage in other business activities that may be in our bestinterests. In addition, our ability to borrow under the New Credit Facility issubject to borrowing base requirements. If we breach any of the covenants inour New Credit Facility or our indenture, we may be in default under our NewCredit Facility or our indenture. If we default, the holders of the New SeniorNotes or the lender under our New Credit Facility could declare all borrowingsowed to them, including accrued interest and other fees, to be due and payable.

***Our share price may be volatile and could declinesubstantially.***

The market price ofour common stock has been, and is expected to continue to be, volatile, bothbecause of actual and perceived changes in our financial results and prospectsand because of general volatility in the stock market. The factors that couldcause fluctuations in our share price may include, among other factorsdiscussed in this section, the following:

·       actualor anticipated variations in the financial results and prospects of ourbusiness or other companies in the retail business;

·       changesin financial estimates by Wall Street research analysts;

·       actualor anticipated changes in the United States economy or the retailingenvironment;

·       changesin the market valuations of other specialty apparel or retail companies;

·       announcementsby our competitors or us; and

·       any goodwill impairment wouldlikely cause a write down that would negatively affect our stock price.

***Our charter documents contain certain anti-takeoverprovisions, and we are entitled to certain other protective provisions underDelaware law.***

We are a Delawarecorporation and the anti-takeover provisions of Delaware law impose variousimpediments to the ability of a third party to acquire control of our company,even if a change of control would be beneficial to our existing stockholders.We also have adopted a stockholder rights plan, commonly known as a “poisonpill,” that entitles our stockholders to acquire additional shares of us, or apotential acquirer of us, at a substantial discount to their market value inthe event of an attempted takeover. In addition, our amended and restatedcertificate of incorporation and by-laws may discourage, delay or prevent amerger or acquisition involving us that our stockholders may consider favorableby, 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.

The provisions, which wehave summarized above, may reduce the market value of our common stock.

***We do not expect to pay cash dividends in theforeseeable future.***

We have not paid any cashdividends on our common stock since our initial public offering and do notanticipate paying cash dividends on our common stock in the foreseeable future.In addition, the terms of 

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our NewSenior Notes and our New Credit Facilitysignificantly restrict our ability to declare or pay dividendson our common stock. Even if we were not restricted under the terms of our NewSenior Notes or New Credit Facility frombeing able to pay dividends, any future payment of dividends would still be atthe discretion 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.

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

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

As of September 30, 2004, the principalcomponents of our debt portfolio were the $125.0 million of New SeniorNotes due 2010 and the $60 million credit facility, both of which aredenominated in U.S. dollars. The fair value of the debt portfolio is referredto as the “debt value.” The New Senior Notes 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.

Our previous credit facility carried a variableinterest rate that is tied to market indices. As of September 30, 2004, wehad no direct borrowings and $3.7 million of letters of credit outstandingunder our previous credit facility (plus an additional $3.1 million ofletters of credit outstanding under a special purpose letter of creditfacility). Borrowings under the previous credit facility would have borneinterest at the rate of between approximately 3.9% to 4.8% per annum. Any futureborrowings under the New Credit Facility would, to the extent of outstandingborrowings, be affected by changes in market interest rates. A change in marketinterest rates on the variable portion of the debt portfolio impacts theinterest incurred and cash flows, but does not impact the value of thefinancial instrument.

The sensitivity analysis as it relates to the fixedportion of our debt portfolio assumes an instantaneous 100 basis point move ininterest rates from their levels as of September 30, 2004, with all othervariables held constant. A 100 basis point increase in market interest rateswould result in a decrease in the value of the debt by approximately$5.2 million as of September 30, 2004. A 100 basis point decline inmarket interest rates would cause the debt value to increase by approximately$5.4 million as of September 30, 2004.

Based on the variable rate debt included in our debtportfolio as of September 30, 2004, a 100 basis point increase in interestrates would result in additional interest incurred for the year of less than$0.1 million. A 100 basis point decrease in interest rates wouldcorrespondingly lower our interest expense for the year by less than$0.1 million.

Other than as describedabove, we do not believe that the market risk exposure on other financialinstruments is material.

**Item 8.    FinancialStatements and Supplementary Data**

Our Consolidated FinancialStatements appear on pages F-1 through F-33, as set forth in Item 15.

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

None.

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**Item 9A.   Controlsand Procedures**

*(a)   Evaluationof disclosure controls and procedures*.  Our disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that are filed or submitted under the Securities Exchange Act of 1934is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms. Thesedisclosure controls and procedures include controls and procedures designed toensure that information required to be disclosed under the Securities ExchangeAct of 1934 is accumulated and communicated to our management on a timely basisto allow decisions regarding required disclosure. We evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures as of September 30, 2004. Based on this evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that as of September 30,2004, these controls and procedures were effective.

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

**Item 9B.   OtherInformation**

None.

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**PART III.**

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

Information concerning directors, appearing under thecaption “Election of Directors” in our Proxy Statement (the “Proxy Statement”)will be filed with the Securities and Exchange Commission in connection withthe Annual Meeting of Stockholders scheduled to be held on January 21,2005, and information concerning executive officers, appearing under thecaption “Item 1. Business—Executive Officers of the Company” in Part Iof this Form 10-K, are incorporated herein by reference in responseto this Item 10.

The Board of Directors hasadopted a Code of Business Conduct and Ethics, which was filed as an exhibit tolast year’s Form 10-K. We intend to satisfy the amendment and waiverdisclosure requirements under applicable securities regulations by posting anyamendments of, or waivers to, the Code of Business Conduct and Ethics on ourweb site.

**Item 11.    ExecutiveCompensation**

The information containedin the Proxy Statement in the section titled “Compensation Committee Report onExecutive Compensation” up to, but not including, the section titled “SecurityOwnership of Certain Beneficial Owners and Management,” with respect toexecutive compensation, and in the section titled “Compensation of Directors”with respect to director compensation, is incorporated herein by reference inresponse to this Item 11.

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

The information containedin the section titled “Security Ownership of Certain Beneficial Owners andManagement” in the Proxy Statement, with respect to security ownership ofcertain beneficial owners and management, and in the section titled “Summary ofAll Existing Equity Compensation Plans,” with respect to securities authorizedfor issuance under equity compensation plans, is incorporated herein byreference in response to this Item 12.

**Item 13.    CertainRelationships and Related Transactions**

The information containedin the section titled “Certain Transactions” of the Proxy Statement, withrespect to certain relationships and related transactions, is incorporatedherein by reference in response to this Item 13.

**Item 14.    PrincipalAccountant Fees and Services**

The information containedin the Proxy Statement in the section titled “Auditor Fees and Services” isincorporated herein by reference in response to this Item 14.

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**PART IV.**

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

(a)           (1)   Financial Statements

The financial statements listed in the accompanyingIndex to Consolidated Financial Statements are filed as part of this Form 10-K,commencing on page F-1.

(2)   Financial Statement Schedules

Schedule II—Valuation and Qualifying Accounts.

All other schedules are omitted because they are notapplicable or not required, or because the required information is included inthe consolidated financial statements or notes thereto.

(3)   Exhibits

See following Index of Exhibits.

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**INDEX OF 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).                                                                                                                                                                                                                                                                                                                         |

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| 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.                                                                                                                                                                                                                                        |
| †10.19      |       | Form of  Non-Qualified Stock Option Agreement under the Company’s 1994 Director Stock  Option Plan.                                                                                                                                                                                                                               |
| *14              |       | Code of Business Conduct  and Ethics (Exhibit 14 to the 2003 Form 10-K).                                                                                                                                                                                                                                                          |

 

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                                        |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *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. |

 

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*       Incorporated by reference.

†                    Managementcontract or compensatory plan or arrangement.

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**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 the 14thday of December, 2004.

|              | 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)* |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned by the following persons on December 14,2004, in the capacities indicated:

| /s/ DAN W. MATTHIAS               |   | Chairman of the Board, Chief Executive Officer and Director (Principal  Executive Officer)          |
|-----------------------------------|--------|-----------------------------------------------------------------------------------------------------|
| **Dan W. Matthias**               |   |
| /s/ REBECCA C. MATTHIAS           |   | President, Chief Operating Officer and Director                                                     |
| **Rebecca C. Matthias**           |   |
| /s/ EDWARD M. KRELL               |   | Executive Vice President—Chief Financial Officer (Principal Financial and  Accounting Officer) |
| **Edward M. Krell**               |   |
| /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**          |   |

 

48

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**MOTHERS WORK, INC. AND SUBSIDIARIES**

***INDEX TOCONSOLIDATED 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-33 |   |
| Schedule  Supporting the Consolidated Financial Statements:                               |   |        |   |
| Report  of Independent Registered Public Accounting Firm on Financial Statement  Schedule |   | F-34        |   |
| Valuation  and Qualifying Accounts                                                        |   | F-35        |   |

 

F-1

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

The Board of Directors and StockholdersMothers Work, Inc.:

We have audited the accompanying consolidated balancesheets of Mothers Work, Inc. and subsidiaries as of September 30,2004 and 2003, and the related consolidated statements of operations,stockholders’ equity and cash flows for each of the years in the three-yearperiod ended September 30, 2004. These consolidated financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Mothers Work, Inc. andsubsidiaries as of September 30, 2004 and 2003, and the results of theiroperations and their cash flows for each of the years in the three-year periodended September 30, 2004, in conformity with U.S generally acceptedaccounting principles.

/s/KPMG LLP

 

Philadelphia, Pennsylvania

November 17, 2004

F-2

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**MOTHERS WORK, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(in thousands, except share and per share amounts)**
| ** **                                                                                                                        | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                        | ** ** | **2004**               | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                        |       |                   |       |   |   |
| Current Assets                                                                                                                    |       |                   |       |   |   |
| Cash and cash equivalents                                                                                                         |       | $                      | 12,867     |   | $ | 18,731 |   |
| Short-term investments                                                                                                            |       | 2,000                  |       | 2,000 |   |
| 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                                                                                               |       | 60,288                 |       | 57,811 |   |
| 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                                                                                                             |       | 11,504                 |       | 13,586 |   |
| Other non-current assets                                                                                                          |       | 995                    |       | 969 |   |
| Total Other Assets                                                                                                                |       | 67,499                 |       | 70,150 |   |
| Total Assets                                                                                                                      |       | $                      | 251,383    |   | $ | 246,603 |   |
| **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                                                                                    |       | 30,561                 |       | 31,346 |   |
| Total Current Liabilities                                                                                                         |       | 50,628                 |       | 51,210 |   |
| Long-Term  Debt                                                                                                                   |       | 127,629                |       | 127,768 |   |
| Deferred Rent                                                                                                                     |       | 6,856                  |       | 6,234 |   |
| Total Liabilities                                                                                                                 |       | 185,113                |       | 185,212 |   |
| Commitments and  Contingencies (Note 13)                                                                                          |       |                   |       |   |   |
| 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)                                                                                           |       | 3,653                  |       | (2,220 | ) |
| Total Stockholders’ Equity                                                                                                   |       | 66,270                 |       | 61,391 |   |
| Total Liabilities  and Stockholders’ Equity                                                                                  |       | $                      | 251,383    |   | $ | 246,603 |   |

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

F-3

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**MOTHERS WORK, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONS(in thousands, except per share amounts)**

 
| ** **                                    | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| 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 |       | 253,885                                     |       | 230,104 |   | 207,728 |   |
| Operating income                              |       | 24,553                                      |       | 37,152 |   | 33,742 |   |
| Interest expense,  net                        |       | 14,765                                      |            | 14,469 |  | 16,476 |  |
| Income before income taxes                    |       | 9,788                                       |       | 22,683 |   | 17,266 |   |
| Income tax  provision                         |       | 3,915                                       |       | 8,733 |   | 6,478 |   |
| Net income                                    |       | 5,873                                       |       | 13,950 |   | 10,788 |   |
| Dividends on  preferred stock                 |       | —                                      |       | — |   | 3,942 |   |
| Net income  available to common stockholders  |       | $                                           | 5,873      |   | $ | 13,950 |   | $ | 6,846 |   |
| Net income per share—Basic               |       | $                                           | 1.13       |   | $ | 2.66 |   | $ | 1.75 |   |
| Average shares  outstanding—Basic        |       | 5,212                                       |       | 5,236 |   | 3,914 |   |
| Net income per share—Diluted             |       | $                                           | 1.07       |   | $ | 2.47 |   | $ | 1.61 |   |
| Average shares  outstanding—Diluted      |       | 5,501                                       |       | 5,646 |   | 4,261 |   |

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

F-4

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**MOTHERS WORK, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY(in thousands)**
| ** **                                       | ** ** | **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               |       |                              | $          | 10,773                 |       |       |       | 3,480                            |       |                                 |       | $ | 35 |   |   | $ | 26,949 |   |   | $ | (23,016 | ) |   | $ | 14,741 |   |   |
| 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                                       |       |                              | —     |                   |       |       | —     |                             |       |                                 | —     |   |   | — |   |   | 10,788 |   |   | 10,788 |   |   |
| Balance at September 30, 2002               |       |                              | —     |                   |       |       | 5,180      |                             |       |                                 | 52         |   |   | 63,623 |   |   | (16,170 | ) |   | 47,505 |   |   |
| 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                                       |       |                              | —     |                   |       |       | —     |                             |       |                                 | —     |   |   | — |   |   | 13,950 |   |   | 13,950 |   |   |
| Balance at September 30, 2003               |       |                              | —     |                   |       |       | 5,231      |                             |       |                                 | 52         |   |   | 63,559 |   |   | (2,220 | ) |   | 61,391 |   |   |
| 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                                       |       |                              | —     |                   |       |       | —     |                             |       |                                 | —     |   |   | — |   |   | 5,873 |   |   | 5,873 |   |   |
| Balance at  September 30, 2004              |       |                              | $          | —                 |       |       |       | 5,207                            |       |                                 |       | $ | 52 |   |   | $ | 62,565 |   |   | $ | 3,653 |   |   | $ | 66,270 |   |   |
|                                                  |            |                                   |            |                        |            |            |            |                                  |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

F-5

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**MOTHERS WORK, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**
| ** **                                                                         | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Cash Flows from Operating  Activities**                                          |       |                                        |       |   |   |   |   |
| Net income                                                                         |       | $                                           | 5,873      |   | $ | 13,950 |   | $ | 10,788 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 10,212                                      |       | 9,862 |   | 9,496 |   |
| Loss on impairment of long-lived assets                                            |       | 1,545                                       |       | 545 |   | 250 |   |
| Loss on disposal of assets                                                         |       | 1,285                                       |       | 700 |   | — |   |
| Accretion of discount on notes                                                     |       | 149                                         |       | 134 |   | 1,035 |   |
| Deferred income tax provision                                                      |       | 2,778                                       |       | 2,529 |   | 5,541 |   |
| Tax benefit of stock option exercises                                              |       | 311                                         |       | 676 |   | 1,674 |   |
| Amortization of deferred financing costs                                           |       | 415                                         |       | 387 |   | 1,670 |   |
| Provision for deferred rent                                                        |       | 606                                         |       | 604 |   | 488 |   |
| 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                                                  |       | (1,945                                      | )          | (318 | ) | 627 |   |
| Increase  (decrease) in—                                                      |       |                                        |       |   |   |   |   |
| Accounts payable, accrued expenses and other current  liabilities                  |       | (1,280                                      | )          | 6,161 |   | (5,589 | ) |
| Net cash provided by operating activities                                          |       | 11,409                                      |       | 30,009 |   | 28,478 |   |
| **Cash Flows from Investing  Activities**                                          |       |                                        |       |   |   |   |   |
| Purchase of short-term investments                                                 |       | (3,500                                      | )          | (4,200 | ) | — |   |
| Proceeds from sale of short-term investments                                       |       | 3,500                                       |       | 2,200 |   | — |   |
| Acquisition of iMaternity, net of cash acquired                                    |       | —                                      |       | — |   | 574 |   |
| Capital expenditures                                                               |       | (14,693                                     | )          | (19,214 | ) | (9,839 | ) |
| Proceeds from disposal of property, plant and  equipment                           |       | —                                      |       | — |   | 175 |   |
| Purchase of intangible assets                                                      |       | (80                                         | )          | (175 | ) | (201 | ) |
| Net cash used in investing activities                                              |       | (14,773                                     | )          | (21,389 | ) | (9,291 | ) |
| **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**                          |       | (5,864                                      | )          | 3,972 |   | 4,401 |   |
| **Cash and  Cash Equivalents, Beginning of Year**                                  |       | 18,731                                      |       | 14,759 |   | 10,358 |   |
| **Cash and Cash Equivalents, End  of Year**                                        |       | $                                           | 12,867     |   | $ | 18,731 |   | $ | 14,759 |   |

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

F-6

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.NATURE OF BUSINESS**

Mothers Work, Inc. and subsidiaries (“MothersWork” or the “Company”) is a specialty designer and retailer of maternityclothing. The Company operated 1,115 retail locations as of September 30,2004, including 883 stores and 232 leased departments, throughout the UnitedStates and Canada. Mothers Work, Inc. was incorporated in Delaware in1982.

On October 17, 2001, the Company completed theacquisition of eSpecialty Brands, LLC, including its wholly-ownedsubsidiaries Dan Howard Industries, Inc., Mother’s Stores, Inc.,Confecciones Acona S.A. and Maternity Factory Warehouse Centre, Inc.(collectively referred to as “iMaternity”). This acquisition enabled theCompany to expand into new geographic areas, and enhance its presence in areas alreadyserved (see Note 5).

In August 2002, theCompany completed a public offering of 1,165,000 shares of its common stock(plus an additional 100,000 shares sold in the offering by certain sellingstockholders) at a price of $27.00 per share and issued $125,000,000 of 111¤4%senior notes due August 1, 2010 (the “New Senior Notes”). The Companyreceived cash proceeds from the equity offering, net of issuance costs, ofapproximately $28,400,000 (see Note 9). The Company received cash proceedsfrom the debt offering of approximately $118,900,000, net of issuance discountof $1,600,000 and debt issuance costs (see Note 8). In conjunction withthe equity offering, certain selling stockholders exercised stock options,which resulted in additional cash proceeds of approximately $600,000.

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***a.   Principles of Consolidation***

The accompanyingConsolidated Financial Statements include the accounts of Mothers Work, Inc.and, as of September 30, 2004 and 2003,its direct and indirect wholly-owned subsidiaries of Cave Springs, Inc.,Mothers Work Canada, Inc., Maternity Factory Warehouse Centre, Inc.(a wholly-owned subsidiary of Mothers Work Canada, Inc.) andConfecciones Acona S.A. As of September 30, 2002, the Company’s direct andindirect wholly-owned subsidiaries included eSpecialty Brands, LLC(including its wholly-owned subsidiaries Dan Howard Industries, Inc.,Mother’s Stores, Inc., Confecciones Acona S.A. and Maternity FactoryWarehouse 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 WorkCanada, Inc., (ii) Confecciones Acona S.A. became a wholly-ownedsubsidiary of Mothers Work, Inc., and (iii) eSpecialty Brands, LLC,Dan Howard Industries, Inc. and Mother’s Stores, Inc. were mergedinto Mothers Work, Inc. All significant intercompany transactions andaccounts have been eliminated in consolidation.

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

The Company operates on afiscal year ending September 30 of each year. All references to fiscalyears of the Company refer to the fiscal years ended on September 30 inthose years. For example, the Company’s “fiscal 2004” ended on September 30,2004.

***c.   Use of Estimates***

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make certain estimates and assumptions that may affect the 

F-7

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

***d.   Cash and Cash Equivalents***

Cash and cash equivalents include cash on hand, cashin the bank and short-term investments with an original maturity of threemonths or less when purchased. Cash overdrafts of $2,979,000 and $2,295,000were included in accounts payable at September 30, 2004 and 2003,respectively.

The Company maintains cashaccounts that, at times, may exceed federally insured limits. The Company hasnot experienced any losses from maintaining cash accounts in excess of suchlimits. Management believes that it is not exposed to any significant creditrisks on its cash accounts.

***e.   Short-Term Investments***

The Company’s short-term investments may be classifiedas either held-to-maturity or available-for-sale. Held-to-maturity securitiesrepresent those securities that the Company has both the intent and ability tohold to maturity and are carried at amortized cost. Interest on thesesecurities, as well as amortization of discounts and premiums, is included ininterest income. Available-for-sale securities represent those securities thatdo not meet the classification of held-to-maturity, are not actively traded andare carried at fair value, which approximates amortized cost. Unrealized gainsand losses on these securities are excluded from earnings and are reported as aseparate component of shareholders’ equity until realized. When available-for-salesecurities are sold, the cost of the securities is specifically identified andis used to determine the realized gain or loss.

The Company’s short-terminvestments as of September 30, 2004 and 2003 were classified asavailable-for-sale and consist exclusively of auction rate securities with thecost equal to the fair value. These securities have interest reset featureswhich are applicable on a 28 day basis and the original maturity of thesecurities is 26 years. Proceeds from the sales of available-for-saleinvestments were $3,500,000 and $2,200,000 in fiscal 2004 and 2003,respectively. There were no realized gains or losses associated with theseavailable-for-sale investments in fiscal 2004 or 2003.

***f.   Inventories***

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

***g.   Advertising Costs***

The Company expenses thecosts of advertising when the advertising occurs, except for the costsassociated 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 andcatalog expenses were $9,922,000, $8,651,000 and $7,580,000 in fiscal 2004,2003 and 2002, respectively.

F-8

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

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

Property, plant andequipment are stated at cost. Depreciation and amortization are computed forfinancial reporting purposes on a straight-line basis, using service livesranging principally from five to ten years for furniture and equipment andforty years for the building. Leasehold improvements are amortized using thestraight-line method over the shorter of the lease term or their useful life,generally to be ten years. The cost of assets sold or retired and the relatedaccumulated depreciation or amortization are removed from the accounts with anyresulting gain or loss included in net income. Maintenance and repairs areexpensed as incurred except for the capitalization of major renewals andbetterments that extend the life of the asset. 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 usedin the valuation include, but are not limited to, management’s plans for futureoperations, brand initiatives, recent operating results and projected cashflows. If the associated undiscounted cash flows are insufficient to supportthe recorded asset, an impairment is recognized to reduce the carrying value ofthe asset. The amount of the impairment loss is determined by comparing thediscounted expected future cash flows with the carrying value.

During fiscal 2004, 2003and 2002, the Company recorded write downs of long-lived assets totaling$1,545,000, $545,000 and $250,000, respectively, on a pre-tax basis.

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

Goodwill represents the excess of cost over the fairvalue of net assets acquired in business combinations. Prior to fiscal 2002,goodwill was amortized using the straight-line method over a period of20 years. Effective October 1, 2001, the Company adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 142, “Goodwill and OtherIntangible Assets,” and no longer amortizes goodwill. As of October 1,2001, management determined that the Company had one reporting unit forpurposes of applying SFAS No.142 based on its reporting structure. TheCompany made its initial assessment of impairment for the transition period asof October 1, 2001 and again as of September 30 of each subsequentyear. 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.

Based on this assessment, no impairment loss wasrecognized at any of the measurement dates. The Company plans to perform anannual assessment for goodwill impairment at the end of each fiscal year or asimpairment indicators arise.If the fair market value of the Company’s outstanding common stock on a controlbasis were to significantly decline in the future, the goodwill would likelybecome impaired.

Asummary of changes in the carrying amount of goodwill for fiscal 2004 and 2003 is 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, 2003 and 2004                                          |   | $      | 50,389 |   |

** **

F-9

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

During fiscal 2003, the iMaternity purchase accountingreserves were reduced by $1,784,000, less a related tax effect of $625,000, andacquired payables were reduced by $1,129,000, resulting in a reduction togoodwill of $2,288,000 (see Note 5).

Intangible assets withdefinite useful lives, which primarily consist of lease acquisition costs, areamortized over the lease term (estimated to be ten years). Management reviewsthe carrying amount of these intangible assets as impairment indicators arise,to assess the continued recoverability based on future undiscounted cash flowsand operating results from the related asset, future asset utilization andchanges in market conditions. As of September 30, 2004, management doesnot believe that there has been any impairment to the carrying value of theseintangible assets. The Company has not identified any unamortizable intangibleassets. Aggregate amortization expense of intangible assets 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        |       |
|                      |            |            |            |            |            |  |

 

***j.   Deferred Financing Costs***

Deferredfinancing costs (see Note 8) are amortized to interest expense over theterm of the related debt using the effective interest method. Amortizationexpense of deferred financing costs in fiscal 2004, 2003 and 2002 was $415,000,$387,000 and $1,670,000, of which $1,173,000 ($763,000 on an after-tax basis) of the fiscal 2002 figure representedaccelerated amortization in connection with the repayment of senior notes.Estimated amortization expense for the next five fiscal years of deferredfinancing costs as of September 30, 2004 is as follows (in thousands):
| **Fiscal Year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2005                 |       | $          | 464        |       |
| 2006                 |       | 519        |       |
| 2007                 |       | 580        |       |
| 2008                 |       | 649        |       |
| 2009                 |       | 726        |       |
|                      |            |            |            |            |            |  |

 

***k.   Deferred Rent***

Rent expense on operatingleases is recorded on a straight-line basis over the term of the lease. The netexcess of rent expense over the actual cash paid has been recorded as deferredrent in the accompanying Consolidated Balance Sheets.

F-10

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

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

Shares repurchased areretired and treated as authorized but unissued shares, with the cost in excessof par value of the reacquired shares charged to additional paid-in capital andthe par value charged to common stock.

***m.   Fair Value of Financial Instruments***

The carrying values ofcash and cash equivalents, short-term investments, trade receivables andaccounts payable approximate fair value due to the short-term nature of thoseinstruments. Based upon a valuation of the New Senior Notes by a third party,the fair value of the long-term debt as of September 30, 2004 wasapproximately $126,716,000, which is slightly lower than its carrying value.

***n.   Revenue Recognition, Sales Returns andAllowances***

Revenue is recognized at the point of sale for retailstore sales, including leased department sales, or when merchandise is shippedto customers for Internet and mail order sales. Allowances for returns arerecorded as a reduction of revenue, based on the Company’s historicalexperience.

***o.   Other Revenues***

Included in net sales arerevenues earned by the Company through a variety of marketing partnershipprograms utilizing the Company’s extensive opt-in customer database and variousin-store marketing initiatives, focused on baby and parent-relatedproduct and services.

***p.   Shipping and Handling Fees and Costs***

The Company includesshipping and handling revenue earned from its catalog and e-commerce activitiesin net sales. Shipping and handling costs, which are included in cost of goodssold in the accompanying Consolidated Statements of Operations, includeshipping supplies, related labor costs and third-party shipping costs.

***q.   Income Taxes***

The Company utilizes theasset and liability method of accounting for income taxes as prescribed by SFASNo. 109, “Accounting for Income Taxes.” Under this method, deferred taxassets and liabilities are recognized for the expected future tax consequencesof temporary differences between the carrying amounts and the tax bases ofassets and liabilities as well as from net operating loss carryforwards. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in operations in the period that includes the enactment date.

 

F-11

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

***r.   Accounting for 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 thedisclosure requirements 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 for stock options has been recognized for stock optionawards granted at fair market value. Had the compensation cost for the Company’sstock-based compensation plans been determined based on the fair value atthe grant dates for awards under those plans in accordance with the provisionsof SFAS No. 123, the Company’s net earnings and earnings per sharewould have been reduced to the pro forma amounts indicated below. The effect ofapplying SFAS No. 123 in this pro forma disclosure is not indicativeof future amounts. SFAS No. 123 does not apply to options awardedprior to the fiscal year ended September 30, 1996. Additional optionawards are anticipated in future years (see Note 11).
| ** **                                                                                                                   | ** ** | **Year Ended September 30,**                  | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2004**                                                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                                   | ** ** | **(in thousands, except  per share amounts)** | ** ** |
| Net income available to  common stockholders:                                                                                |       |                                                         |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                                            | 5,873      |   | $ | 13,950 |   | $ | 6,846 |   |
| 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                                                                       |       | $                                                            | 4,464      |   | $ | 11,040 |   | $ | 5,896 |   |
| Net income  available to common stockholders per share—Basic:                                                           |       |                                                         |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                                            | 1.13       |   | $ | 2.66 |   | $ | 1.75 |   |
| Pro forma                                                                                                                    |       | 0.86                                                         |       | 2.11 |   | 1.51 |   |
| Net income net income  available to common stockholders per share—Diluted:                                              |       |                                                         |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                                            | 1.07       |   | $ | 2.47 |   | $ | 1.61 |   |
| Pro forma                                                                                                                    |       | 0.81                                                         |       | 1.99 |   | 1.38 |   |

 

***s.   Earnings per Share***

Basic earnings per share is computed by dividing netincome available to common stockholders by the weighted average number ofoutstanding common shares. Diluted earnings per share is computed based uponthe weighted average number of outstanding common shares, after giving effectto the potential dilutive effect from the assumed exercise of the common stockequivalents including stock options and warrants, as well as the assumedconversion of dilutive securities of the Company, including any convertiblepreferred stock and debt (see Note 9).

F-12

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

The following summarizesthose effects for the diluted earnings per share calculation (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 |   |

 

Options to purchase467,170, 202,850 and 10,000 shares of the Company’s common stock wereoutstanding as of September 30, 2004, 2003 and 2002, respectively, butwere not included in the computation of diluted earnings per share for fiscal2004, 2003 and 2002, respectively, as their effect would have beenantidilutive.

***t.   Statements of Cash Flows***

In fiscal 2004, 2003 and2002, 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 Use Software***

The Company records thecosts of computer software, inclusive of website development costs, inaccordance with Statement of Position (“SOP”) 98-1, “Accounting for the Costsof 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 fiscal 2004, 2003 and 2002, the Companycapitalized $50,000, $84,000 and $104,000, respectively, of costs related tothe development of internal-use software.

***v.   Business and Credit Risk***

Financial instruments,primarily cash and cash equivalents, short-term investments and accountsreceivable, potentially subject the Company to concentrations of credit risk.The Company limits its credit risk associated with cash and cash equivalentsand short-term investments by placing such investments in highly liquid fundsand instruments. Receivables associated with third party credit cards areprocessed by financial institutions, which are monitored for financialstability. The Company is dependent on key suppliers to provide sufficientquantities of inventory at competitive prices. No single supplier represented10% or more of net purchases in fiscal 2004, 2003 or 2002. A majority of theCompany’s purchases during fiscal 2004 were imported. The Company imported from27 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***

The Company isself-insured for workers’ compensation and employee-related health carebenefits, up to certain stop-loss limits. Such costs are accrued based on knownclaims and an estimate of incurred but 

F-13

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

notreported claims. Further, the Company utilizes a cooperative arrangement with anumber of other companies to assist in 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 associatedwith these risks are estimated by considering historical claims experience andother actuarial assumptions.

***x.   Store Preopening Costs***

Non-capital expenditures,such as payroll costs incurred prior to the opening of a new store, are chargedto expense in the period in which they were incurred.

***y.   Reclassifications***

Certain reclassificationshave been made to the prior year consolidated financial statements to conformto the current year presentation.

***z.   New Accounting Pronouncements***

****OnMarch 31, 2004, the Financial Accounting Standards Board (“FASB”)issued its exposure draft, “Share-Based Payment,” which is a proposed amendmentto SFAS No. 123. Generally, the approach in theexposure draft is similar to the approach described in SFAS No. 123.However, the exposure draft would require all share-based payments toemployees, including grants of employee stock options, to be recognized in the Company’sstatement of operations based on their fairvalues. There are a number of issues that are not resolved in the exposuredraft, including the final methodology for calculating fair value. The FASBexpects to issue a final standard in the near futurethat would be effective for interim and annual periods beginning after June 15,2005. The pro forma impact of the adoption of SFAS No. 123 on the Company’shistorical financial statements is included in these notes to consolidatedfinancial statements. The Company expects to continue to grant stock-basedcompensation to employees. The impact of the new standard, when and if issued,may have a material adverse impact on the Company’s future results ofoperations.

**3.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-14

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

Property,plant and equipment as of September 30 was comprised of the following (inthousands):
| ** **                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Land                                             |       | $        | 1,400      |     | $          | 1,400 |   |
| Building and  improvements                       |       | 12,062   |       | 11,549   |       |
| Furniture and  equipment                         |       | 47,748   |       | 42,349   |       |
| Leasehold  improvements                          |       | 68,510   |       | 69,944   |       |
|                                             |       | 129,720  |       | 125,242  |       |
| Less: accumulated  depreciation and amortization |       | (69,432  | )          | (67,431  | )          |
|                                             |       | $        | 60,288     |     | $          | 57,811 |   |

 

During fiscal 2004 and 2003, the Company recordedpre-tax charges under SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets,” of $1,545,000 and $545,000, respectively, andduring fiscal 2002, the Company recorded pre-tax charges under SFAS No. 121*,*“*Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,”*of$250,000, related to the impairment of leasehold improvements and furniture andequipment at certain of its retail locations.

As of September 30,2004, $1,200,000 of assets held for sale (not included above) relate to themanufacturing and warehouse facilities located in Costa Rica that were acquiredin the purchase of iMaternity (see Note 5). These facilities, shut downduring fiscal 2002, are being marketed for sale, are not being depreciated andare separately reflected in the consolidated balance sheet as “Assets Held forSale.”

**5. ACQUISITION**

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

Based on the allocation of purchase price, theapplication of the purchase method of accounting resulted in approximately$23,093,000 of excess purchase price over the estimated fair value of the nettangible 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 theacquisition, the Company assumed certain liabilities with trade creditors of$1,700,000 that were in dispute. During fiscal 2003, a determination was madethat a portion of these liabilities and certain other acquired payables wouldnot be paid. The Company reduced the iMaternity purchase accounting reserves by$1,784,000, reflected a related reduction of deferred income tax assets of$625,000, and reduced the acquired payables by $1,129,000, resulting in areduction to goodwill of $2,288,000.

F-15

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5. ACQUISITION (Continued)**

At the Acquisition Date, iMaternity operated a totalof 166 Dan Howard and Mothertime maternity clothing stores, including someunder the iMaternity tradename, and the online iMaternity.com website. TheCompany developed a plan in conjunction with the acquisition to close 92iMaternity stores and convert the remaining acquired locations to the Company’sexisting store concepts of Motherhood and Mimi. In fiscal 2003, the Companyconcluded that it would not close 12 of the original stores that were intendedto be closed, and the estimated lease termination costs accrued for theseanticipated closures of $1,519,000, less a related tax effect of $532,000, wasreversed against goodwill. During fiscal 2004, the Company closed four iMaternitystores which were part of the original 92 planned store closures. Further, theplan included the shutdown of iMaternity’s corporate headquarters and warehouseoperation in Chicago, as well as its manufacturing and warehousing facilitiesin Costa Rica. In connection with the plan, the Company originally recordedseverance costs for involuntarily terminated employees of the acquired businessof $2,587,000, lease termination fees and related legal costs of $4,200,000,and accrued for other costs to be incurred to complete the exit activities ofthe acquired business totaling $2,150,000. Approximately 850 employees of theacquired 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 closed110 acquired iMaternity stores, of which 82 were included as part of the 92planned store closures. During fiscal 2002, the Company closed the corporateheadquarters and warehouse operation in Chicago, an internet-relateddevelopment center in San Diego, California and other domestic warehousingfacilities. The iMaternity manufacturing and warehousing operations in CostaRica have been shut down, are being marketed for sale and are expected to besold during fiscal 2005. The carrying values of the Costa Rican facilities werereduced by $200,000 during fiscal 2002 to their estimated realizable values asof the Acquisition Date, which were determined based on a market surveyreceived from an independent third party less estimated selling costs, and isclassified as “Assets Held For Sale” in the accompanying consolidated balancesheets.

As of September 30, 2004, the remaining accrualfor exit costs of $201,000 is principally for expected costs related to theCosta 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 aremonthly installments made on the non-compete covenant and severance arrangementwith a former executive of iMaternity. During fiscal 2003, the remainingseverance accrual was reduced by $97,000, less a related tax effect of $34,000,against goodwill. The balance of the severance reserve reflects a non-competeand severance arrangement that is payable ratably on a monthly basis through September 30,2006.

F-16

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.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 |   |   |

 

Thefollowing table displays the net non-cash assets that were acquired inconjunction with the iMaternity acquisition as adjusted for the above-mentionedchanges to the acquired 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-17

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**6. ACCRUED EXPENSES ANDOTHER CURRENT LIABILITIES**

As of September 30,accrued expenses and other current liabilities were comprised of the following(in thousands):
| ** **                                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Salaries, wages  and employee benefits                       |       | $        | 8,944      |     | $          | 8,089 |   |
| Income taxes  payable                                        |       | 1,344    |       | 1,991    |       |
| Interest                                                     |       | 2,358    |       | 2,356    |       |
| 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 5)        |       | 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    |       |
|                                                         |       | $        | 30,561     |     | $          | 31,346 |   |

 

**7. LINE OF CREDIT**

On October 15, 2004,the Company entered into a new five-year $60,000,000 senior secured revolvingcredit facility (the “New Credit Facility”), which replaced the former $60million credit facility that included a $56,000,000 borrowing base revolvingline of credit. The New Credit Facility will mature on October 15, 2009. Uponthe Company’s request and with the consent of the lender, permitted borrowingsunder 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. 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. The Companypaid certain closing fees in connection with the negotiation and execution ofthe New Credit Facility. The Company also pays 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 containsvarious affirmative and negative covenants and representations and warranties. There are no financial covenant requirementsunder the New Credit Facility unlesseither (i) Excess Availability (as defined in the agreement) falls below $10,000,000, or (ii) averageFinancial Covenant Adjusted Availability (as defined in the agreement) for any calendar month is less than $15,000,000.If either of the events in item (i) or (ii) above occurs, the Companywould be required to meet a certain minimum fixed charge coverage ratio (whichincreases from 1.00x during the first two years of the New Credit Facility to1.10x during the fifth year of the New Credit Facility). The New Credit Facility is secured by a security interest in the Company’saccounts receivable, inventory, real estate interests, letter of credit rights,cash, intangibles and certain other assets. The interest rate on outstandingborrowings is equal to, at the Company’s election, either the lender’s primerate or the lender’s LIBOR rate plus the applicable margin. The applicablemargin for LIBOR rate borrowings is variable, ranging from 1.25% to 1.75%,based upon the availability calculation made in accordance with the NewCredit Facility. Any amountsoutstanding under the New Credit Facility may be accelerated and become due andpayable immediately and all loan and 

F-18

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**7. LINEOF CREDIT (Continued)**

letter of creditcommitments thereunder may be terminated upon an event of default and expirationof 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 under,other material indebtedness, (v) certain bankruptcy or insolvency events, (vi) achange of control, (vii) material uninsured losses, (viii) indictmentsof the Company or senior management in a material forfeiture action, and (ix) customaryERISA defaults, among others.

Prior to entering into the New Credit Facility, theCompany had a $60 million credit facility maturing on September 15, 2005,which included a $56 million borrowing base revolving line of credit andapproximately $4 million to support a special purpose letter of creditfacility. 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 credit facility was secured by a security interest inthe Company’s accounts receivable, inventory, equipment, fixtures, cash andother assets. There were no financial covenant requirements in the agreementunless the AAA falls below $10 million. In such event, the Company would havehad to achieve minimum cash flow, as defined in the agreement, of not less thanzero. During fiscal 2004, 2003 and 2002, the Company always exceeded theminimum required AAA.

As of September 30,2004, outstanding borrowings under the credit facility consisted of no directborrowings and $3,700,000 in letters of creditwith AAA and available borrowings of $52,300,000, compared to no directborrowings and $3,900,000 in letters of credit with AAA and availableborrowings of $52,100,000 as of September 30, 2003. In addition, pursuantto the special purpose letter of credit facility, as of September 30, 2004and 2003, the Company had an outstanding standby letter of credit of $3,149,000and $3,300,000, respectively, to collateralize an outstanding industrialrevenue bond. As of September 30, 2003, the Company had a $1,000,000letter of credit to collateralize a government mortgage note; this letter of credit wassubsequently cancelled during fiscal 2004. Borrowings under the credit facilityas of September 30, 2004 would have borne interest at the rate of betweenapproximately 3.84% and 4.75% per annum. The Company had no direct borrowingsunder the credit facility during fiscal 2004 and 2003.

F-19

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8. LONG-TERM DEBT**

Thefollowing table summarizes 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-termdebt maturities 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, the Company repurchased theoutstanding $92,000,000 of 125¤8% senior notes(the “Old Senior Notes”) with a portion of the proceeds from the issuance of$125,000,000 of 111¤4%senior notes due 2010 (the “New Senior Notes”) and 1,165,000 shares of commonstock (see Note 9). The Company received net proceeds from the debtoffering of approximately $118,900,000, net of issuance discount ofapproximately $1,600,000 and after deducting fees and expenses of the offering.The Company used approximately $92,700,000 of the net proceeds from the debtoffering for the repurchase of the Old Senior Notes, including accrued andunpaid interest and related fees and expenses. In addition, the Company usedapproximately $2,600,000 of the net proceeds from the debt offering for therepayment of subordinated notes that had been issued in lieu of cash dividendson shares of Series A Preferred Stock previously converted into commonstock.

F-20

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

In connection with the issuance of the New SeniorNotes in fiscal 2002, the Company incurred deferred financing costs of $4,497,000.These deferred financing costs, along with the debt discount, are beingamortized and included in interest expense over the term of the New SeniorNotes, using the effective interest method. In connection with the repurchaseof the Old Senior Notes in fiscal 2002, the Company wrote off the remainingdeferred financing costs of $1,173,000 related to the Old Senior Notes.

The New Senior Notes are due August 1, 2010 andwere issued at 98.719% of their face amount, resulting in an annual effective interestrate of 11.50%. Interest on the New Senior Notes is payable semi-annually incash on February 1 and August 1, commencing on February 1, 2003.The New Senior Notes were issued by Mothers Work, are senior unsecuredobligations of Mothers Work, and are unconditionally guaranteed on a seniorbasis by all of the Company’s domestic subsidiaries (see Note 14). The NewSenior Notes are redeemable at the Company’s option, in whole or in part at anytime on or after August 1, 2006 at 105.625% of their face amount, plusaccrued and unpaid interest, declining ratably to 100% of their face amount,plus accrued and unpaid interest, on or after August 1, 2009.Additionally, prior to August 1, 2005, the Company may redeem, at itsoption, 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 Senior Notes impose certain restrictions onthe Company’s ability to, among other things, incur additional indebtedness,pay dividends, repurchase stock, and enter into other various types oftransactions.

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 of Series APreferred Stock. The Company was restricted under the terms of the Old Senior Notesfrom paying cash dividends to the holders of the Series A Preferred Stockupon conversion. Accordingly, the Company issued $331,000 of subordinated notesin fiscal 2001, with unpaid interest compounding annually at the prime rateuntil paid. During fiscal 2002, a total of 11,496 shares of the Series APreferred Stock with a stated value of approximately $3,200,000 were convertedinto 114,955 shares of common stock. The Company was restricted under the termsof the Old Senior Notes from paying cash dividends to the holders of the Series APreferred 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 convertibleafter August 1, 2003 into common stock in accordance with the terms ofthose  notes. The subordinated notes,totaling approximately $2,600,000 including accrued and unpaid interest, wererepaid in full in August 2002 using a portion of the net proceeds from thedebt offering.

**9. COMMON AND PREFERREDSTOCK**

In connection with the Motherhood acquisition on August 1,1995, the Company issued 41,000 shares of Series A Preferred Stock with astated value of $11,500,000. The holders of the Series A Preferred Stockwere entitled to receive cash dividends, which were cumulative to the extentnot paid, and compounded annually at 8.5% of the stated value. In addition, theSeries A Preferred Stock was convertible into shares of common stock atspecified conversion rates depending on the date of conversion. Pursuant to theoptional redemption provisions of the Series A Preferred Stock, theCompany redeemed all of the outstanding Series A Preferred Stock in August 2002using a portion of the proceeds from the debt and equity offerings.

F-21

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9. COMMONAND PREFERRED STOCK (Continued)**

In connection with the Rights Agreement dated March 17,1997 (see Note 10), the Company authorized 10,000 shares of Series BJunior Participating Preferred Stock (the “Series B Preferred Stock”). Infiscal 2003, the Board of Directors of the Company authorized an additional290,000 shares of Series B Preferred Stock. The Series B PreferredStock can be purchased in units equal to one one-thousandth of a share (the “Series BUnits”) under the terms of the Rights Agreement. The holders of the Series BUnits are entitled to receive dividends when and if declared on common stock. Series BUnits are junior to the common stock for both dividends and liquidations. Each Series BUnit votes as one share of common stock.

In connection with the acquisition of iMaternity, theCompany issued 302,619 shares of Series C Preferred Stock, having anaggregate stated value of $19,500,000 and valued at an estimated $59.48 pershare, or $17,999,000, as determined by an independent third party appraiser.The excess by which the stated value of the Series C Preferred Stockexceeded its carrying value was accreted to the earliest redemption date usingthe effective interest method. This accretion was recorded as dividends in theaccompanying consolidated statements of operations. Additionally, the holdersof the 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 purchased all outstanding shares of the Series CPreferred Stock for $20,890,000, which included accrued and unpaid dividends of$1,390,000. As a result of the purchase of the Series C Preferred Stock, theCompany recognized the remaining unaccreted discount of $1,310,000 asadditional dividends on preferred stock in fiscal 2002.

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

In August 2002, the Company completed a publicequity offering whereby the Company issued 1,165,000 shares of common stock,including the full exercise of the over-allotment option by the underwriters.In addition, as part of this offering, certain selling stockholders sold100,000 shares of the Company’s common stock. The Company received net proceedsfrom the equity offering of approximately $28,400,000 after deducting fees andexpenses of the offering.

The Company used the net proceeds of the equityoffering, along with the net proceeds of the $125,000,000 offering of NewSenior Notes, to repay certain indebtedness, to redeem the Series APreferred Stock, to repurchase the Series C Preferred Stock, to repay theoutstanding borrowings under its credit facility, and for general corporatepurposes. The Company received net proceeds from the debt and equity offeringsof approximately $147,900,000, after deducting fees and expenses of theofferings and including approximately $600,000 of cash proceeds from theexercise of stock options by certain selling stockholders in conjunction withthe equity offering.

The Company used approximately $92,700,000 of the netproceeds of the offerings for the repurchase of the Old Senior Notes, and usedapproximately $2,600,000 for the repayment of subordinated notes that had beenissued in lieu of cash dividends on shares of Series A Preferred Stockpreviously converted into common stock. The Company used approximately $13,400,000to redeem all of the outstanding Series A Preferred Stock, includingaccrued and unpaid dividends, of which approximately $12,400,000 has been paidas of September 30, 2004 and approximately $1,000,000 will be paid outupon submission of proper documentation from the remaining holders of the Series APreferred Stock.

F-22

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9. COMMONAND PREFERRED STOCK (Continued)**

Additionally, the Company used approximately$20,900,000 of the 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 $18,300,000 of netproceeds from the offerings were used to repay all of the outstanding borrowingsunder the 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 17).

**10. RIGHTS AGREEMENT**

In accordance with the Company’s Rights Agreement, theCompany provided and will provide one Right outstanding for each share ofMothers Work common stock now or hereafter outstanding. 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. The rights expire on October 9, 2005(the “Final Expiration Date”).

On March 17, 1997, the Company amended its RightsAgreement to provide the independent directors of the Company with somediscretion in determining when the Distribution Date (as defined in the RightsAgreement) shall occur and the date until which the Rights may be redeemed. Inaddition, the Amended and Restated Rights Agreement exempts from its operationany person that acquires, obtains the right to acquire, or otherwise obtainsbeneficial ownership of 10.0% or more of the then outstanding shares of theCompany’s common stock (an “Acquiring Person”) without any intention ofchanging or influencing control of the Company provided that such person, aspromptly as practicable, divests himself or itself of a sufficient number ofshares of common stock so that such person would no longer be an AcquiringPerson.

The Rights are not exercisable until the DistributionDate, which will occur upon the earlier of (i) ten business days followinga public announcement that an Acquiring Person has acquired beneficialownership of 10.0% or more of the Company’s outstanding common stock, and tenbusiness days following the commencement of a tender offer or exchange offerthat would result in a person or group owning 10.0% or more of the Company’soutstanding common stock, or (ii) such later date as may be determined byaction of a majority of the independent directors. The Rights have certainanti-takeover effects. The Rights will cause substantial dilution to a personor group that attempts to acquire the Company without conditioning the offer onthe redemption of the Rights.

The Rights can be mandatorily redeemed by action of amajority of the independent directors at any time prior to the earlier of the FinalExpiration Date and the Distribution Date for $.01 per Right. Upon exercise andthe occurrence of certain events, as defined in the Rights Agreement, eachholder of a Right, except the Acquiring Person, will have the right to receive Series BUnits, or common stock of the acquiring company, in each case having a valueequal to two times the exercise price of the Right.

On October 14, 2001,the Company amended its Rights Agreement to include Centre Partners and itsaffiliates as exempt persons under the terms of the Rights Agreement. Inaddition, on June 4, 2002, the Company further amended the RightsAgreement to (i) increase the number of shares of Company common stockthat may be beneficially owned by the Meridian Group, (ii) amend thedefinition of 

F-23

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**10.RIGHTS AGREEMENT (Continued)**

BeneficialOwnership to exclude, under certain circumstances, any deemed attribution ofbeneficial ownership between the Meridian Group and a specified individual whohas served as a general partner of certain entities within the Meridian Group, (iii) amendthe definition of Independent Director, and (iv) amend the definition ofMeridian Group.

**11. STOCK OPTION PLANS ANDWARRANTS**

The Company has two stock option plans: the DirectorStock Option Plan and the Amended and Restated 1987 Stock Option Plan. Underthe Director Stock Option Plan, as of October 1, 2002, each outsidedirector is granted 3,000 fully vested options on an annual basis, at anexercise price equal to the fair market value of the stock on the grant date.Under the 1987 Stock Option Plan, as amended and restated, officers and certainemployees may be granted options to purchase the Company’s common stock atexercise prices equal to the fair market value of the stock at the date ofgrant or at other prices as determined by the Compensation Committee of theBoard of Directors. No options have been granted by the Company at less thanthe fair market value of the Company’s common stock on the date of grant forany of the periods presented. In February 2003, the stockholders of theCompany approved an amendment to increase the number of shares of common stockavailable for issuance upon the exercise of options granted under these plansby 500,000, up to a total of 2,175,000 options which may be issued (includingup to a total of 200,000 options which may be issued under the Director StockOption 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 350,137options available for grant under the Amended and Restated 1987 Stock OptionPlan and 98,000 options available for grant under the Director Stock OptionPlan.

Stockoption activity for 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-24

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**11. STOCK OPTION PLANS ANDWARRANTS (Continued)**

**During fiscal 2004, options topurchase 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 wereexercisable as of September 30, 2004, 2003 and 2002, respectively, and hada weighted-average exercise price of $16.19, $15.49 and $10.32, for thoserespective periods.

Theweighted average fair value of the stock options granted during 2004, 2003 and2002 was estimated to be $15.85, $23.35 and $8.41, respectively. The weightedaverage fair value of each option granted is calculated on the date of grantusing the Black-Scholes option-pricing model with the followingweighted-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 |   |

 

Thefollowing table summarizes 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 debt issued in the acquisition ofA Pea in the Pod in 1995, the Company issued 140,123 warrants for the purchaseof the Company’s common stock at $.01 per share. These warrants were exercisedon March 12, 2002.

In connection with theacquisition of iMaternity on October 17, 2001 (see Note 5), theCompany issued to the sellers warrants to purchase 350,000 shares of theCompany’s common stock at an exercise price of $22.50 per share (the “Warrants”).The Warrants were immediately vested upon grant and are 

F-25

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

exercisable for seven years from the date of grant.During the year ended September 30, 2002, the Company repurchased Warrantsto purchase 125,000 shares of the Company’s common stock for a purchase priceof $4.50 per underlying share, or a total of $562,500. In the first quarter offiscal 2003, certain holders of the Warrants turned in Warrants to purchase100,000 shares of the Company’s common stock and were issued 44,113 shares ofthe Company’s common stock pursuant to a cashless exercise net issuanceelection. As of September 30, 2004, Warrants to purchase 125,000 sharesremain outstanding.

**12. INCOME TAXES**

Forthe years ended September 30, income tax provisions were comprised of thefollowing (in thousands):
| ** **          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
| Current provision   |       | $        | 1,137      |     | $          | 6,204    |       | $ | 937 |   |
| Deferred  provision |       | 2,778    |       | 2,529    |       | 5,541    |       |
|                |       | $        | 3,915      |     | $          | 8,733    |       | $ | 6,478 |   |

 

Thereconciliations of the statutory federal rate to the Company’s effective incometax rates for the years ended September 30, were as follows:
| ** **                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory federal  tax rate          |       | 34.0     | %          | 35.0     | %          | 35.0     | %          |   |
| State taxes, net  of federal benefit |       | 4.2      |       | 3.2      |       | 2.2      |       |   |
| Other                                |       | 1.8      |       | 0.3      |       | 0.3      |       |   |
|                                 |       | 40.0     | %          | 38.5     | %          | 37.5     | %          |   |

 

Thedeferred tax effects of temporary differences giving rise to the Company’s netdeferred tax assets as of September 30, were as follows (in thousands):
| ** **                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| *Deferred tax assets:*                       |       |     |       |     |       |
| Net operating  losses carryforwards          |       | $        | 1,919      |     | $          | 2,242 |   |
| Depreciation                                 |       | 7,602    |       | 9,562    |       |
| Deferred rent                                |       | 2,306    |       | 2,095    |       |
| 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      |       |
|                                         |       | 16,177   |       | 18,354   |       |
| *Deferred tax liability:*                    |       |     |       |     |       |
| Prepaid expenses                             |       | (13      | )          | (113     | )          |
|                                         |       | $        | 16,164     |     | $          | 18,241 |   |

 

F-26

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**12.INCOME TAXES (Continued)**

As of September 30,2004, the Company has net operating loss carryforwards for federal tax purposesof $5,484,000, which were acquired in the acquisition of iMaternity and beginto expire in 2021. While the acquired net operating loss carryforwards aresubject to certain annual limitations due to the change in ownership, theCompany does not expect the limitations to reduce its ability to ultimately usesuch carryforwards. The tax benefit of the acquired net operating losscarryforwards was recorded under the purchase method of accounting.

The above deferred tax assets reflect only the federaltax benefit associated with the temporary differences given the historicaluncertainty related to realizing state tax benefits. Had the state tax benefitsbeen reflected, thedeferred tax assets would be approximately $1,400,000 higher.

No valuation allowance hasbeen provided for the net federal deferred tax assets. Based on the Company’shistorical levels of taxable income, management believes it is more likely thannot that the Company will realize the federal net deferred tax assets as of September 30,2004. There can be no assurance that the Company will generate taxable earningsor any specific level of earnings in the future.

**13. COMMITMENTS ANDCONTINGENCIES**

The Company leases its retail facilities and certainequipment under various non-cancelable operating leases. Certain of theseleases have renewal options. Total rent expense under operating leases amountedto $76,675,000, $67,281,000 and $61,341,000 in fiscal 2004, 2003 and 2002,respectively. Such amounts include contingent rentals based upon a percentageof sales totaling $388,000, $740,000 and $688,000 in fiscal 2004, 2003 and2002, respectively.

Storeoperating leases and warehouse leases generally provide for payment of directoperating costs in addition to rent. Future annual minimum operating leasepayments, excluding such direct operating costs, as well as leases forequipment rental as of September 30, 2004 are as follows (in thousands):
| **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 party to an action filed against theCompany alleging that certain former and current employees should have receivedovertime compensation under Washington law in Spokane County Superior Court.The plaintiffs in this action sought unspecified actual damages, penalties andattorneys’ fees. On or about April 23, 2003, one purported subclass of theplaintiffs accepted a settlement arrangement in the amount of $50,000, plusattorney’s fees and costs incurred through such date. After a trial with theremaining purported subclass, in May 2003, the jury found for the Companyon all but one claim, for which it awarded the remaining plaintiffs damages inthe amount of $106,000. The parties are currently contesting costs and expensesbeing sought by the plaintiffs in the amount of approximately 

F-27

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

$390,000. The Companyrecorded  expenses during fiscal 2004 and2003 of $78,000 and $546,000, respectively, for the estimated legal fees andsettlement costs of this case, including the contested costs and expenses notedabove.

In addition, from time totime, the Company is named as a defendant in legal actions arising from itsnormal business activities. Although the amount of any liability that couldarise with respect to currently pending cannot be accurately predicted, theCompany does not believe that the resolution of any pending action will have amaterial adverse effect on its financial position, results of operations orliquidity.

**14. GUARANTOR SUBSIDIARIES**

Pursuant to the terms of the indenture relating to theNew Senior Notes, each of the domestic subsidiaries of Mothers Work, Inc.(the “Guarantor Subsidiaries”) has jointly and severally provided anunconditional guarantee of the obligations of Mothers Work with respect to theNew Senior Notes. There are no restrictions on any of the assets of theGuarantor Subsidiaries which would limit their ability to transfer funds toMothers Work in the form of loans, advances or cash dividends, except asprovided by applicable law. None of the Company’s foreign subsidiaries (the “Non-GuarantorSubsidiaries”) have guaranteed the New Senior Notes. The condensedconsolidating financial information for the Company, the GuarantorSubsidiaries, and the Company’s Non-Guarantor Subsidiaries as of and for thefiscal year ended September 30, 2004 as presented below has been preparedfrom the books and records maintained by the Guarantor Subsidiaries and theCompany. The condensed financial information may not necessarily be indicativeof the results of operations or financial position had the GuarantorSubsidiaries operated as independent entities. Certain intercompany revenuesand expenses included in the subsidiary records are eliminated inconsolidation. As a result of this activity, an amount due to/due from parentwill exist at any time.

F-28

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**14. GUARANTOR SUBSIDIARIES(Continued)**

**MothersWork, Inc.Condensed Consolidating BalanceSheetSeptember 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                         |       |                                     | $          | 11,826                      |       |                                                   |       | $                               | 44         |                                |       |   | $ | 997 |   |   |   | $ | — |   |   |   | $ | 12,867 |   |   |
| Short-term investments                            |       |                                     | 2,000      |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 2,000 |   |   |
| 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         |       |                                     | 7,215      |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 7,215 |   |   |
| Total Current Assets                              |       |                                     | 119,596    |                        |       |                                                   | 44         |                            |       |                                | 2,756      |   |   |   | — |   |   |   | 122,396 |   |   |
| Property, Plant  and Equipment, net               |       |                                     | 58,806     |                        |       |                                                   | —     |                            |       |                                | 1,482      |   |   |   | — |   |   |   | 60,288 |   |   |
| Assets Held for  Sale                             |       |                                     | —     |                        |       |                                                   | —     |                            |       |                                | 1,200      |   |   |   | — |   |   |   | 1,200 |   |   |
| Other Assets                                      |       |                                     | 67,496     |                        |       |                                                   | 3          |                            |       |                                | —     |   |   |   | — |   |   |   | 67,499 |   |   |
| Investments in  and Advances to (from) Affiliates |       |                                     | (1,257     | )                           |       |                                                   | 215,150    |                            |       |                                | (4,525     | ) |   |   | (209,368 | ) |   |   | — |   |   |
| Total Assets                                      |       |                                     | $          | 244,641                     |       |                                                   |       | $                               | 215,197    |                                |       |   | $ | 913 |   |   |   | $ | (209,368 | ) |   |   | $ | 251,383 |   |   |
| **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    |       |                                     | 23,936     |                        |       |                                                   | 6,319      |                            |       |                                | 306        |   |   |   | — |   |   |   | 30,561 |   |   |
| Total Current Liabilities                         |       |                                     | 43,984     |                        |       |                                                   | 6,338      |                            |       |                                | 306        |   |   |   | — |   |   |   | 50,628 |   |   |
| Long-Term  Debt                                   |       |                                     | 127,629    |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 127,629 |   |   |
| Deferred Rent                                     |       |                                     | 6,758      |                        |       |                                                   | —     |                            |       |                                | 98         |   |   |   | — |   |   |   | 6,856 |   |   |
| Total Liabilities                                 |       |                                     | 178,371    |                        |       |                                                   | 6,338      |                            |       |                                | 404        |   |   |   | — |   |   |   | 185,113 |   |   |
| Total  Stockholders’ Equity                  |       |                                     | 66,270     |                        |       |                                                   | 208,859    |                            |       |                                | 509        |   |   |   | (209,368 | ) |   |   | 66,270 |   |   |
| Total Liabilities  and Stockholders’ Equity  |       |                                     | $          | 244,641                     |       |                                                   |       | $                               | 215,197    |                                |       |   | $ | 913 |   |   |   | $ | (209,368 | ) |   |   | $ | 251,383 |   |   |

 

F-29

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**14. GUARANTOR SUBSIDIARIES(Continued)**

**MothersWork, Inc.Condensed Consolidating Statementof OperationsFor 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                                  |       |                                     | 275,584    |                        |       |                                                   | 27,245     |                            |       |                                | 3,854      |   |   |   | (27,245 | ) |   |   | 278,438 |   |   |
| Selling, general  and administrative expenses |       |                                     | 277,527    |                        |       |                                                   | 165        |                            |       |                                | 3,438      |   |   |   | (27,245 | ) |   |   | 253,885 |   |   |
| Operating income  (loss)                      |       |                                     | (2,943     | )                           |       |                                                   | 27,080     |                            |       |                                | 416        |   |   |   | — |   |   |   | 24,553 |   |   |
| Interest income (expense), net           |       |                                     | (24,564    | )                           |       |                                                   | 9,799      |                            |       |                                | —     |   |   |   | — |   |   |   | (14,765 | ) |   |
| Equity in  earnings of subsidiaries           |       |                                     | 37,295     |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | (37,295 | ) |   |   | — |   |   |
| Income before  income taxes                   |       |                                     | 9,788      |                        |       |                                                   | 36,879     |                            |       |                                | 416        |   |   |   | (37,295 | ) |   |   | 9,788 |   |   |
| Income tax  provision                         |       |                                     | 3,915      |                        |       |                                                   | 12,908     |                            |       |                                | 166        |   |   |   | (13,074 | ) |   |   | 3,915 |   |   |
| Net income                                    |       |                                     | $          | 5,873                       |       |                                                   |       | $                               | 23,971     |                                |       |   | $ | 250 |   |   |   | $ | (24,221 | ) |   |   | $ | 5,873 |   |   |

 

F-30

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**MOTHERSWORK, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**14. GUARANTOR SUBSIDIARIES (Continued)**

**Mothers Work, Inc.****Condensed Consolidating Cash Flow Statement****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                                                                         |       |                                     | $          | 5,873                       |       |                                                   |       | $                               | 23,971     |                                |       |   | $ | 250 |   |   |   | $ | (24,221 | ) |   |   | $ | 5,873 |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                     |       |                                     | 10,077     |                        |       |                                                   | —     |                            |       |                                | 135        |   |   |   | — |   |   |   | 10,212 |   |   |
| Loss on impairment  of long-lived assets                                           |       |                                     | 1,545      |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 1,545 |   |   |
| Loss on disposal  of assets                                                        |       |                                     | 1,285      |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 1,285 |   |   |
| Accretion of  discount on notes                                                    |       |                                     | 149        |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 149 |   |   |
| Deferred income  tax provision                                                     |       |                                     | 2,778      |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 2,778 |   |   |
| Tax benefit of  stock option exercises                                             |       |                                     | 311        |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 311 |   |   |
| Amortization of  deferred financing costs                                          |       |                                     | 415        |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 415 |   |   |
| Provision for  deferred rent                                                       |       |                                     | 547        |                        |       |                                                   | —     |                            |       |                                | 59         |   |   |   | — |   |   |   | 606 |   |   |
| 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                                                 |       |                                     | (1,945     | )                           |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | (1,945 | ) |   |
| Investments in and  advances to (from) affiliates                                  |       |                                     | (9,118     | )                           |       |                                                   | (16,173    | )                               |       |                                | 1,070      |   |   |   | 24,221 |   |   |   | — |   |   |
| Increase (decrease) in—                                                       |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Accounts payable,  accrued expenses and other current liabilities                  |       |                                     | 6,452      |                        |       |                                                   | (7,787     | )                               |       |                                | 55         |   |   |   | — |   |   |   | (1,280 | ) |   |
| Net cash provided  by operating activities                                         |       |                                     | 10,296     |                        |       |                                                   | 11         |                            |       |                                | 1,102      |   |   |   | — |   |   |   | 11,409 |   |   |
| Cash Flows from Investing  Activities:                                             |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Purchase of  short-term investments                                                |       |                                     | (3,500     | )                           |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | (3,500 | ) |   |
| Proceeds from sale  of short-term investments                                      |       |                                     | 3,500      |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | 3,500 |   |   |
| Capital  expenditures                                                              |       |                                     | (14,125    | )                           |       |                                                   | —     |                            |       |                                | (568       | ) |   |   | — |   |   |   | (14,693 | ) |   |
| Purchase of intangible assets                                                      |       |                                     | (80        | )                           |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | (80 | ) |   |
| Net cash used in  investing activities                                             |       |                                     | (14,205    | )                           |       |                                                   | —     |                            |       |                                | (568       | ) |   |   | — |   |   |   | (14,773 | ) |   |
| Cash Flows from Financing Activities:                                              |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Increase  (decrease) in line of credit borrowings                                  |       |                                     | —     |                        |       |                                                   | —     |                            |       |                                | —     |   |   |   | — |   |   |   | — |   |   |
| 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                              |       |                                     | (6,409     | )                           |       |                                                   | 11         |                            |       |                                | 534        |   |   |   | — |   |   |   | (5,864 | ) |   |
| Cash and Cash  Equivalents, Beginning of  Year                                     |       |                                     | 18,235     |                        |       |                                                   | 33         |                            |       |                                | 463        |   |   |   | — |   |   |   | 18,731 |   |   |
| Cash and Cash  Equivalents, End of Year                                            |       |                                     | $          | 11,826                      |       |                                                   |       | $                               | 44         |                                |       |   | $ | 997 |   |   |   | $ | — |   |   |   | $ | 12,867 |   |   |

 

F-31

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**15. EMPLOYMENT AGREEMENTS**

The Company has employment agreements with itsChairman of the Board/Chief Executive Officer (“CEO”) and its President/ChiefOperating Officer (“COO”). These agreements, as amended, provided for basecompensation of $477,405, $463,500 and $450,000 for fiscal 2004, 2003 and 2002, respectively, increasingannually thereafter in an amount to be determined by the Compensation Committeeof the Board of Directors, and salary continuation and severance paymentsshould employment of the executives be terminated under specified conditions,as defined therein. The agreements, which expire on September 30, 2007,automatically extend for successive one-year periods extending the expirationdate to three years from the date of the extension, unless either the Companyor the executive gives written notice to the other party that the term will notbe further extended. Additionally, the CEO and COO are eligible for an annualcash bonus and stock options based on performance, as specified by the CompensationCommittee.

The Company also has an employment agreement with its Executive VicePresident—Chief Financial Officer. This agreement provided for basecompensation of $360,000 for fiscal 2004, which is subject to potentialincrease 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, whichexpires on September 30, 2006, automatically extends forsuccessive one-year periods extending the expiration date to two years from thedate of the extension, unless either the Company or the executive gives writtennotice to the other party that the term will not be further extended.

**16. EMPLOYEE BENEFIT PLANS**

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 can contribute up to 20% of their annualsalary. Employees who meet certain criteria are eligible for a matchingcontribution from the Company based on a sliding scale. Company matches aremade in the first quarter of the succeeding calendar year. Company matches vestover a period of approximately six years from each employee’s commencement ofemployment with the Company. Company matching contributions totaling $82,000,$76,000 and $65,000 were made in fiscal 2004, 2003 and 2002, respectively. Inaddition the Company may make discretionary contributions to the plan, whichvest over a period of approximately six years from each employee’s commencementof employment with the Company. The Company has not made any discretionarycontributions.

**17. 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 had purchased and retired 142,269 shares in the aggregateunder the repurchase program at a total cost of $3,242,000, at an average costof $22.79 per share, of which 75,715 shares were repurchased in fiscal 2004, atan average cost of $23.44 per share. The indenture governing the New SeniorNotes and the terms of both theCompany’s New Credit Facility andprevious credit facility contain restrictions that placelimits on certain payments by the Company, including payments to repurchaseshares of its common stock. The Company’s repurchases of common stock have beenmade in compliance with all restrictions under the indenture governing the NewSenior Notes and the terms of its New Credit Facility and previous credit facility.

F-32

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**MOTHERS WORK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**18. QUARTERLY FINANCIALINFORMATION (UNAUDITED)**

Quarterly financial results for the years ended September 30,2004 and 2003 are as follows (in thousands, except per share amounts): 
| ** **                                          | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|
| **Fiscal 2004**                                | ** ** | ** **             | ** ** | **9/30/04** | ** ** | **6/30/04** | ** ** | **3/31/04** | ** ** | **12/31/03** | ** ** |
| 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** | ** ** |
| 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 |   |
|                                              |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Company’s business, like that of other retailers, is seasonal. TheCompany’s quarterly net sales have historically been highest in its thirdfiscal quarter, corresponding to the Spring selling season, followed by itsfirst fiscal quarter, corresponding to the 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 the Company’soperating expenses and interest expense, and the historically higher saleslevel in the third quarter, the Company has typically generated a verysignificant percentage of its full year operating income and net income duringthe third quarter.

**19. 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 ofDirectors of the Company $77,500 in fiscal 2002 for merchandising consultingfees (none in fiscal 2004 or 2003). The consulting arrangement was cancelledduring 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 is currently Of Counsel at Pepper Hamilton LLP.The Company incurred legal fees to this law firm of $147,000, $348,000 and$1,510,000 in fiscal 2004, 2003 and 2002, respectively. As of September 30,2004, the Company had amounts outstanding to this law firm of $41,000, whichare included in accounts payable in the accompanying consolidated balancesheets.

During fiscal 2004, the Company repurchased anaggregate 14,954 shares of common stock from both the Company’s CEO and COO aspart of the share repurchase program.

 

F-33

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**Reportof Independent Registered Public Accounting Firm on Financial Statement Schedule**

The Board of Directors andStockholdersMothers Work, Inc.:

Under date of November 17, 2004, we reported onthe consolidated balance sheets of Mothers Work, Inc. and subsidiaries asof September 30, 2004 and 2003, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for each of the years in thethree-year period ended September 30, 2004. In connection with our auditsof the aforementioned consolidated financial statements, we also audited therelated financial statement schedule as listed in the accompanying index. Thisfinancial statement schedule is the responsibility of the Company’s management.Our responsibility is to express an opinion on this financial statementschedule based on our audits.

In our opinion, suchfinancial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.

/s/ KPMG LLP

Philadelphia, PennsylvaniaNovember 17, 2004

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**MOTHERS WORK, INC. AND SUBSIDIARIESSCHEDULE II—VALUATION ANDQUALIFYING 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-35

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