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Destination Maternity Corp - Quarter Report: 2007 March (Form 10-Q)

 

United States

Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-Q

ý

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

 

For the quarterly period ended March 31, 2007

 

 

 

Or

 

 

 

o

 

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from            to

Commission file number 0-21196

MOTHERS WORK, INC.
(Exact name of registrant as specified in its charter)

Delaware

 

13-3045573

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer Identification No.)

 

 

 

456 North 5th Street, Philadelphia, Pennsylvania

 

19123

(Address of principal executive offices)

 

(Zip code)

 

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o                               Accelerated filer x                               Non-accelerated filer o

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

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

Common Stock, $.01 par value 5,945,129 shares outstanding as of May 3, 2007

 




MOTHERS WORK, INC. AND SUBSIDIARIES
INDEX

PART I.  FINANCIAL INFORMATION

 

 

Item 1.

 

Financial Statements (unaudited)

 

 

 

 

Consolidated Balance Sheets

 

 

 

 

Consolidated Statements of Operations

 

 

 

 

Consolidated Statements of Stockholders’ Equity and Comprehensive Income

 

 

 

 

Consolidated Statements of Cash Flows

 

 

 

 

Notes to Consolidated Financial Statements

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

 

 

PART II.  OTHER INFORMATION

 

 

Item 1.

 

Legal Proceedings

 

 

Item 1A.

 

Risk Factors

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

Item 6.

 

Exhibits

 

 

 

 

 

 

 

Signatures

 

 

 

 

 

2




PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

MOTHERS WORK, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

 

 

March 31, 2007

 

September 30, 2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

7,144

 

$

18,904

 

Short-term investments

 

 

9,425

 

Trade receivables, net

 

14,051

 

11,631

 

Inventories

 

98,435

 

94,259

 

Deferred income taxes

 

6,018

 

6,018

 

Prepaid expenses and other current assets

 

4,144

 

8,395

 

Total current assets

 

129,792

 

148,632

 

Property, plant and equipment, net

 

73,162

 

71,430

 

Assets held for sale

 

700

 

700

 

Other assets:

 

 

 

 

 

Goodwill

 

50,389

 

50,389

 

Deferred financing costs, net of accumulated amortization of $1,534 and $1,927

 

3,012

 

2,795

 

Other intangible assets, net of accumulated amortization of $2,452 and $2,413

 

653

 

726

 

Deferred income taxes

 

13,710

 

12,543

 

Other non-current assets

 

509

 

521

 

Total other assets

 

68,273

 

66,974

 

Total assets

 

$

271,927

 

$

287,736

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Line of credit borrowings

 

$

 

$

 

Current portion of long-term debt

 

656

 

814

 

Accounts payable

 

22,379

 

19,593

 

Accrued expenses and other current liabilities

 

40,683

 

44,453

 

Total current liabilities

 

63,718

 

64,860

 

Long-term debt

 

92,626

 

117,535

 

Deferred rent and other non-current liabilities

 

23,680

 

24,641

 

Total liabilities

 

180,024

 

207,036

 

 

 

 

 

 

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, 2,000,000 shares authorized

 

 

 

 

 

Series A cumulative convertible preferred stock, $.01 par value; 41,000 shares authorized, none outstanding

 

 

 

Series B junior participating preferred stock, $.01 par value; 300,000 shares authorized, none outstanding

 

 

 

Common stock, $.01 par value; 20,000,000 shares authorized, 5,938,689 and 5,624,374 shares issued and outstanding, respectively

 

59

 

56

 

Additional paid-in capital

 

79,862

 

71,431

 

Retained earnings

 

13,167

 

9,213

 

Accumulated other comprehensive loss

 

(1,185

)

 

Total stockholders’ equity

 

91,903

 

80,700

 

Total liabilities and stockholders’ equity

 

$

271,927

 

$

287,736

 

 

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

3




MOTHERS WORK, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net sales

 

$

143,857

 

$

144,643

 

$

292,341

 

$

296,036

 

Cost of goods sold

 

67,797

 

68,620

 

139,231

 

143,830

 

Gross profit

 

76,060

 

76,023

 

153,110

 

152,206

 

Selling, general and administrative expenses

 

69,065

 

71,414

 

138,613

 

143,102

 

Operating income

 

6,995

 

4,609

 

14,497

 

9,104

 

Interest expense, net

 

2,790

 

3,785

 

5,922

 

7,579

 

Loss on extinguishment of debt

 

 

 

2,093

 

 

Income before income taxes

 

4,205

 

824

 

6,482

 

1,525

 

Income tax provision

 

1,640

 

322

 

2,528

 

595

 

Net income

 

$

2,565

 

$

502

 

$

3,954

 

$

930

 

 

 

 

 

 

 

 

 

 

 

Net income per share—Basic

 

$

0.44

 

$

0.09

 

$

0.69

 

$

0.18

 

Average shares outstanding—Basic

 

5,824

 

5,291

 

5,765

 

5,280

 

Net income per share—Diluted

 

$

0.41

 

$

0.09

 

$

0.64

 

$

0.17

 

Average shares outstanding—Diluted

 

6,227

 

5,501

 

6,183

 

5,402

 

 

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

4




MOTHERS WORK, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(in thousands)

(unaudited)

 

 

Common Stock

 

 

 

 

 

Accumulated

 

 

 

Comprehensive Income

 

 

 

Number

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

 

 

 

 

of

 

 

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Loss

 

Total

 

Quarter

 

Year to Date

 

Balance as of September 30, 2006

 

5,624

 

$

56

 

$

71,431

 

$

9,213

 

$

 

$

80,700

 

 

 

 

 

Net income

 

 

 

 

 

 

 

3,954

 

 

3,954

 

$

2,565

 

$

3,954

 

Initial prior service cost for retirement plans, net of tax

 

 

 

 

 

(1,202

)

(1,202

)

 

 

 

 

Amortization of prior service cost, net of tax

 

 

 

 

 

17

 

17

 

17

 

17

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

2,582

 

$

3,971

 

Stock-based compensation

 

107

 

1

 

988

 

 

 

989

 

 

 

 

 

Exercise of stock options

 

208

 

2

 

3,559

 

 

 

3,561

 

 

 

 

 

Tax benefit from stock option exercises

 

 

 

2,462

 

 

 

2,462

 

 

 

 

 

Reclassification of equity award from liabilities

 

 

 

1,422

 

 

 

1,422

 

 

 

 

 

Balance as of March 31, 2007

 

5,939

 

$

59

 

$

79,862

 

$

13,167

 

$

(1,185

)

$

91,903

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of September 30, 2005

 

5,269

 

$

53

 

$

63,164

 

$

111

 

$

 

$

63,328

 

 

 

 

 

Net income

 

 

 

 

930

 

 

930

 

$

502

 

$

930

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

502

 

$

930

 

Stock-based compensation

 

 

 

533

 

 

 

533

 

 

 

 

 

Exercise of stock options

 

47

 

 

430

 

 

 

430

 

 

 

 

 

Tax benefit from stock option exercises

 

 

 

225

 

 

 

225

 

 

 

 

 

Balance as of March 31, 2006

 

5,316

 

$

53

 

$

64,352

 

$

1,041

 

$

 

$

65,446

 

 

 

 

 

 

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

5




MOTHERS WORK, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

Six Months Ended
March 31,

 

 

 

2007

 

2006

 

Cash Flows from Operating Activities

 

 

 

 

 

Net income

 

$

3,954

 

$

930

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

7,812

 

7,937

 

Stock-based compensation expense

 

989

 

811

 

Loss on impairment of long-lived assets

 

390

 

1,851

 

Gain on disposal of assets

 

(163

)

(197

)

Loss on extinguishment of debt

 

2,093

 

 

Accretion of discount on senior notes

 

82

 

91

 

Deferred income tax benefit

 

(432

)

(302

)

Amortization of deferred financing costs

 

297

 

314

 

Changes in assets and liabilities:

 

 

 

 

 

Decrease (increase) in —

 

 

 

 

 

Trade receivables

 

(2,420

)

(3,064

)

Inventories

 

(4,176

)

9,108

 

Prepaid expenses and other assets

 

4,263

 

474

 

Increase (decrease) in —

 

 

 

 

 

Accounts payable, accrued expenses and other current liabilities

 

(546

)

4,732

 

Deferred rent and other non-current liabilities

 

(1,671

)

311

 

Net cash provided by operating activities

 

10,472

 

22,996

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Purchase of short-term investments

 

(19,550

)

(25,525

)

Proceeds from sale of short-term investments

 

28,975

 

22,975

 

Capital expenditures

 

(9,116

)

(8,046

)

Proceeds from sale of property, plant and equipment

 

85

 

 

Proceeds from sale of assets held for sale

 

 

225

 

Purchase of intangible assets

 

(9

)

(11

)

Net cash provided by (used in) investing activities

 

385

 

(10,382

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

(Decrease) increase in cash overdraft

 

(885

)

540

 

Repayment of long-term debt

 

(25,330

)

(313

)

Premium on repurchase of long-term debt

 

(1,406

)

 

Deferred financing costs

 

(1,019

)

 

Proceeds from exercise of stock options

 

3,561

 

430

 

Excess tax benefit from exercise of stock options

 

2,462

 

242

 

Net cash (used in) provided by financing activities

 

(22,617

)

899

 

Net (Decrease) Increase in Cash and Cash Equivalents

 

(11,760

)

13,513

 

Cash and Cash Equivalents, Beginning of Period

 

18,904

 

3,037

 

Cash and Cash Equivalents, End of Period

 

$

7,144

 

$

16,550

 

 

 

 

 

 

 

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

 

Cash paid for interest

 

$

6,275

 

$

7,332

 

Cash (received) paid for income taxes

 

$

(1,972

)

$

1,071

 

 

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

6




MOTHERS WORK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2007

(unaudited)

1.              BASIS OF FINANCIAL STATEMENT PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with the requirements for Form 10-Q and Article 10 of Regulation S-X and, accordingly, certain information and footnote disclosures have been condensed or omitted.  Reference is made to the Annual Report on Form 10-K as of and for the year ended September 30, 2006 for Mothers Work, Inc. and subsidiaries (the “Company” or “Mothers Work”) as filed with the Securities and Exchange Commission (“SEC”), for additional disclosures including a summary of the Company’s accounting policies.

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

The Company operates on a fiscal year ending September 30 of each year.  All references to fiscal years of the Company refer to fiscal years ended on September 30 in those years.  For example, the Company’s “fiscal 2007” will end on September 30, 2007.  Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year presentation.

2.              EARNINGS PER SHARE (EPS)

Basic earnings per share (“Basic EPS”) is computed by dividing net income by the weighted average number of common shares outstanding, excluding restricted stock awards for which the restrictions have not lapsed.  Diluted earnings per share (“Diluted EPS”) is computed by dividing net income by the weighted average number of common shares outstanding, after giving effect to the potential dilution, if applicable, from the assumed lapse of restrictions on restricted stock awards and from the exercise of securities, such as stock options and warrants, into shares of common stock as if those securities were exercised.

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

 

 

Three Months Ended
March 31, 2007

 

Three Months Ended
March 31, 2006

 

 

 

Net
Income

 

Shares

 

EPS

 

Net
Income

 

Shares

 

EPS

 

Basic EPS

 

$

2,565

 

5,824

 

$

0.44

 

$

502

 

5,291

 

$

0.09

 

Incremental shares from the assumed lapse of restrictions on restricted stock awards

 

 

101

 

(0.01

)

 

 

 

Incremental shares from the assumed exercise of outstanding stock options

 

 

302

 

(0.02

)

 

210

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS

 

$

2,565

 

6,227

 

$

0.41

 

$

502

 

5,501

 

$

0.09

 

 

 

 

 

Six Months Ended
March 31, 2007

 

Six Months Ended
March 31, 2006

 

 

 

Net
Income

 

Shares

 

EPS

 

Net
Income

 

Shares

 

EPS

 

Basic EPS

 

$

3,954

 

5,765

 

$

0.69

 

$

930

 

5,280

 

$

0.18

 

Incremental shares from the assumed lapse of restrictions on restricted stock awards

 

 

67

 

(0.01

)

 

 

 

Incremental shares from the assumed exercise of outstanding stock options

 

 

351

 

(0.04

)

 

122

 

(0.01

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS

 

$

3,954

 

6,183

 

$

0.64

 

$

930

 

5,402

 

$

0.17

 

 

For the three months ended March 31, 2007 and 2006, options and warrants to purchase 43,000 and 450,760 shares, respectively, were excluded from the calculation of Diluted EPS as their effect would have been antidilutive.  For the six months ended March 31, 2007 and 2006, options and warrants to purchase 25,500 and 758,615 shares, respectively, were excluded from the calculation of Diluted EPS as their effect would have been antidilutive.  These options and warrants could potentially dilute EPS in the future.

7




 

 

3.                 INVENTORIES

Inventories were comprised of the following (in thousands):

 

March 31, 2007

 

September 30, 2006

 

Finished goods

 

$

91,435

 

$

86,937

 

Work-in-progress

 

2,866

 

2,736

 

Raw materials

 

4,134

 

4,586

 

 

 

$

98,435

 

$

94,259

 

 

4.                 ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

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

 

March 31, 2007

 

September 30, 2006

 

Salaries, wages and employee benefits

 

$

11,353

 

$

14,657

 

Income taxes payable

 

1,273

 

1,565

 

Interest

 

1,850

 

2,273

 

Deferred rent

 

4,079

 

4,192

 

Sales taxes

 

3,617

 

3,170

 

Insurance

 

2,045

 

1,892

 

Audit and legal

 

3,139

 

4,137

 

Remaining payout for redemption of Series A Preferred Stock

 

679

 

679

 

Accrued store construction costs

 

1,252

 

681

 

Gift certificates and store credits

 

4,720

 

3,895

 

Other

 

6,676

 

7,312

 

 

 

$

40,683

 

$

44,453

 

 

5.                 LONG-TERM DEBT AND LINE OF CREDIT

In November 2006, the Company’s Board of Directors authorized the repurchase of $25,000,000 principal amount of the Company’s 111¤4% senior notes (the “Senior Notes”).  On December 8, 2006, the Company completed the repurchase of the authorized amount at 105.625% of the $25,000,000 principal amount, plus accrued and unpaid interest.  In connection with the repurchase, the Company recorded a pre-tax charge totaling $2,093,000, representing the premium paid plus the write-off of unamortized debt issuance discount and deferred financing costs.

On March 13, 2007, the Company entered into a Term Loan and Security Agreement (the “Term Loan Agreement”) for a $90,000,000 senior secured Term Loan B due March 13, 2013 (the “Term Loan”), the proceeds of which were received on April 18, 2007 and were used to redeem the remaining $90,000,000 principal amount of the Senior Notes (see Note 12).  The interest rate on the Term Loan is equal to, at the Company’s election, either (i) the prime rate plus 1.00%, or (ii) the LIBOR rate plus the applicable margin.  The applicable margin is initially fixed at 2.50% through and including the fiscal quarter ending September 30, 2007.  Thereafter, the applicable margin for LIBOR borrowings is either 2.25% or 2.50%, depending on the Company’s Consolidated Leverage Ratio (as defined).  In order to mitigate the Company’s floating rate interest risk on the variable rate Term Loan, it entered into an interest rate swap agreement with the Agent bank for the Term Loan that commenced on April 18, 2007, the date the $90,000,000 Term Loan proceeds were received, and expires on April 18, 2012.  The interest rate swap agreement enables the Company to effectively convert an amount of the Term Loan equal to the notional amount of the interest rate swap from a floating interest rate of LIBOR plus 2.50% (subject to reduction to LIBOR plus 2.25% if the Company achieves a specified leverage ratio), to a fixed interest rate of 7.50% (subject to reduction to 7.25% if the Company achieves a specified leverage ratio).  The notional amount of the interest rate swap is $75,000,000 at inception of the swap agreement and decreases over time to a notional amount of $5,000,000 at the expiration date.  Commencing with the third quarter of fiscal 2007, the Company is required to make minimum repayments of the principal amount of the Term Loan in quarterly installments of $225,000 each.  Additionally, the Term Loan can be prepaid at the Company’s option, in part or in whole, at any time without any prepayment premium or penalty.  The Term Loan Agreement imposes certain restrictions on the Company’s ability to, among other things, incur additional indebtedness, pay dividends, repurchase stock, and enter into other various types of transactions.  The Term Loan Agreement also contains quarterly financial covenants that require the Company to maintain a specified maximum permitted Consolidated Leverage Ratio and a specified minimum permitted Consolidated Interest Coverage Ratio (as defined).  As of March 31, 2007, the Company was in compliance with the financial covenants of its Term Loan Agreement.

In connection with the Term Loan transaction, the Company amended its existing $60,000,000 revolving credit facility (the “Credit Facility”) in order to permit the new Term Loan financing.  This amendment of the Credit Facility also extended its maturity from October 15, 2009 to March 13, 2012, increased its size to $65,000,000, and reduced the LIBOR-based interest rate option under

8




the facility by 0.25%.  There are no financial covenant requirements under the Credit Facility provided that Excess Availability (as defined) does not fall below 10% of the Borrowing Base (as defined).  If Excess Availability were to fall below 10% of the Borrowing Base, the Company would be required to meet a specified minimum Fixed Charge Coverage Ratio (as defined).  During the first six months of fiscal 2007 and the first six months of fiscal 2006, the Company exceeded minimum requirements for Excess Availability.

6.              RETIREMENT PLANS

On March 2, 2007, the Company entered into Supplemental Executive Retirement Agreements with its Chairman of the Board and Chief Executive Officer and its President and Chief Operating Officer (the “SERP Agreements”).  The purpose of the SERP Agreements is to provide the executives with supplemental pension benefits following their cessation of employment.

The amount of the benefit payable under each SERP Agreement is the actuarial present value of a single life annuity equal to 60% of the executive’s “deemed final pay,” commencing upon cessation of employment.  For this purpose, “deemed final pay” means the executive’s current base salary, increased by 3% for each new fiscal year that begins before the executive’s cessation of employment.  This benefit vested 331/3% on March 2, 2007.  Starting on September 30, 2007 and on each September 30 thereafter until fully vested, the benefit will vest either (i) 15%, if during that entire fiscal year the executive provided continuous full-time service to the Company, or (ii) 7.5%, if during that entire fiscal year the executive provided at least continuous 50% part-time service to the Company.  Notwithstanding the foregoing, the benefit is subject to full acceleration if, following a change in control, the executive’s employment ceases due to a termination without cause or a resignation with good reason.  In connection with the initiation of the SERP Agreements, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” and recorded after-tax prior service cost of $1,202,000 (net of income tax benefit of $769,000) as Accumulated Other Comprehensive Loss.

The components of net periodic pension cost on a pre-tax basis were as follows (in thousands):

 

Three Months Ended,
March 31,

 

Six Months Ended
March 31,

 

 

 

2007

 

2006

 

2007

 

2006

 

Service cost

 

$

131

 

$

 

$

131

 

$

 

Interest cost

 

10

 

 

10

 

 

Amortization of prior service cost

 

29

 

 

29

 

 

Total net periodic benefit cost

 

$

170

 

$

 

$

170

 

$

 

 

The SERP Agreements also provide that the Company will establish a grantor trust, the assets of which will be used to pay benefits under the SERP Agreements (or to satisfy the claims of the Company’s general creditors in the event of the Company’s bankruptcy or insolvency).  The grantor trust will be funded periodically, on an actuarial basis, such that the total assets of the trust from time to time will reasonably approximate the Company’s then current obligation under the SERP Agreements (provided that, upon a change in control, the Company has agreed to fully fund the grantor trust, regardless of the extent to which the SERP benefits are then vested).   On April 30, 2007, the Company made an initial contribution to the grantor trust of $2,662,000 and no further contributions are expected to be made during fiscal 2007.

7.              NEW ACCOUNTING PRONOUNCEMENTS

FASB Interpretation No. 48

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.”  FASB Interpretation No. 48 provides guidance for the recognition and measurement of uncertain tax positions in an enterprise’s financial statements.  Recognition involves a determination of whether it is more likely than not that a tax position will be sustained upon examination with the presumption that the tax position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information.  This interpretation is effective for fiscal years beginning after December 15, 2006.  Early adoption is permitted if the enterprise has not issued financial statements, including interim financial statements, in the period of adoption.  The impact from adoption of FASB Interpretation No. 48, if any, on the Company’s consolidated financial position or results of operations has not yet been determined.  The Company plans to adopt FASB Interpretation No. 48 effective as of October 1, 2007.

EITF Issue 06-3

In June 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).”  EITF Issue 06-3 provides guidance related to the presentation in financial statements of any tax assessed

9




by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer, including, but not limited to, sales, use, value added, and some excise taxes.  The EITF concluded that the presentation of taxes within the scope of EITF Issue 06-3 on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should disclosed.  In addition, the aggregate amount of any such taxes that are reported on a gross basis should be disclosed in interim and annual financial statements.  The guidance in EITF Issue 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006.  The Company presently reports taxes within the scope of EITF Issue 06-3 on a net basis and adoption did not have any impact on the consolidated financial statements.

SAB No. 108

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.”  SAB No. 108 states that SEC registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement, contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years.   SAB No. 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006.  The Company does not expect the adoption of SAB No. 108 to have a material impact on the Company’s consolidated financial statements.

SFAS No. 157

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The impact from adoption of SFAS No. 157, if any, on the Company’s consolidated financial position or results of operations has not yet been determined.

SFAS No. 158

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”  SFAS No. 158 requires an employer to recognize the funded status of a benefit plan, measured as the difference between plan assets at fair value and the projected benefit obligation, in its statement of financial position.  SFAS No. 158 also requires an employer to measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position.  This statement is effective as of the end of the fiscal year ending after December 15, 2006, except for the requirement to measure plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, which is effective for fiscal years ending after December 15, 2008.  In March 2007, the Company entered into SERP Agreements with two executives and adopted the provisions of SFAS No. 158.

SFAS No. 159

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value and requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet.  SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007.  The impact from adoption of SFAS No. 159, if any, on the Company’s consolidated financial position or results of operations has not yet been determined.

8.              GUARANTOR SUBSIDIARIES

Pursuant to the terms of the indenture relating to the Senior Notes, each of the domestic subsidiaries of Mothers Work, Inc. (the “Guarantor Subsidiaries”) has jointly and severally provided an unconditional guarantee of the obligations of Mothers Work with respect to the Senior Notes.  There are no restrictions on any of the assets of the Guarantor Subsidiaries which would limit their ability to transfer funds to Mothers Work in the form of loans, advances or cash dividends, except as provided by applicable law.  None of the Company’s foreign subsidiaries (the “Non-Guarantor Subsidiaries”) have guaranteed the Senior Notes.  The condensed consolidating financial information for the Company, the Guarantor Subsidiaries, and the Non-Guarantor Subsidiaries as of March 31, 2007 and September 30, 2006 and for the three months and six months ended March 31, 2007 and 2006 as presented below has been prepared from the books and records maintained by the Guarantor Subsidiaries and the Company.  The condensed consolidating financial information may not necessarily be indicative of the results of operations or financial position had the Guarantor Subsidiaries operated as independent entities.  Certain intercompany revenues and expenses included in the subsidiary records are eliminated in consolidation.  As a result of this activity, an amount due to/due from parent will exist at any time.

10




Mothers Work, Inc.

Condensed Consolidating Balance Sheet

March 31, 2007

(in thousands)

(unaudited)

 

 

Mothers Work
(Parent
Company)

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries
(Foreign
Operations)

 

Consolidating
Eliminations

 

Mothers Work
Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

5,619

 

$

103

 

$

1,422

 

$

 

$

7,144

 

Trade receivables, net

 

14,051

 

 

 

 

14,051

 

Inventories

 

95,215

 

 

3,220

 

 

98,435

 

Deferred income taxes

 

6,018

 

 

 

 

6,018

 

Prepaid expenses and other current assets

 

4,061

 

2

 

81

 

 

4,144

 

Total current assets

 

124,964

 

105

 

4,723

 

 

129,792

 

Property, plant and equipment, net

 

70,949

 

 

2,213

 

 

73,162

 

Assets held for sale

 

 

 

700

 

 

700

 

Other assets

 

68,088

 

65

 

120

 

 

68,273

 

Investments in and advances to (from) affiliates

 

1,615

 

291,985

 

(3,698

)

(289,902

)

 

Total assets

 

$

265,616

 

$

292,155

 

$

4,058

 

$

(289,902

)

$

271,927

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’
EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

Line of credit borrowings

 

$

 

$

 

$

 

$

 

$

 

Current portion of long-term debt

 

656

 

 

 

 

656

 

Accounts payable

 

22,379

 

 

 

 

22,379

 

Accrued expenses and other current liabilities

 

35,513

 

4,744

 

426

 

 

40,683

 

Total current liabilities

 

58,548

 

4,744

 

426

 

 

63,718

 

Long-term debt

 

92,626

 

 

 

 

92,626

 

Deferred rent and other non-current liabilities

 

22,539

 

 

1,141

 

 

23,680

 

Total liabilities

 

173,713

 

4,744

 

1,567

 

 

180,024

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

91,903

 

287,411

 

2,491

 

(289,902

)

91,903

 

Total liabilities and stockholders’ equity

 

$

265,616

 

$

292,155

 

$

4,058

 

$

(289,902

)

$

271,927

 

 

11




Mothers Work, Inc.

Condensed Consolidating Balance Sheet

September 30, 2006

(in thousands)

(unaudited)

 

 

Mothers Work
(Parent
Company)

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries
(Foreign
Operations)

 

Consolidating
Eliminations

 

Mothers Work
Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

16,878

 

$

96

 

$

1,930

 

$

 

$

18,904

 

Short-term investments

 

9,425

 

 

 

 

9,425

 

Trade receivables, net

 

11,631

 

 

 

 

11,631

 

Inventories

 

91,653

 

 

2,606

 

 

94,259

 

Deferred income taxes

 

6,018

 

 

 

 

6,018

 

Prepaid expenses and other current assets

 

8,226

 

 

169

 

 

8,395

 

Total current assets

 

143,831

 

96

 

4,705

 

 

148,632

 

Property, plant and equipment, net

 

69,026

 

 

2,404

 

 

71,430

 

Assets held for sale

 

 

 

700

 

 

700

 

Other assets

 

66,774

 

69

 

131

 

 

66,974

 

Investments in and advances to (from) affiliates

 

1,839

 

274,649

 

(4,184

)

(272,304

)

 

Total assets

 

$

281,470

 

$

274,814

 

$

3,756

 

$

(272,304

)

$

287,736

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’
EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

Line of credit borrowings

 

$

 

$

 

$

 

$

 

$

 

Current portion of long-term debt

 

814

 

 

 

 

814

 

Accounts payable

 

19,593

 

 

 

 

19,593

 

Accrued expenses and other current liabilities

 

39,281

 

4,756

 

416

 

 

44,453

 

Total current liabilities

 

59,688

 

4,756

 

416

 

 

64,860

 

Long-term debt

 

117,535

 

 

 

 

117,535

 

Deferred rent and other non-current liabilities

 

23,547

 

 

1,094

 

 

24,641

 

Total liabilities

 

200,770

 

4,756

 

1,510

 

 

207,036

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

80,700

 

270,058

 

2,246

 

(272,304

)

80,700

 

Total liabilities and stockholders’ equity

 

$

281,470

 

$

274,814

 

$

3,756

 

$

(272,304

)

$

287,736

 

 

12




Mothers Work, Inc.

Consolidating Statement of Operations

For the Three Months Ended March 31, 2007 and 2006

(in thousands)

(unaudited)

 

 

Mothers Work
(Parent Company)

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries
(Foreign
Companies)

 

Consolidating
Eliminations

 

Mothers Work
Consolidated

 

For the Three Months Ended March 31, 2007

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

140,079

 

$

7,265

 

$

3,778

 

$

(7,265

)

$

143,857

 

Cost of goods sold

 

66,132

 

 

1,665

 

 

67,797

 

Gross profit

 

73,947

 

7,265

 

2,113

 

(7,265

)

76,060

 

Selling, general and administrative expenses

 

74,040

 

215

 

2,075

 

(7,265

)

69,065

 

Operating income (loss)

 

(93

)

7,050

 

38

 

 

6,995

 

Interest income (expense), net

 

(8,863

)

6,073

 

 

 

(2,790

)

Equity in earnings of subsidiaries

 

13,161

 

 

 

(13,161

)

 

Income before income taxes

 

4,205

 

13,123

 

38

 

(13,161

)

4,205

 

Income tax provision

 

1,640

 

4,593

 

14

 

(4,607

)

1,640

 

Net income

 

$

2,565

 

$

8,530

 

$

24

 

$

(8,554

)

$

2,565

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31, 2006

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

140,943

 

$

7,377

 

$

3,700

 

$

(7,377

)

$

144,643

 

Cost of goods sold

 

66,635

 

 

1,985

 

 

68,620

 

Gross profit

 

74,308

 

7,377

 

1,715

 

(7,377

)

76,023

 

Selling, general and administrative expenses

 

77,198

 

71

 

1,522

 

(7,377

)

71,414

 

Operating income

 

(2,890

)

7,306

 

193

 

 

4,609

 

Interest income (expense), net

 

(8,692

)

4,907

 

 

 

(3,785

)

Equity in earnings of subsidiaries

 

12,406

 

 

 

(12,406

)

 

Income before income taxes

 

824

 

12,213

 

193

 

(12,406

)

824

 

Income tax provision

 

322

 

4,275

 

75

 

(4,350

)

322

 

Net income

 

$

502

 

$

7,938

 

$

118

 

$

(8,056

)

$

502

 

 

13




Mothers Work, Inc.

Consolidating Statement of Operations

For the Six Months Ended March 31, 2007 and 2006

(in thousands)

(unaudited)

 

 

Mothers Work
(Parent Company)

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries
(Foreign
Companies)

 

Consolidating
Eliminations

 

Mothers Work
Consolidated

 

For the Six Months Ended March 31, 2007

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

284,296

 

$

14,964

 

$

8,045

 

$

(14,964

)

$

292,341

 

Cost of goods sold

 

135,785

 

 

3,446

 

 

139,231

 

Gross profit

 

148,511

 

14,964

 

4,599

 

(14,964

)

153,110

 

Selling, general and administrative expenses

 

149,046

 

333

 

4,198

 

(14,964

)

138,613

 

Operating income (loss)

 

(535

)

14,631

 

401

 

 

14,497

 

Interest income (expense), net

 

(17,988

)

12,066

 

 

 

(5,922

)

Loss on extinguishment of debt

 

(2,093

)

 

 

 

(2,093

)

Equity in earnings of subsidiaries

 

27,098

 

 

 

(27,098

)

 

Income before income taxes

 

6,482

 

26,697

 

401

 

(27,098

)

6,482

 

Income tax provision

 

2,528

 

9,344

 

156

 

(9,500

)

2,528

 

Net income

 

$

3,954

 

$

17,353

 

$

245

 

$

(17,598

)

$

3,954

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended March 31, 2006

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

288,478

 

$

15,270

 

$

7,558

 

$

(15,270

)

$

296,036

 

Cost of goods sold

 

140,446

 

 

3,384

 

 

143,830

 

Gross profit

 

148,032

 

15,270

 

4,174

 

(15,270

)

152,206

 

Selling, general and administrative expenses

 

154,523

 

153

 

3,696

 

(15,270

)

143,102

 

Operating income (loss)

 

(6,491

)

15,117

 

478

 

 

9,104

 

Interest income (expense), net

 

(17,036

)

9,457

 

 

 

(7,579

)

Equity in earnings of subsidiaries

 

25,052

 

 

 

(25,052

)

 

Income before income taxes

 

1,525

 

24,574

 

478

 

(25,052

)

1,525

 

Income tax provision

 

595

 

8,601

 

186

 

(8,787

)

595

 

Net income

 

$

930

 

$

15,973

 

$

292

 

$

(16,265

)

$

930

 

 

14




Mothers Work, Inc.

Consolidating Cash Flow Statement

For the Six Months Ended March 31, 2007

(in thousands)

(unaudited)

 

 

Mothers Work
(Parent
Company)

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries
(Foreign
Companies)

 

Consolidating
Eliminations

 

Mothers Work
Consolidated

 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

3,954

 

$

17,353

 

$

245

 

$

(17,598

)

$

3,954

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

7,576

 

4

 

232

 

 

7,812

 

Stock-based compensation expense

 

989

 

 

 

 

989

 

Loss on impairment of long-lived assets

 

329

 

 

61

 

 

390

 

Gain on disposal of assets

 

(163

)

 

 

 

(163

)

Accretion of discount on senior notes

 

82

 

 

 

 

82

 

Loss on extinguishment of debt

 

2,093

 

 

 

 

2,093

 

Deferred income tax benefit

 

(432

)

 

 

 

(432

)

Amortization of deferred financing costs

 

297

 

 

 

 

297

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

Decrease (increase) in—

 

 

 

 

 

 

 

 

 

 

 

Trade receivables

 

(2,420

)

 

 

 

(2,420

)

Inventories

 

(3,562

)

 

(614

)

 

(4,176

)

Prepaid expenses and other assets

 

4,177

 

(2

)

88

 

 

4,263

 

Investments in and advances to (from) affiliates

 

224

 

(17,336

)

(486

)

17,598

 

 

Increase (decrease) in—

 

 

 

 

 

 

 

 

 

 

 

Accounts payable, accrued expenses and other current liabilities

 

(539

)

(12

)

5

 

 

(546

)

Deferred rent and other non-current liabilities

 

(1,718

)

 

47

 

 

(1,671

)

Net cash provided by (used in) operating activities

 

10,887

 

7

 

(422

)

 

10,472

 

Cash Flows from Investing Activities

 

 

 

 

 

 

 

 

 

 

 

Purchase of short-term investments

 

(19,550

)

 

 

 

(19,550

)

Proceeds from sale of short-term investments

 

28,975

 

 

 

 

28,975

 

Capital expenditures

 

(9,030

)

 

(86

)

 

(9,116

)

Proceeds from sale of property, plant and equipment

 

85

 

 

 

 

85

 

Purchase of intangible assets

 

(9

)

 

 

 

(9

)

Net cash provided by (used in) investing activities

 

471

 

 

(86

)

 

385

 

Cash Flows from Financing Activities

 

 

 

 

 

 

 

 

 

 

 

Decrease in cash overdraft

 

(885

)

 

 

 

(885

)

Repayment of long-term debt

 

(25,330

)

 

 

 

(25,330

)

Premium on repurchase of long-term debt

 

(1,406

)

 

 

 

(1,406

)

Deferred financing costs

 

(1,019

)

 

 

 

(1,019

)

Proceeds from exercise of stock options

 

3,561

 

 

 

 

3,561

 

Excess tax benefit of stock option exercises

 

2,462

 

 

 

 

2,462

 

Net cash used in financing activities

 

(22,617

)

 

 

 

(22,617

)

Net (Decrease) Increase in Cash and Cash Equivalents

 

(11,259

)

7

 

(508

)

 

(11,760

)

Cash and Cash Equivalents, Beginning of Period

 

16,878

 

96

 

1,930

 

 

18,904

 

Cash and Cash Equivalents, End of Period

 

$

5,619

 

$

103

 

$

1,422

 

$

 

$

7,144

 

 

15




Mothers Work, Inc.

Consolidating Cash Flow Statement

For the Six Months Ended March 31, 2006

(in thousands)

(unaudited)

 

 

Mothers Work
(Parent
Company)

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries
(Foreign
Companies)

 

Consolidating
Eliminations

 

Mothers Work
Consolidated

 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

930

 

$

15,973

 

$

292

 

$

(16,265

)

$

930

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

7,709

 

 

228

 

 

7,937

 

Stock-based compensation expense

 

811

 

 

 

 

811

 

Loss on impairment of long-lived assets

 

1,851

 

 

 

 

1,851

 

Gain on disposal of assets

 

(197

)

 

 

 

(197

)

Accretion of discount on senior notes

 

91

 

 

 

 

91

 

Deferred income tax benefit

 

(302

)

 

 

 

(302

)

Amortization of deferred financing costs

 

314

 

 

 

 

314

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

Decrease (increase) in—

 

 

 

 

 

 

 

 

 

 

 

Trade receivables

 

(3,141

)

 

77

 

 

(3,064

)

Inventories

 

9,416

 

 

(308

)

 

9,108

 

Prepaid expenses and other assets

 

504

 

2

 

(32

)

 

474

 

Investments in and advances to (from) affiliates

 

(2,374

)

(13,579

)

(312

)

16,265

 

 

Increase (decrease) in—

 

 

 

 

 

 

 

 

 

 

 

Accounts payable, accrued expenses and other current liabilities

 

7,046

 

(2,423

)

109

 

 

4,732

 

Deferred rent and other non-current liabilities

 

279

 

 

32

 

 

311

 

Net cash provided by (used in) operating activities

 

22,937

 

(27

)

86

 

 

22,996

 

Cash Flows from Investing Activities

 

 

 

 

 

 

 

 

 

 

 

Purchase of short-term investments

 

(25,525

)

 

 

 

(25,525

)

Proceeds from sale of short-term investments

 

22,975

 

 

 

 

22,975

 

Capital expenditures

 

(7,936

)

 

(110

)

 

(8,046

)

Proceeds from sale of assets held for sale

 

 

 

225

 

 

225

 

Purchase of intangible assets

 

(7

)

 

(4

)

 

(11

)

Net cash (used in) provided by investing activities

 

(10,493

)

 

111

 

 

(10,382

)

Cash Flows from Financing Activities

 

 

 

 

 

 

 

 

 

 

 

Increase in cash overdraft

 

540

 

 

 

 

540

 

Repayment of long-term debt

 

(313

)

 

 

 

(313

)

Proceeds from exercise of stock options

 

430

 

 

 

 

430

 

Excess tax benefit of stock option exercises

 

242

 

 

 

 

242

 

Net cash provided by financing activities

 

899

 

 

 

 

899

 

Net Increase (Decrease) in Cash and Cash Equivalents

 

13,343

 

(27

)

197

 

 

13,513

 

Cash and Cash Equivalents, Beginning of Period

 

2,901

 

37

 

99

 

 

3,037

 

Cash and Cash Equivalents, End of Period

 

$

16,244

 

$

10

 

$

296

 

$

 

$

16,550

 

 

16




9.                 COMMITMENTS AND CONTINGENCIES

From time to time, the Company is named as a defendant in legal actions arising from normal business activities. Litigation is inherently unpredictable and although the amount of any liability that could arise with respect to currently pending actions cannot be accurately predicted, the Company does not believe that the resolution of any pending action will have a material adverse effect on its financial position, results of operations or liquidity.

10.          SEGMENT AND ENTERPRISE WIDE DISCLOSURES

Operating Segment.  Under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” a company may be required to report segmented information about separately identifiable parts of its business, which both (i) meet the definition of an “operating segment” under SFAS No. 131, and (ii) exceed certain quantitative thresholds established in SFAS No. 131.  The Company has determined that its business is comprised of one operating segment: the design, manufacture and sale of maternity apparel and related accessories.  While the Company offers a wide range of products for sale, the substantial portion of its products are initially distributed through the same distribution facilities, many of the Company’s products are manufactured at common contract manufacturer production facilities, the Company’s products are marketed through a common marketing department, and these products are sold to a similar customer base, consisting of expectant mothers.

Geographic Information.  Information concerning the Company’s operations by geographic area was as follows (in thousands):

 

Three Months Ended,
March 31,

 

Six Months Ended
March 31,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net Sales to Unaffiliated Customers

 

 

 

 

 

 

 

 

 

United States

 

$

140,079

 

$

140,943

 

$

284,296

 

$

288,478

 

Canada

 

$

3,778

 

$

3,700

 

$

8,045

 

$

7,558

 

 

 

March 31
2007

 

September 30,
2006

 

Long-Lived Assets

 

 

 

 

 

United States

 

$

71,482

 

$

69,621

 

Canada

 

$

2,333

 

$

2,535

 

Costa Rica

 

$

700

 

$

700

 

 

Major CustomersFor the periods presented, the Company did not have any one customer who represented more than 10% of its net sales.

11.          INTEREST EXPENSE, NET

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

 

Three Months Ended,
March 31,

 

Six Months Ended
March 31,

 

 

 

2007

 

2006

 

2007

 

2006

 

Interest expense

 

$

2,847

 

$

3,902

 

$

6,217

 

$

7,739

 

Interest income

 

(57

)

(117

)

(295

)

(160

)

Interest expense, net

 

$

2,790

 

$

3,785

 

$

5,922

 

$

7,579

 

 

12.          SUBSEQUENT EVENT

On April 18, 2007, the Company completed the redemption of the remaining outstanding amount of its Senior Notes at 105.625% of the $90,000,000 principal amount, plus accrued and unpaid interest.  In connection with the redemption, the Company recorded a pre-tax charge totaling $7,330,000, representing the premium paid of $5,063,000 plus the write-off of unamortized debt issuance discount and deferred financing costs of $2,267,000.

17




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

Results of Operations

The following tables set forth certain operating data as a percentage of net sales and as a percentage change for the three and six months ended March 31:

 

 

 

 

 

 

 

 

 

 

% Period to Period
Increase (Decrease)

 

 

 

% of Net Sales (1)

 

Three
Months

 

Six
Months

 

 

 

Three
Months Ended
March 31,

 

Six
Months Ended
March 31,

 

Ended
March 31,
2007 vs.

 

Ended
March 31,
2007 vs.

 

 

 

2007

 

2006

 

2007

 

2006

 

2006

 

2006

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

(0.5

)%

(1.2

)%

Cost of goods sold (2)

 

47.1

 

47.4

 

47.6

 

48.6

 

(1.2

)

(3.2

)

Gross profit

 

52.9

 

52.6

 

52.4

 

51.4

 

0.0

 

0.6

 

Selling, general and administrative expenses (3)

 

48.0

 

49.4

 

47.4

 

48.3

 

(3.3

)

(3.1

)

Operating income

 

4.9

 

3.2

 

5.0

 

3.1

 

51.8

 

59.2

 

Interest expense, net

 

1.9

 

2.6

 

2.0

 

2.6

 

(26.3

)

(21.9

)

Loss on extinguishment of debt

 

 

 

0.7

 

 

 

N.M.

 

Income before income taxes

 

2.9

 

0.6

 

2.2

 

0.5

 

410.3

 

325.0

 

Income tax provision

 

1.1

 

0.2

 

0.9

 

0.2

 

409.3

 

324.9

 

Net income

 

1.8

%

0.3

%

1.4

%

0.3

%

411.0

 

325.2

 

 


N.M.—Not meaningful

(1)          Components may not add to total due to rounding.

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

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

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

 

Three Months Ended

 

 

 

March 31, 2007

 

March 31, 2006

 

Retail Locations

 

Stores

 

Leased
Departments

 

Total Retail
Locations

 

Stores

 

Leased
Departments

 

Total Retail
Locations

 

Beginning of period

 

807

 

787

 

1,594

 

851

 

743

 

1,594

 

Opened

 

7

 

59

 

66

 

5

 

2

 

7

 

Closed

 

(19

)

(25

)

(44

)

(25

)

(17

)

(42

)

End of period

 

795

 

821

 

1,616

 

831

 

728

 

1,559

 

 

 

Six Months Ended

 

 

 

March 31, 2007

 

March 31, 2006

 

Retail Locations

 

Stores

 

Leased
Departments

 

Total Retail
Locations

 

Stores

 

Leased
Departments

 

Total Retail
Locations

 

Beginning of period

 

810

 

731

 

1,541

 

852

 

739

 

1,591

 

Opened

 

10

 

119

 

129

 

11

 

12

 

23

 

Closed

 

(25

)

(29

)

(54

)

(32

)

(23

)

(55

)

End of period

 

795

 

821

 

1,616

 

831

 

728

 

1,559

 

 

18




Our fiscal year ends on September 30.  All references in this discussion to our fiscal years refer to the fiscal year ended on September 30 in the year mentioned.  For example, our “fiscal 2007” will end on September 30, 2007.

Three Months Ended March 31, 2007 and 2006

Net Sales.  Our net sales for the second quarter of fiscal 2007 decreased by 0.5%, or approximately $0.7 million, to $143.9 million from $144.6 million for the second quarter of fiscal 2006.  The slight decrease in net sales versus last year resulted primarily from a decrease in comparable store sales, largely offset by increased sales from our leased department and licensed relationships and marketing partnerships.  Comparable store sales decreased by 1.6% for the second quarter of fiscal 2007, based on 1,412 retail locations, versus a comparable store sales increase of 1.4% for the second quarter of fiscal 2006, based on 998 retail locations.  The comparable store sales decrease of 1.6% for the second quarter of fiscal 2007 was favorably impacted by approximately 1 percentage point due to having one more Saturday in this fiscal year’s second quarter compared to last year.

As of March 31, 2007, we operated a total of 795 stores and 1,616 total retail locations, compared to 831 stores and 1,559 total retail locations as of March 31, 2006.  In addition, our Oh Baby! by Motherhood™ collection is available at Kohl’s® stores throughout the United States.  During the second quarter of fiscal 2007, we opened seven stores, including four multi-brand store openings, and closed 19 stores, with nine of the store closings related to multi-brand store openings.

Gross Profit.  Our gross profit for the second quarter of fiscal 2007 increased slightly by approximately $0.1 million, to $76.1 million from $76.0 million for the second quarter of fiscal 2006, reflecting an increase in gross margin offsetting the effect of our lower sales volume.  Gross profit as a percentage of net sales (gross margin) for the second quarter of fiscal 2007 was 52.9% compared to 52.6% for the second quarter of fiscal 2006.  The increase in gross margin of 0.3 percentage points compared to the prior year resulted primarily from less price promotional activity compared to last year, a continued reduction in product costs and increased marketing partnership revenues, somewhat offset by increased product overhead expenses and the effect of increased sales from our licensed arrangement.

Selling, General and Administrative Expenses.  Our selling, general and administrative expenses for the second quarter of fiscal 2007 decreased by 3.3%, or $2.3 million, to $69.1 million from $71.4 million for the second quarter of fiscal 2006.  This decrease in expense for the quarter resulted primarily from decreased store closing costs, lower variable incentive compensation costs and lower store occupancy expenses, as a result of our reduced number of stores, partially offset by increased employee benefits expenses.  As a percentage of net sales, selling, general and administrative expenses decreased to 48.0% for fiscal 2007 compared to 49.4% for fiscal 2006.  This decrease in the expense percentage for the quarter resulted primarily from the decreased store closing costs and lower incentive compensation and store occupancy expenses, partially offset by higher employee benefits expenses.  We recorded a gain of $0.1 million related to store closings for the second quarter of fiscal 2007, as compared to $1.4 million of charges incurred for store closings in the second quarter of fiscal 2006 (primarily lease termination expenses).  The significant majority of the store closing costs in fiscal 2006 related to stores closed in conjunction with the opening of our Destination Maternity™ superstore in New York City.  In addition, we incurred impairment charges for write-downs of store long-lived assets of $0.1 million for fiscal 2007, as compared to $0.3 million for fiscal 2006.

Operating Income.  Our operating income for the second quarter of fiscal 2007 increased by 51.8%, or $2.4 million, to $7.0 million from $4.6 million for the second quarter of fiscal 2006, due primarily to lower selling, general and administrative expenses.  Operating income as a percentage of net sales (operating income margin) for the second quarter of fiscal 2007 increased to 4.9% from 3.2% for the second quarter of fiscal 2006.  The increase in operating income margin was due primarily to our lower operating expense ratio and, to a lesser extent, our improved gross margin.

Interest Expense, Net.  Our net interest expense for the second quarter of fiscal 2007 decreased by 26.3%, or $1.0 million, to $2.8 million from $3.8 million for the second quarter of fiscal 2006.  This decrease was primarily due to the repurchase of $35.0 million of our Senior Notes from August 2006 through December 2006.  During the second quarter of fiscal 2007, our average level of direct borrowings under our credit facility was $1.2 million, but we did not have any direct borrowings under our credit facility as of March 31, 2007.  During the second quarter of fiscal 2006, we had no direct borrowings under our credit facility.

Income Tax Provision.  Our effective tax rate was a provision of 39.0% for the second quarter of fiscal 2007 and 39.1% for the second quarter of fiscal 2006.  We expect our effective tax rate for the full year fiscal 2007 to be approximately 39%.

19




Net Income.  Net income for the second quarter of fiscal 2007 was $2.6 million, or $0.41 per share (diluted), compared to net income of $0.5 million, or $0.09 per share (diluted), for the second quarter of fiscal 2006, representing increases versus last year of 411% in net income and 351% in diluted earnings per share.

Our average diluted shares outstanding of 6,227,000 for the second quarter of fiscal 2007 was 13.2% higher than the 5,501,000 average diluted shares outstanding for the second quarter of fiscal 2006.  The increase in average diluted shares outstanding reflects higher shares outstanding in fiscal 2007 compared to fiscal 2006, as a result of stock option exercises and restricted stock awards, as well as the higher dilutive impact of outstanding stock options in fiscal 2007 compared to fiscal 2006.

Six Months Ended March 31, 2007 and 2006

Net Sales.  Our net sales for the first six months of fiscal 2007 decreased by 1.2%, or $3.7 million, to $292.3 million from $296.0 million for the first six months of fiscal 2006.  The slight decrease in net sales versus last year resulted primarily from a decrease in comparable store sales, largely offset by increased sales from our leased department and licensed relationships and marketing partnerships.  Comparable store sales decreased by 1.9% for the first six months of fiscal 2007, based on 1,395 retail locations, versus a comparable store sales increase of 2.4% for the second quarter of fiscal 2006, based on 982 retail locations.

Gross Profit.  Our gross profit for the first six months of fiscal 2007 increased by 0.6%, to $153.1 million from $152.2 million for the first six months of fiscal 2006, reflecting an increase in gross margin offsetting the effect of our lower sales volume.  Gross profit as a percentage of net sales (gross margin) for the first six months of fiscal 2007 was 52.4% compared to 51.4% for the first six months of fiscal 2006.  The increase in gross margin of 1.0 percentage points compared to the prior year resulted primarily from a higher maintained gross margin in our own stores as a result of lower overall markdowns compared to last year as well as the impact of our continued sourcing improvements.

Selling, General and Administrative Expenses.  Our selling, general and administrative expenses for the first six months of fiscal 2007 decreased by 3.1%, or $4.5 million, to $138.6 million from $143.1 million for the first six months of fiscal 2006.  This decrease in expense for the six-month period resulted primarily from lower store occupancy expenses, as a result of our reduced number of stores, decreased store closing costs, a decrease in impairment charges for write-downs of store long-lived assets and lower variable incentive compensation costs, partially offset by increased employee benefits and legal expenses.  As a percentage of net sales, selling, general and administrative expenses decreased to 47.4% for fiscal 2007 compared to 48.3% for fiscal 2006.  This decrease in the expense percentage for the six-month period resulted primarily from decreased store closing costs, the decrease in impairment charges, and lower store occupancy expenses and incentive compensation, partially offset by higher employee benefits and legal expenses.  We recorded a gain of $0.1 million related to store closings for the first six months of fiscal 2007, as compared to $1.6 million of charges incurred for store closings in the first six months of fiscal 2006 (primarily lease termination expenses).  The significant majority of the store closing costs in fiscal 2006 related to stores closed in conjunction with the opening of our Destination Maternity™ superstore in New York City.  In addition, we incurred impairment charges for write-downs of store long-lived assets of $0.4 million for fiscal 2007, as compared to $1.9 million for fiscal 2006.

Operating Income.  Our operating income for the first six months of fiscal 2007 increased by 59.2%, or $5.4 million, to $14.5 million from $9.1 million for the first six months of fiscal 2006, due primarily to lower selling, general and administrative expenses and, to a lesser extent, increased gross profit.  Operating income as a percentage of net sales (operating income margin) for the first six months of fiscal 2007 increased to 5.0% from 3.1% for the first six months of fiscal 2006.  The increase in operating income margin was due to our improved gross margin and our lower operating expense ratio.

Interest Expense, Net.  Our net interest expense for the first six months of fiscal 2007 decreased by 21.9%, or $1.7 million, to $5.9 million from $7.6 million for the first six months of fiscal 2006.  This decrease was primarily due to the repurchase of $35.0 million of our Senior Notes from August 2006 through December 2006 and, to a lesser extent, increased interest income resulting from increased balances of cash and short-term investments.  During the first six months of fiscal 2007, our average level of direct borrowings under our credit facility was $0.6 million, but we did not have any direct borrowings under our credit facility as of March 31, 2007.  During the first six months of fiscal 2006, our average level of direct borrowings under our credit facility was $0.7 million.

Loss on Extinguishment of DebtIn December 2006, we repurchased $25.0 million principal amount of our outstanding Senior Notes. The $25.0 million Senior Note repurchase resulted in a first quarter pre-tax charge of $2.1 million, representing the premium paid plus the write-off of unamortized debt issuance discount and deferred financing costs.

20




Income Tax Provision.  Our effective tax rate was a provision of 39.0% for the second quarter of fiscal 2007 and fiscal 2006.  We expect our effective tax rate for the full year fiscal 2007 to be approximately 39%.

Net Income.  Net income for the first six months of fiscal 2007 was $4.0 million, or $0.64 per share (diluted), compared to net income of $0.9 million, or $0.17 per share (diluted), for the first six months of fiscal 2006, representing increases versus last year of 325% in net income and 272% in diluted earnings per share.

Our average diluted shares outstanding of 6,183,000 for the first six months of fiscal 2007 was 14.5% higher than the 5,402,000 average diluted shares outstanding for the first six months of fiscal 2006.  The increase in average diluted shares outstanding reflects higher shares outstanding in fiscal 2007 compared to fiscal 2006, as a result of stock option exercises and restricted stock awards, as well as the higher dilutive impact of outstanding stock options in fiscal 2007 compared to fiscal 2006.

Seasonality

Our business, like that of many other retailers, is seasonal.  Our quarterly net sales have historically been highest in our third fiscal quarter, corresponding to the Spring selling season, followed by the first fiscal quarter, corresponding to the Fall/holiday selling season.  Given the typically higher gross margin we experience in the third fiscal quarter compared to other quarters, the relatively fixed nature of most of our operating expenses and interest expense, and the historically higher sales level in the third quarter, we have typically generated a very significant percentage of our full year operating income and net income during the third quarter.  Results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.  Quarterly results may fluctuate materially depending upon, among other things, the timing of new store openings and new leased department openings, net sales and profitability contributed by new stores and leased departments, increases or decreases in comparable store sales, the timing of the fulfillment of purchase orders under our product and license arrangements, adverse weather conditions, shifts in the timing of certain holidays and promotions, changes in inventory and production levels and the timing of deliveries of inventory, and changes in our merchandise mix.

Liquidity and Capital Resources

Our cash needs have primarily been for: (i) debt service, (ii) capital expenditures, including leasehold improvements, fixtures and equipment for new stores, store relocations and expansions of our existing stores, as well as improvements and new equipment for our distribution and corporate facilities and information systems, and (iii) working capital, including inventory to support our new business initiatives and our new and existing retail locations.  We have historically financed these capital requirements from cash flows from operations, borrowings under our credit facility or available cash balances.

In November 2006, our Board of Directors authorized the repurchase of $25.0 million principal amount of our Senior Notes.  This was in addition to the repurchase of $10.0 million principal amount of our Senior Notes completed during August and September 2006.  On December 8, 2006, we completed the repurchase of the authorized amount at 105.625% of the $25.0 million principal amount, plus accrued and unpaid interest.  After giving effect to both the $10.0 million repurchase in fiscal 2006 and the $25.0 million redemption completed on December 8, 2006, we have $90.0 million remaining outstanding principal amount of the original $125.0 million principal amount of our Senior Notes as of March 31, 2007.  On April 18, 2007, we completed the redemption of the remaining $90.0 million principal amount of our outstanding Senior Notes through a new Term Loan financing, which we expect will result in a decrease in annualized pre-tax interest expense of approximately $3.6 million.  This decrease in annualized interest expense from the new Term Loan financing will begin to be recognized in our third quarter.  The new Term Loan extends the maturity for $90.0 million principal amount of our debt from August 1, 2010 (the maturity date of the redeemed Senior Notes) to March 13, 2013 (the maturity date of the new Term Loan), with quarterly required principal payments of $225,000.  The April 2007 redemption of the Senior Notes, which was at a price of 105.625% of principal amount, plus accrued interest, will result in a “Loss on extinguishment of debt” of approximately $7.3 million on a pre-tax basis, consisting of the approximately $5.1 million cash redemption premium and approximately $2.2 million of non-cash expense from the write-off of unamortized deferred financing costs and debt issuance costs, which will be recognized in our third quarter.

Cash and cash equivalents decreased by $11.8 million during the first six months of fiscal 2007 compared to an increase of $13.5 million for the first six months of fiscal 2006.  Cash provided by operations of $10.5 million for the first six months of fiscal 2007 decreased by $12.5 million from the $23.0 million cash provided by operations for the first six months of fiscal 2006.  This decrease in cash provided by operations was primarily the result of: (i) an increase in inventories in the first six months of fiscal 2007 compared to a decrease in the first six months of fiscal 2006, and (ii) a decrease in accounts payable, accrued expenses and other current liabilities in the first six months of fiscal 2007 compared to an increase in the first six months of fiscal 2006,

21




partially offset by increased earnings and a $2.4 million federal income tax refund.  Total inventories as of March 31, 2007 were $98.4 million, an increase of approximately $4.1 million or 4.4% above the $94.3 million inventories balance as of September 30, 2006.  Total inventories of $96.8 million as of March 31, 2006 were $9.1 million below the $105.9 million inventories balance as of September 30, 2005.  During the first six months of fiscal 2007, we used a significant majority of our cash provided by operations to pay for capital expenditures.  We funded the $25.0 million repurchase of our Senior Notes by utilizing available cash, cash generated by net proceeds from the sales (net of purchases) of short-term investments, cash generated from stock option exercises, as well as the remaining cash provided by operations.  During the first six months of fiscal 2006, we used our cash provided by operations primarily to increase our cash balance and short-term investments and, to a much lesser extent, to pay for capital expenditures.

For the first six months of fiscal 2007, we spent $9.1 million on capital expenditures, including $5.7 million for leasehold improvements, fixtures and equipment principally for new store facilities, as well as improvements to existing stores, and $3.4 million for our information systems and distribution and corporate facilities.  This compares to $8.0 million in capital expenditures for the first six months of fiscal 2006, of which $7.0 million was spent for new store facilities and improvements to existing stores and retail locations, and $1.0 million for our information systems and distribution and corporate facilities.  The increase in capital expenditures was primarily due to increased expenditures for information systems enhancements, partially offset by decreased expenditures for new stores.

On March 13, 2007, we entered into a Term Loan and Security Agreement for a $90.0 million senior secured Term Loan B due March 13, 2013, the proceeds of which were received on April 18, 2007 and were used to redeem the remaining $90.0 million principal amount of our Senior Notes.  The interest rate on the Term Loan is equal to, at our election, either (i) the prime rate plus 1.00%, or (ii) the LIBOR rate plus the applicable margin.  The applicable margin is initially fixed at 2.50% through and including the fiscal quarter ending September 30, 2007.  Thereafter, the applicable margin for LIBOR rate borrowings is either 2.25% or 2.50%, depending on our Consolidated Leverage Ratio (as defined).  In order to mitigate our floating rate interest risk on the variable rate Term Loan, we entered into an interest rate swap agreement with the Agent bank for the Term Loan that commenced on April 18, 2007, the date the $90.0 million Term Loan proceeds were received, and expires on April 18, 2012.  The interest rate swap agreement enables us to effectively convert an amount of the Term Loan equal to the notional amount of the interest rate swap from a floating interest rate of LIBOR plus 2.50% (subject to reduction to LIBOR plus 2.25% if we achieve a specified leverage ratio), to a fixed interest rate of 7.50% (subject to reduction to 7.25% if we achieve a specified leverage ratio).  The notional amount of the interest rate swap is $75.0 million at inception of the swap agreement and decreases over time to a notional amount of $5.0 million at the expiration date.  Commencing with the third quarter of fiscal 2007, we are required to make minimum repayments of the principal amount of the Term Loan in quarterly installments of $225,000 each.  Additionally, the Term Loan can be prepaid at our option, in part or in whole, at any time, without any prepayment premium or penalty.  The Term Loan Agreement imposes certain restrictions on our ability to, among other things, incur additional indebtedness, pay dividends, repurchase stock, and enter into other various types of transactions.  The Term Loan Agreement also contains quarterly financial covenants that require us to maintain a specified maximum permitted Consolidated Leverage Ratio and a specified minimum permitted Consolidated Interest Coverage Ratio (as defined).  As of March 31, 2007, we were in compliance with the financial covenants of our Term Loan Agreement.

In connection with the Term Loan transaction, we amended our existing $60.0 million revolving Credit Facility in order to permit the new Term Loan financing.  This amendment of the Credit Facility also extends its maturity from October 15, 2009 to March 13, 2012, modestly increases its size to $65.0 million, and reduces the LIBOR-based interest rate option under the facility by 0.25%.  There are no financial requirements under the Credit Facility provided that Excess Availability (as defined) does not fall below 10% of the Borrowing Base (as defined).  If Excess Availability were to fall below 10% of the Borrowing Base, we would be required to meet a specified minimum Fixed Charge Coverage Ratio (as defined).  During the first six months of fiscal 2007 and the first six months of fiscal 2006, we exceeded the minimum requirements for Excess Availability.

As of March 31, 2007, we had no outstanding borrowings under the Credit Facility and $8.4 million in letters of credit, with $56.6 million of availability under our credit line.  We had average direct borrowings of $0.6 million under our credit facility for the first six months of fiscal 2007, compared to average direct borrowings of $0.7 million during the first six months of fiscal 2006.

Our management believes that our current cash and working capital positions, expected operating cash flows and available borrowing capacity under our Credit Facility, will be sufficient to fund our working capital, capital expenditures and debt repayment requirements and to fund stock and/or debt repurchases, if any, for at least the next twelve months.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. These generally accepted accounting principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and

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liabilities at the date of our consolidated financial statements and the reported amounts of net sales and expenses during the reporting period.

Our significant accounting policies are described in Note 2 of “Notes to Consolidated Financial Statements” in our Annual Report on Form 10-K for the year ended September 30, 2006.  We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.  If actual results were to differ significantly from estimates made, future reported results could be materially affected.  However, we are not currently aware of any reasonably likely events or circumstances that would result in materially different results.

Our senior management has reviewed these critical accounting policies and estimates and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations with the Audit Committee of our Board of Directors.

Inventories.  We value our inventories, which consist primarily of maternity apparel, at the lower of cost or market. Cost is determined on the first-in, first-out method (FIFO) and includes the cost of merchandise, freight, duty and broker fees.  A periodic review of inventory quantities on hand is performed in order to determine if inventory is properly valued at the lower of cost or market.  Factors related to current inventories such as future consumer demand and fashion trends, current aging, current analysis of merchandise based on receipt date, current and anticipated retail markdowns or wholesale discounts, and class or type of inventory are analyzed to determine estimated net realizable values.  Criteria utilized by us to quantify aging trends include factors such as the amount of merchandise received within the past twelve months, merchandise received more than one year before with quantities on-hand in excess of 12 months of sales, and merchandise currently selling below cost.  A provision is recorded to reduce the cost of inventories to its estimated net realizable value, if required.  Inventories as of March 31, 2007 and September 30, 2006 totaled $98.4 million and $94.3 million, respectively, representing 36.2% and 32.8% of total assets, respectively.  Given the significance of inventories to our consolidated financial statements, the determination of net realizable values is considered to be a critical accounting estimate.  Any significant unanticipated changes in the factors noted above could have a significant impact on the value of our inventories and our reported operating results.

Long-Lived Assets.  Our long-lived assets consist principally of store leasehold improvements (included in the “Property, plant and equipment, net” line item in our consolidated balance sheets) and, to a much lesser extent, lease acquisition costs (included in the “Other intangible assets, net” line item in our consolidated balance sheets).  These long-lived assets are recorded at cost and are amortized using the straight-line method over the shorter of the lease term or their useful life.  Net long-lived assets as of March 31, 2007 and September 30, 2006 totaled $73.8 million and $72.2 million, respectively, representing 27.1% and 25.1% of total assets, respectively.

In assessing potential impairment of these assets, we periodically evaluate the historical and forecasted operating results and cash flows on a store-by-store basis.  Newly opened stores may take time to generate positive operating and cash flow results.  Factors such as: (i) store type, that is, company store or leased department, (ii) store concept, that is, Motherhood Maternity®, Mimi Maternity®, A Pea in the Pod® or Destination Maternity, (iii) store location, for example, urban area versus suburb, (iv) current marketplace awareness of our brands, (v) local customer demographic data, (vi) anchor stores within the mall in which our store is located and (vii) current fashion trends are all considered in determining the time frame required for a store to achieve positive financial results, which is assumed to be within two years from the date a store location is opened.  If economic conditions are substantially different from our expectations, the carrying value of certain of our long-lived assets may become impaired.  As a result of our impairment assessment, we recorded write-downs of long-lived assets of $0.4 million for the first six months of fiscal 2007, and $1.9 million for the first six months of fiscal 2006, respectively.

Goodwill.  The purchase method of accounting for business combinations requires the use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the net tangible and identifiable intangible assets.  Goodwill represents the excess of the aggregate purchase price over the fair value of net assets acquired in business combinations and is separately disclosed in our consolidated balance sheets.  As of both March 31, 2007 and September 30, 2006, goodwill totaled $50.4 million, representing 18.5% and 17.5% 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, but instead be tested for impairment at least annually or as impairment indicators arise.

The impairment test requires us to compare the fair value of business reporting units to their carrying value,

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including assigned goodwill.  In assessing potential impairment of goodwill, we have determined that we have one reporting unit for purposes of applying SFAS No. 142 based on our reporting structure.  The fair value of our single reporting unit is determined based on the fair market value of our outstanding common stock on a control basis and, if necessary, an outside independent valuation is obtained to determine the fair value.  The carrying value of our single reporting unit, expressed on a per share basis, is represented by the book value per share of our outstanding common stock.  The results of the annual impairment test performed as of September 30, 2006, indicated the fair value of the reporting unit exceeded its carrying value.  If the per share fair value of our single reporting unit was less than the book value per share on September 30, 2006, our goodwill would likely have been impaired.  As of March 31, 2007, our book value was $15.48 per share of outstanding common stock and the closing trading price of our common stock was $33.14 per share.

Accounting for Income Taxes.  As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate.  This process requires us to estimate our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation of property and equipment and valuation of inventories, for tax and accounting purposes.  We determine our provision for income taxes based on federal and state tax laws and regulations currently in effect, some of which have been recently revised.  Legislation changes currently proposed by certain of the states in which we operate, if enacted, could increase our transactions or activities subject to tax.  Any such legislation that becomes law could result in an increase in our state income tax expense and our state income taxes paid, which could have a material and adverse effect on our net income or cash flow.

The temporary differences between the book and tax treatment of income and expenses result in deferred tax assets and liabilities, which are included within our consolidated balance sheets.  We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income.  Actual results could differ from our assessments if adequate taxable income is not generated in future periods.  Net deferred tax assets as of March 31, 2007 and September 30, 2006 totaled $19.7 million and $18.6 million, respectively, representing 7.3% and 6.5% of total assets, respectively.  To the extent we believe that recovery is not more likely than not, we must establish a valuation allowance.  To the extent we establish a valuation allowance or change the allowance in a future period, income tax expense will be impacted.

Accounting for Contingencies.  From time to time, we are named as a defendant in legal actions arising from our normal business activities.  We account for contingencies such as these in accordance with SFAS No. 5, “Accounting for Contingencies.”  SFAS No. 5 requires us to record an estimated loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated.  An interpretation of SFAS No. 5 further states that when there is a range of loss and no amount within that range is a better estimate than any other, then the minimum amount of the range shall be accrued.  Accounting for contingencies arising from contractual or legal proceedings requires management, after consultation with outside legal counsel, to use its best judgment when estimating an accrual related to such contingencies.  As additional information becomes known, our accrual for a loss contingency could fluctuate, thereby creating variability in our results of operations from period to period.  Likewise, an actual loss arising from a loss contingency which significantly exceeds the amount accrued for in our financial statements could have a material adverse impact on our operating results for the period in which such actual loss becomes known.

Recent Accounting Pronouncements

FASB Interpretation No. 48

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.”  FASB Interpretation No. 48 provides guidance for the recognition and measurement of uncertain tax positions in an enterprise’s financial statements.  Recognition involves a determination of whether it is more likely than not that a tax position will be sustained upon examination with the presumption that the tax position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information.  This interpretation is effective for fiscal years beginning after December 15, 2006.  Early adoption is permitted if the enterprise has not issued financial statements, including interim financial statements, in the period of adoption.  The impact from adoption of FASB Interpretation No. 48, if any, on our consolidated financial position or results of operations has not yet been determined.  We plan to adopt FASB Interpretation No. 48 effective as of October 1, 2007.

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EITF Issue 06-3

In June 2006, the EITF issued EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).”  EITF Issue 06-3 provides guidance related to the presentation in financial statements of any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer, including, but not limited to, sales, use, value added, and some excise taxes.  The EITF concluded that the presentation of taxes within the scope of EITF Issue 06-3 on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should disclosed.  In addition, the aggregate amount of any such taxes that are reported on a gross basis should be disclosed in interim and annual financial statements.  The guidance in EITF Issue 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006.  We report taxes within the scope of EITF Issue 06-3 on a net basis and adoption did not have any impact on our consolidated financial statements.

SAB No. 108

In September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.”  SAB No. 108 states that SEC registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement, contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years.   SAB No. 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006.  We do not expect the adoption of SAB No. 108 to have a material impact on our consolidated financial statements.

SFAS No. 157

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The impact from adoption of SFAS No. 157, if any, on our consolidated financial position or results of operations has not yet been determined.

SFAS No. 158

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”  SFAS No. 158 requires an employer to recognize the funded status of a benefit plan, measured as the difference between plan assets at fair value and the projected benefit obligation, in its statement of financial position.  SFAS No. 158 also requires an employer to measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position.  This statement is effective as of the end of the fiscal year ending after December 15, 2006, except for the requirement to measure plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, which is effective for fiscal years ending after December 15, 2008.  In March 2007, we entered into SERP Agreements with two executives and adopted the provisions of SFAS No. 158.

SFAS No. 159

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value and requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet.  SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007.  The impact from adoption of SFAS No. 159, if any, on our consolidated financial position or results of operations has not yet been determined.

Forward-Looking Statements

Some of the information in this report, including information incorporated by reference, if applicable, (as well as information included in oral statements or other written statements made or to be made by us), contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  The forward-looking statements involve a number of risks and uncertainties.  A number of factors could cause our actual results, performance, achievements or industry results to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.  These factors include, but are not limited to: the success of our new business initiatives, future sales trends in our existing store base, weather, changes in consumer spending patterns, raw material price increases, consumer preferences and

25




overall economic conditions, the impact of competition and pricing, availability of suitable store locations, continued availability of capital and financing, ability to hire and develop senior management and sales associates, ability to develop and source merchandise, ability to receive production from foreign sources on a timely basis, potential stock repurchases, potential debt prepayments, war or acts of terrorism and other factors referenced in our Annual Report on Form 10-K, including those set forth under the caption “Risk Factors.”

In addition, these forward-looking statements necessarily depend upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks, uncertainties and other factors.  Accordingly, any forward-looking statements included in this report do not purport to be predictions of future events or circumstances and 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,” or the negative of any of these terms, or comparable terminology, or by discussions of our outlook, plans, goals, strategy or intentions.  Forward-looking statements speak only as of the date made.  We assume no obligation to update any of these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting these forward-looking statements.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

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

As of March 31, 2007, we had cash and cash equivalents of $7.1 million, which include money market accounts that bear interest at variable rates.  A change in market interest rates earned on the cash and cash equivalents impacts the interest income and cash flows, but does not materially impact the fair market value of the financial instruments.  Due to the average maturity and conservative nature of our investment portfolio, we believe a sudden change in interest rates would not have a material effect on the value of our investment portfolio.

As of March 31, 2007, the principal components of our debt portfolio were the $90.0 million of Senior Notes and the $65.0 million Credit Facility, both of which are denominated in U.S. dollars.  On April 18, 2007, we redeemed the Senior Notes with the proceeds from a new variable rate $90.0 million Term Loan financing.  The fair market value of the debt portfolio is referred to as the “Debt Value.”

Our Credit Facility carries a variable interest rate that is tied to market indices.  As of March 31, 2007, we had no direct borrowings and $8.4 million of letters of credit outstanding under our Credit Facility.  Borrowings under the Credit Facility would have resulted in interest at a rate between approximately 6.57% and 8.25% per annum as of March 31, 2007.  Any future borrowings under the Credit Facility would, to the extent of outstanding borrowings, be affected by changes in market interest rates.  A change in market interest rates on the variable rate portion of the debt portfolio impacts the interest expense incurred and cash flows, but does not impact the Debt Value of the financial instrument.

The Term Loan carries a variable interest rate that is tied to market indices.  The sensitivity analysis as it relates to this portion of our debt portfolio assumes an instantaneous 100 basis point move in interest rates from their levels as of March 31, 2007, as if the Term Loan financing and redemption of the Senior Notes had occurred on that date, with all other variables held constant.  The Debt Value of the Term Loan is approximately $90.0 million; its principal amount.  A 100 basis point increase in market interest rates would result in additional annual interest expense on the Term Loan of approximately $0.9 million.  A 100 basis point decline in market interest rates would correspondingly lower our annual interest expense on the Term Loan by approximately $0.9 million.

In order to mitigate our floating rate interest risk on the variable rate Term Loan, we entered into an interest rate swap agreement with the Agent bank for the Term Loan that commenced on April 18, 2007.  The interest rate swap agreement enables us to effectively convert an amount of the Term Loan equal to the notional amount of the interest rate swap from a floating interest rate (LIBOR plus 2.50% at inception), to a fixed interest rate (7.50% at inception).  The notional amount of the interest rate swap is $75.0 million at inception of the swap agreement and decreases over time to a notional amount of $5.0 million at the expiration date.  Based on the scheduled swap notional amount during the first year of the swap agreement, a 100 basis point increase in market interest rates would result in interest expense savings for the year of approximately $0.7 million.  A 100 basis point decline in market interest rates would correspondingly increase our interest expense for the year by approximately $0.7 million.  Thus, a 100 basis point increase in market interest rates during the first year of the swap agreement would result in additional interest expense for the year of approximately $0.2 million on the Term Loan and swap agreement combined.  A 100 basis point decline in market interest rates during the first year of the swap agreement would correspondingly lower our interest expense for the year by approximately $0.2 million on the Term Loan and swap agreement combined.

Based on the limited other variable rate debt included in our debt portfolio as of March 31, 2007, a 100 basis point

26




increase in interest rates would result in additional interest incurred for the year of less than $0.1 million.  A 100 basis point decrease in interest rates would correspondingly lower our interest expense for the year by less than $0.1 million.

Other than as described above, we do not believe that the market risk exposure on other financial instruments is material.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures

Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to our management on a timely basis to allow decisions regarding required disclosure.  We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2007. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2007, these controls and procedures were effective.

Internal Control over Financial Reporting

There have been no changes in internal control over financial reporting identified in connection with the foregoing evaluation that occurred during the fiscal quarter ended March 31, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1.  Legal Proceedings

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

Item 1A.  Risk Factors

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” of our Form 10-K for the year ended September 30, 2006.  The risks described in our Form 10-K are not the only risks that we face.  Additional risks not presently known to us or that we do not currently consider significant may also have an adverse effect on us. If any of the risks actually occur, our business, results of operations, cash flows or financial condition could suffer.

Item 4.   Submission of Matters to a Vote of Security Holders

At the Company’s Annual Meeting of Stockholders held on January 19, 2007, the stockholders of the Company elected two directors of the Company, approved the Company’s Management Incentive Program, and ratified the Audit Committee’s appointment of KPMG LLP as the Company’s independent registered public accounting firm for the fiscal year ending September 30, 2007.

Mr. Dan W. Matthias and Mr. Elam M. Hitchner, III were elected to serve as directors at the meeting.  The voting results were 5,208,331 shares for and 45,406 shares withheld for Mr. Matthias and 5,031,425 shares for and 222,312 shares withheld for Mr. Hitchner.  Rebecca C. Matthias, Joseph A. Goldblum, Anne T. Kavanagh, William A. Schwartz, Jr. and David Schlessinger continue to serve their terms as directors.

The shareholders voted 3,532,201 shares for, 239,830 shares against, 2,586 shares abstained, and there were 1,479,120 broker non-votes for the adoption of the Company’s Management Incentive Program.  The shareholders voted 5,242,167 shares for, 9,547 shares against, and 2,023 shares abstained for the ratification of the appointment of KPMG LLP.

Item 6.  Exhibits

Exhibit
No.

 

Description

 

 

 

10.30*†

 

Management Incentive Program (effective as of December 13, 2006) (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated December 13, 2006).

10.31*†

 

Second Amended and Restated Employment Agreement with Rebecca C. Matthias dated March 2, 2007 (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 2, 2007 (the “March 2, 2007 Form 8-K”)).

10.32*†

 

Second Amended and Restated Employment Agreement with Dan W. Matthias dated March 2, 2007 (Exhibit 10.2 to the March 2, 2007 Form 8-K).

10.33†

 

Supplemental Retirement Agreement with Rebecca C. Matthias dated March 2, 2007.

10.34†

 

Supplemental Retirement Agreement with Dan W. Matthias dated March 2, 2007.

10.35*

 

Term Loan and Security Agreement, dated March 13, 2007, among Mothers Work, Inc. and Cave Springs, Inc., each as a Borrower, and Mothers Work Canada, Inc., as a Guarantor, and Bank of America, N.A, as Term Administrative Agent and Term Collateral Agent, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Runner (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 13, 2007 (the “March 13, 2007 Form 8-K”)).

10.36*

 

Second Amended and Restated Loan and Security Agreement, dated March 13, 2007, among Mothers Work, Inc. and Cave Springs, Inc., each as a Borrower, and Mothers Work Canada, Inc., as a Guarantor, and Bank of America, N.A, as the Lender (Exhibit 10.2 to the March 13, 2007 Form 8-K).

31.1

 

Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

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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.

 


*                    Incorporated by reference.

                     Management contract or compensatory plan or arrangement.

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Signatures

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

 

MOTHERS WORK, INC.

 

 

 

 

 

Date: May 10, 2007

By:

/s/ DAN W. MATTHIAS

 

 

 

 

Dan W. Matthias

 

 

 

Chairman of the Board and
Chief Executive Officer

 

 

 

 

 

 

 

 

 

Date: May 10, 2007

By:

/s/ EDWARD M. KRELL

 

 

 

 

Edward M. Krell

 

 

 

Executive Vice President—
Chief Financial Officer

 

 

30




INDEX OF EXHIBITS FILED WITH

FORM 10-Q OF MOTHERS WORK, INC.

FOR THE QUARTER ENDED MARCH 31, 2007

Exhibit
No.

 

Description

 

 

 

10.30*†

 

Management Incentive Program (effective as of December 13, 2006) (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated December 13, 2006).

10.31*†

 

Second Amended and Restated Employment Agreement with Rebecca C. Matthias dated March 2, 2007 (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 2, 2007 (the “March 2, 2007 Form 8-K”)).

10.32*†

 

Second Amended and Restated Employment Agreement with Dan W. Matthias dated March 2, 2007 (Exhibit 10.2 to the March 2, 2007 Form 8-K).

10.33†

 

Supplemental Retirement Agreement with Rebecca C. Matthias dated March 2, 2007.

10.34†

 

Supplemental Retirement Agreement with Dan W. Matthias dated March 2, 2007.

10.35*

 

Term Loan and Security Agreement, dated March 13, 2007, among Mothers Work, Inc. and Cave Springs, Inc., each as a Borrower, and Mothers Work Canada, Inc., as a Guarantor, and Bank of America, N.A, as Term Administrative Agent and Term Collateral Agent, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Runner (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 13, 2007 (the “March 13, 2007 Form 8-K”)).

10.36*

 

Second Amended and Restated Loan and Security Agreement, dated March 13, 2007, among Mothers Work, Inc. and Cave Springs, Inc., each as a Borrower, and Mothers Work Canada, Inc., as a Guarantor, and Bank of America, N.A, as the Lender (Exhibit 10.2 to the March 13, 2007 Form 8-K).

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.

 


*                    Incorporated by reference.

                     Management contract or compensatory plan or arrangement.

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