Destination Maternity Corp - Quarter Report: 2019 August (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended August 03, 2019

or

For the transition period from                      to                     

Commission file number 0-21196

Destination Maternity Corporation

(Exact name of registrant as specified in its charter)

(856) 291-9700

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(1) of the Exchange Act    ☐

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

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 — 14,226,121 shares outstanding as of September 3, 2019

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

INDEX

2

PART I—FINANCIAL INFORMATION

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

             (unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

3

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

4

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

5

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

6

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

7

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The accompanying unaudited consolidated financial statements for the three and six months ended August 3, 2019 and August 4, 2018 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. See the Company’s Annual Report on Form 10-K as of and for the year ended February 2, 2019 for Destination Maternity Corporation and subsidiaries (the “Company” or “Destination Maternity”) 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 52/53-week fiscal year ending on the Saturday nearest January 31 of each year. References to the Company’s fiscal 2019 refer to the 52-week fiscal year, or periods within such fiscal year, which began February 3, 2019 and will end February 1, 2020. References to the Company’s fiscal 2018 refer to the 52-week fiscal year, or periods within such fiscal year, which began February 4, 2018 and ended February 2, 2019.

As of August 3, 2019, the Company was in compliance with all covenants under the Credit Facility and Term Loan Agreement. However, the lender under the Credit Facility has imposed additional availability reserves which will increase over time. Based on the Company’s current operating plan, the Company anticipates significant liquidity constraints, and considering these liquidity concerns, there is no assurance that the Company will be able to remain in compliance.  If any event of default is triggered and the Company does not obtain a waiver from its lenders, the lenders can, among other things, accelerate the entire outstanding amount of the debt, which could result in the Company needing to seek bankruptcy protection to protect stakeholder value. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern.  The Company is, with the assistance of strategic advisors including Greenhill & Co., LLC, exploring various potential strategic and financial alternatives and is engaged in ongoing discussions with its lenders. Such strategic and financial alternatives include, among other things, a sale of the company or certain of its assets and consideration of out-of-court restructurings as well as bankruptcy court proceedings to effectuate any such sale or to recapitalize or restructure the Company’s indebtedness and other obligations.  There are no assurances that such alternatives will be available on terms acceptable to the Company, or at all. In an effort to reduce costs and better position the Company for operational profitability the Company has adopted a plan to close approximately 50 underperforming stores as their leases expire over the next six months.  The Company has also made provisions to have sufficient inventory available through the anticipated duration of the Company’s exploration of financial and strategic alternatives.

Basic net income (loss) (or earnings) per share (“Basic EPS”) is computed by dividing net income (loss) by the weighted average number of common shares outstanding, excluding restricted stock awards for which the restrictions have not lapsed. Diluted net income (loss) (or earnings) per share (“Diluted EPS”) is computed by dividing net income (loss) 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 and restricted stock unit (“RSU”) awards, and from shares of common stock resulting from the assumed exercise of outstanding stock options. Common shares issuable in connection with the award of performance-based restricted stock units (“PRSUs”) are excluded from the calculation of EPS until the PRSUs’ performance conditions are achieved and the shares in respect of the PRSUs become issuable (see Note 14).

8

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

In addition to PRSUs, for the three and six months ended August 3, 2019 and August 4, 2018 stock options and unvested restricted stock totaling approximately 707,000 and 538,000 shares, respectively, were excluded from the calculation of Diluted EPS as their effect would have been antidilutive. Stock options and unvested restricted stock totaling approximately 717,000 and 1,696,000 shares of the Company’s common stock were outstanding as of August 3, 2019 and August 4, 2018, respectively, but were not included in the computation of Diluted EPS for the three and six months ended August 3, 2019 and August 4, 2018 due to the Company’s net loss. Had the Company reported a profit for the three and six months ended August 3, 2019 and August 4, 2018 the weighted average number of dilutive shares outstanding for computation of Diluted EPS would have been approximately 13,872,000, 13,887,000, 14,284,000 and 14,124,000 shares, respectively.

Trade receivables are recorded based on revenue recognized for sales of the Company’s merchandise and for other revenue earned by the Company through its marketing partnership programs and international franchise agreements, and are non-interest bearing. The Company evaluates the collectability of trade receivables based on a combination of factors, including aging of trade receivables, write-off experience, analysis of historical trends and expectations of future performance. An allowance for doubtful accounts is recorded for trade receivables that are considered unlikely to be collected. When the Company’s collection efforts are unsuccessful, uncollectible trade receivables are charged against the allowance for doubtful accounts. As of August 3, 2019, and February 2, 2019 the Company’s trade receivables were net of allowance for doubtful accounts of $166,000 and $166,000, respectively.

Inventories were comprised of the following (in thousands):

9

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

After completion of a debt refinancing on February 1, 2018 the Company has in place a $50,000,000 senior secured revolving credit facility (the “Credit Facility”), which was entered into in connection with the issuance of the Company’s $25,000,000 Term Loan (as defined below) (see Note 7).   Proceeds from advances under the Credit Facility, subject to certain restrictions, may be used to provide financing for working capital, letters of credit, capital expenditures, and other general corporate purposes.

The Credit Facility, which matures on January 31, 2023, contains various affirmative and negative covenants and representations and warranties including the requirement that the Company maintain Excess Availability (as defined in the related Credit Agreement) of more than the greater of 10% of the Combined Loan Caps (as defined in the related Credit Agreement) and $7,000,000. In the event the outstanding balance of the Term Loan exceeds the Term Loan Borrowing Base (as defined in the related Term Loan Agreement) then a reserve will be imposed against availability under the Credit Facility. The Credit Facility is secured by a security interest in the Company’s trade receivables, inventory, letter of credit rights, cash, intangibles and certain other assets. The interest rate on outstanding borrowings is equal to, at the Company’s election, either 1) the lender’s base rate plus 0.50% or 2) a LIBOR rate plus 1.0%. The Company also pays an unused line fee under the Credit Facility of 0.25% per annum.

Any amounts outstanding under the Credit Facility may be accelerated and become due and payable immediately and all loan and letter of credit commitments thereunder may be terminated upon an event of default and expiration of any applicable cure period. Events of default include: 1) nonpayment of obligations due under the subject loan agreement and related loan documents, 2) cross-defaults to other indebtedness and documents, 3) failure to perform any covenant or agreement contained in the subject loan agreement, 4) material misrepresentations, 5) failure to pay, or certain other defaults under, other material indebtedness of the Company, 6) certain bankruptcy or insolvency events, 7) a change of control, 8) indictments of the Company or senior management in a material forfeiture action, 9) default under certain material contracts to the extent such termination or default has or could reasonably be expected to have a material adverse effect, and 10) customary ERISA defaults, among others.

In connection with the original execution and subsequent amendments of the Credit Facility, the Company incurred deferred financing costs of $1,281,000. These deferred financing costs are being amortized over the term of the Credit Facility agreement and are included in “interest expense, net” in the consolidated statements of operations.

As of August 3, 2019, the Company had $23,300,000 in outstanding borrowings under the Credit Facility, $6,297,000 in letters of credit and $5,169,000 of availability based on the Company’s Borrowing Base formula and availability reserve requirements. As of August 4, 2018, the Company had $7,300,000 in outstanding borrowings under the previous Credit Facility, $7,327,000 in letters of credit and $19,044,000 of availability. For the three months ended August 3, 2019 and August 4, 2018 borrowings had a weighted interest rate of 4.37% and 4.13% per annum, respectively. For the six months ended August 3, 2019 and August 4, 2018 borrowings had a weighted interest rate of 4.45% and 3.97% per annum, respectively.  During the six months ended August 3, 2019 and August 4,

10

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

2018 the Company’s average levels of direct borrowings were $26,904,000 and $16,356,000, respectively, and the Company’s maximum borrowings were $32,300,000 and $27,400,000, respectively.

On February 1, 2018 (the “Closing Date”) the Company entered into a Term Loan Credit Agreement (the “Term Loan Agreement”) which provides for a term loan of up to $25,000,000 and matures on January 31, 2023 (the “Term Loan”).  On the Closing Date the Company borrowed $22,500,000.    The Term Loan provided for an additional loan of $2,500,000 which could be borrowed at the Company’s discretion within a period of 45 days after delivery to the lender of the Company’s first quarter fiscal 2018 financial statements and satisfaction of certain other requirements. The Company met these requirements and borrowed the additional $2,500,000 on July 16, 2018.       

The interest rate on the Term Loan is equal to a LIBOR rate plus 9.0%. The Company is required to make minimum repayments of the principal amount of the Term Loan in quarterly installments of $312,500 which commenced on July 31, 2018, with the remaining outstanding balance payable on the maturity date. There is a minimum excess availability requirement of the greater of 10% of the Combined Loan Cap, as defined in the Term Loan Agreement, or $7,000,000. Additionally, the Term Loan can be prepaid at the Company's option subject to certain restrictions and subject to a prepayment premium as follows: 1) if the prepayment occurs on or prior to the second anniversary of the Closing Date, the greater of  a) interest on the prepayment that would otherwise have been paid with the 24 month period following the Closing Date minus actual interest payments made through the prepayment date and b) 2% of the prepayment and 2) 2% of the prepayment amount if paid between the second and third anniversary of the Closing Date.

The Term Loan is secured by a security interest in substantially all of the assets of the Company, including accounts receivable, inventory, equipment, letter of credit rights, cash, intellectual property and other intangibles, and certain other assets. The security interest granted to the Term Lenders is, in certain respects, subordinate to the security interest granted to the Credit Facility Lender. The Term Loan Agreement prohibits the payment of dividends or share repurchases by the Company for three years and imposes certain restrictions on the Company's ability to, among other things, incur additional indebtedness and enter into other various types of transactions.

There were $2,455,000 of deferred financing costs incurred in connection with the Term Loan. These deferred financing costs are reflected as a direct deduction from the Term Loan liability in the consolidated balance sheets and are being amortized over the term of the Term Loan Agreement. The amortization is included in “interest expense, net” in the consolidated statements of operations.

As of August 3, 2019, and August 4, 2018 there was $23,438,000 and $24,688,000, respectively, of principal outstanding under the Term Loan.

On February 22, 2019 the Company entered into a 24-month, $1,802,000 software development financing arrangement. The note has monthly payments of $81,648 with an interest rate of 8.16%. As of August 3, 2019, there was $1,379,000 of principal outstanding.

As of August 3, 2019, and August 4, 2018 there was $1,349,000 and $4,510,000, respectively, outstanding under a five-year equipment financing arrangement with the Company’s Credit Facility bank. The equipment note bears annual interest at 3.38%, with payments of $272,000 (including interest) due monthly through December 2019. The equipment note is collateralized by substantially all the material handling equipment at the Company’s distribution facility in Florence, New Jersey. Any amounts outstanding under the equipment note may be accelerated and become due and payable immediately upon an event of default and expiration of any applicable cure period. The specified events of default are substantially the same as those in the Credit Facility agreement (see Note 7).

In June 2017 the Company received $3,401,000 in proceeds from a three-year financing arrangement in the form of a sale and leaseback for certain furniture, fixtures and software. Monthly payments under the leaseback arrangement were $123,000 for the first 24 months and $48,000 for months 25 to 36. At the end of the leaseback term, the Company has the option to extend the lease for an additional year or to repurchase the financed property for a price to be agreed. As of August 3, 2019, and August 3, 2018 there was $935,000 and $1,988,000, respectively, of principal outstanding under this financing arrangement.

11

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Company has operating leases for its retail locations, distribution center and corporate office. Many of these leases include one or more renewal options which can extend the lease for up to an additional 15 years.  In the event we are reasonably certain that an option to extend a lease will be exercised, we use the expected expiration date to determine the operating lease right-of-use asset and lease liability. We also have short-term leases that can be terminated by the Company or by the landlord with notification periods as short as 30 days, which are excluded from the operating lease liability. Some of our leases provide for rental payments based solely on a percent of retail sales which are treated as variable lease expenses and not included as part of the operating lease liability.  Most leases include payments for lease components such as minimum rent, non-lease components such as common area maintenance and not-lease components such as real estate taxes and insurance.  Finance leases were not material as of August 3, 2019 and the three and six-month periods then ended.  

For the three and six months ended August 3, 2019, the components of lease expense were as follows (in thousands):

The following table presents the operating lease balances within the Consolidated Balance Sheet, weighted average remaining lease term and weighted average discount rates related to the Company’s operating leases as of August 3, 2019 ($ in thousands):

The following table presents the maturity of the Company’s operating lease liabilities as of August 3, 2019 (in thousands):

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DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Supplemental cash flow information related to the Company’s operating leases for the three and six months ended August 3, 2019 (in thousands):

The accounting standard for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard establishes a framework for measuring fair value focused on exit price and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements as follows:

The carrying values of trade receivables and accounts payable approximate fair value due to the short-term nature of those instruments.

The Company’s Credit Facility has variable interest rates that are tied to market indices. As of August 3, 2019, and February 2, 2019, the Company had $23,300,000 and $20,400,000, respectively, of direct borrowings outstanding under the Credit Facility. The carrying value of the Company’s Credit Facility borrowings approximates fair value as the variable interest rates approximate current market rates, which the Company considers to be Level 2 inputs.

The Company’s Term Loan, which represents a significant majority of the Company’s long-term debt, bears interest at variable rates, which adjust based on market conditions with a minimum annual rate of 9.00%. The carrying value of the Company’s Term Loan approximates fair value as the variable interest rates approximate current market rates for similar instruments available to companies with comparable credit quality, which the Company considers to be Level 2 inputs. The fair value of the Company’s fixed-rate equipment notes was determined using a discounted cash flow analysis based on interest rates currently available to the Company, which the Company considers to be Level 2 inputs. The difference between the carrying value and fair value of long-term debt held by the Company with a fixed rate of interest is not material.

The following disaggregates the Company’s net sales by major source (in thousands):

13

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

In January 2019, a ship carrying five containers of Company merchandise experienced a fire while in transit to a domestic port.  The merchandise was subsequently received and inspected, and it was determined that three of the containers of merchandise were a total loss.  The Company insures merchandise in transit at average selling price and has received a payment for merchandise in the three damaged containers in the amount of $2,546,000. For the three months ended August 3, 2019 the Company recorded other income in the amount of $1,917,000 which represents the amount by which the $2,546,000 payment received exceeded the carrying value of the damaged merchandise (the “Insurance Claim”). The remaining two containers of merchandise are still in the process of being inspected.  

Over the last several years the Company has engaged in a series of management and organizational changes and, in connection therewith, retained consulting firms to review its costs and business strategy associated with such management and organizational changes.   On June 24, 2019 the Company announced a reduction in force to achieve a more efficient and profitable organization. The reduction in force resulted in a one-time severance charge of $1,289,000 recorded during the three months ended August 3, 2019. During the three and six months ended August 3, 2019 and August 4, 2018 the Company incurred $1,798,000, $2,460,000, $667,000 and $931,000, respectively, of charges related to these management and organizational changes.

In the first quarter of fiscal 2018 the Company received notification from a stockholder group of their intent to nominate a slate of alternative nominees for election to the Company’s Board of Directors at the Annual Meeting of Stockholders that was held on May 23, 2018 (the “Proxy Solicitation”).  At the Company’s 2018 Annual Meeting of Stockholders the Company’s stockholders replaced the incumbent board in its entirety and elected the Company’s new Board of Directors. During the three and six months ended August 4, 2018 the Company incurred $1,256,000 and $2,142,000 of charges related to the Proxy Solicitation.   

A summary of other income and charges is as follows (in thousands):

In fiscal 2015, the Company completed the relocation of its corporate headquarters and distribution operations from Philadelphia, Pennsylvania to southern New Jersey. To partially offset the costs of these relocations, the Board of the New Jersey Economic Development Authority (“NJEDA”) approved the Company for an incentive package of up to $40,000,000 in benefits under the Grow New Jersey Assistance Program (“Grow NJ”) in the form of transferrable income tax credits over a ten-year period from the State of New Jersey. The award provides annually over a ten-year period up to $7,000 per eligible new full-time job, as defined under Grow NJ, with a requirement that at least 100 eligible jobs be created and subject to an annual award limit of $4,000,000.

The Grow NJ award requires an annual compliance report that includes certification of average annual employment figures after the end of each fiscal year. After the end of the ten-year Grow NJ award earnings period there is a five-year compliance period during which the Company must maintain the average of its annual eligible jobs certified during the preceding ten years or a pro-rata amount up to one-tenth of the previously awarded income tax credits would be subject to recapture and repayment to the State of New Jersey annually during the five-year compliance period. The Company believes the likelihood of any recapture and repayment is remote.

The annual benefit from the Grow NJ award available to the Company is expected to significantly exceed the Company’s annual income tax liability to the State of New Jersey. In order to maximize the realizable value of the incentive package, the Company entered into an agreement with a third party to sell up to 100%  of the annual income tax credits awarded to the Company. The Company recognizes its Grow NJ award on an annual basis for each fiscal year based on the realizable value of the award earned and

14

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

expected to be received, primarily from the sale of the income tax credits, net of any associated costs. The Grow NJ award is reflected in the Company’s consolidated financial statements as a reduction to the costs incurred by the Company in connection with the relocations. The expected realizable amount of the Grow NJ award is included in the consolidated balance sheet in deferred income taxes. As of August 3, 2019, the Company had recorded a deferred tax asset of $3,967,000 related to the NJ Grow award. Of this amount, $2,671,000 relates to the annual award earned in fiscal 2018, the cash proceeds of which are expected to be received during fiscal 2019.  In December 2018, the Company received $2,829,000 cash proceeds, net of costs, from the receipt and subsequent sales of the tax credit certificate earned for fiscal 2017. During the three and six months ended August 3, 2019, the Company recognized the cost reduction related to the Grow NJ award in the amount of $580,000 and $1,196,000, respectively, as compared to the three and six months ended August 4, 2018 in which the Company recognized $710,000 and $1,285,000 respectively.

Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, requires that a valuation allowance be recorded to reduce deferred tax assets when it is more likely than not that the tax benefit of the deferred tax assets will not be realized. In situations where a three-year cumulative loss condition exists, accounting standards limit the ability to consider projections of future results as positive evidence to assess the realizability of deferred tax assets.  In fiscal 2016 the Company’s financial results reflected a three-year cumulative loss and consequently, in fiscal 2016 the Company recorded a non-cash charge as a valuation allowance against substantially all its deferred tax assets.  Three-year cumulative losses have continued since fiscal 2016 and the Company continues to record a valuation allowance against its deferred tax assets.

In January 2006, the stockholders of the Company approved the adoption of the Amended and Restated 2005 Equity Incentive Plan (the “2005 Plan”) and, subsequently, have approved amendments to increase the number of issuable shares under the 2005 Plan. Under the 2005 Plan, employees, directors, consultants and other individuals who provide services to the Company may be granted awards in the form of stock options, stock appreciation rights, restricted stock, RSU’s or deferred stock units. Up to 3,550,000 shares of the Company’s common stock may be issued in respect of awards under the 2005 Plan, as amended, with no more than 2,250,000 of those shares permitted to be issued in respect of restricted stock, RSU’s, or deferred stock units granted under the 2005 Plan. Awards of stock options to purchase the Company’s common stock will have exercise prices as determined by the Compensation Committee of the Board of Directors (the “Compensation Committee”), but such exercise prices may not be lower than the fair market value of the stock on the date of grant.

No stock options have been granted by the Company with an exercise price less than the fair market value of the Company’s common stock on the date of grant for any of the periods presented. The majority of the stock options issued under the 2005 Plan vest ratably over four-year periods and generally expire ten years from the date of grant, and restricted stock and time-based RSU awards issued under the 2005 Plan generally have restrictions that lapse ratably over periods ranging from one to four years however, awards with respect to up to 177,500 shares of our common stock may be granted under the 2005 Plan with a vesting period of less than one year. Performance-based awards issued under the 2005 Plan generally vest based upon the achievement of pre-established performance goals over a specified three-year period. The number of shares of our common stock that may be earned in respect of performance-based awards may be greater or less than the target number of shares granted based on the actual performance achieved. The non-executive chairman of the Company’s Board of Directors is granted 6,000 shares of restricted stock on an annual basis and each non-employee director, other than the non-executive chairman, of the Company’s Board of Directors is eligible for a grant of 4,000 shares of restricted stock on an annual basis, in each case that will generally vest one year from the date of grant. The Company issues new shares of common stock upon exercise of vested stock options. As of August 3, 2019, there were 1,057,485 shares of the Company’s common stock available for grants of awards under the 2005 Plan.

15

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Stock option activity for all plans was as follows:

The following table summarizes information about stock options outstanding as of August 3, 2019:

The following table summarizes information about restricted stock and RSU activity for the 2005 Plan and includes grants of 113,326 PRSUs which is the number of shares of common stock that would be delivered upon vesting assuming that the target level of performance is achieved.  If performance was achieved at the maximum level, 226,652 shares of common stock would be delivered in respect of such PRSU’s.      

Adopted

In February 2016 the FASB issued ASU No. 2016-02, Leases (Topic 842), referred to hereafter as ASC 842. ASC 842 affects any entity that enters a lease, as that term is defined, and its guidance supersedes Topic 840, Leases. As it substantively relates to the Company, ASC 842 requires lessees to recognize a right-of-use asset (“ROU asset”) and a lease liability, initially measured at the present value of the lease payments, in the consolidated balance sheet.

On February 3, 2019 the Company adopted ASC 842 using the modified retrospective method for all lease arrangements in effect at the beginning of the period of adoption. Results for periods beginning February 3, 2019 are presented under ASC 842, prior period amounts were not restated and continue to be reported under the Company’s historical method of lease accounting, ASC 840,

16

DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Leases. Adoption of ASC 842 had a material impact of the Company’s balance sheet as the result of recognizing ROU assets and lease liabilities for operating leases. There was no material impact to our consolidated statement of operations or cash flows and there was no impact to covenant compliance under our current debt agreements. Accounting for finance leases remained substantially unchanged. For leases that commenced prior to the effective date of ASC 842 the Company adopted practical expedients that allowed for retention of its previous assessment of the following: (i) whether a contract contained a lease, (ii) lease classification and (iii) initial direct costs. The Company also elected not to recognize ROU assets and lease liabilities for leases with a term of 12 months or less and to account for leases which have both lease and non-lease components as a single component.

At the date of adoption, the Company recorded operating lease ROU assets of $135 million, operating lease liabilities of $159 million, primarily related to its retail real estate, distribution center and corporate office and a $2.6 million adjustment to accumulated deficit resulting from the impairment of certain operating lease ROU assets. Refer to Note 8. Leases for additional disclosures required by ASC 842.

The Company determines if an arrangement is a lease at inception. ROU assets represent the Company’s right to use an underlying asset during the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement of the lease based on the net present value of the fixed lease payments over the lease term.  The lease term includes options to extend or terminate the lease when it is reasonably certain that we will exercise the option. ROU assets include prepaid lease payments, lease incentives received and capitalized lease costs. As the Company’s leases do not provide an implicit interest rate, the Company uses its incremental borrowing rate based on information available at the lease commencement date to determine the present value of lease payments. Lease expense for operating leases is recognized on a straight-line basis over the lease term as an operating expense while the expense for finance leases is recognized as depreciation and interest expense over the lease term.  

In August 2018, the FASB issued ASU 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. ASU 2018-15 requires implementation costs incurred by customers in cloud computing arrangements to be deferred over the non-cancellable term of the cloud computing arrangements plus any optional renewal periods (1) that are reasonably certain to be exercised by the customer or (2) for which exercise of the renewal option is controlled by the cloud service provider. The effective date of this pronouncement is for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, and early adoption is permitted. The Company adopted ASU 2018-15 effective February 3, 2019 and the adoption did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

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.

On September 16, 2019, we adopted a plan to close approximately 50 underperforming stores as their leases expire over the next six months to reduce costs and better position the Company for operational profitability. In connection with the store closures, the Company expects to incur estimated pre-tax charges ranging from an aggregate of $0.7 million to $1.0 million, including costs associated with lease terminations, asset impairments and employee severance.

In January 2019, a ship carrying five containers of Company merchandise experienced a fire while in transit to a domestic port.  The merchandise was subsequently received and inspected, and it was determined that three of the containers of merchandise were a total loss.  The Company insures merchandise in transit at average selling price and has received a payment for merchandise in the three damaged containers. The remaining two containers of merchandise are still in the process of being inspected. The Company believes that its insurance coverage is adequate to cover any potential loss, should such a loss occur.  

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DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Operating Segment. For purposes of the disclosure requirements for segments of a business enterprise, 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. Geographic revenue information is allocated based on the country in which the products or services are sold, and in the case of international franchise revenues, on the location of the customer. Information concerning the Company’s operations by geographic area was as follows (in thousands):

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

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

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We operate on a 52/53-week fiscal year ending on the Saturday nearest January 31 of each year. References in this discussion to our fiscal 2019 refer to the 52-week fiscal year, or periods within such fiscal year, which began February 3, 2019 and will end February 1, 2020. References to our fiscal 2018 refer to the 52-week fiscal year, or periods within such fiscal year, which began February 4, 2018 and ended February 2, 2019.

Forward-Looking Statements

Some of the information in this report, including the information incorporated by reference (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 risks and uncertainties. The following factors, among others, in some cases have affected, and in the future, 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: our cash runway and availability to access our revolving credit facility, our ability to consummate a strategic or financial transaction, the effectiveness of our cost reduction initiatives, our ability to raise additional capital, our ability to continue to comply with our debt covenants, our ability to continue to operate as a going concern, our ability to maintain our relationships on the same terms with our customers, vendors, suppliers, landlords, and employees, the possibility that we may need to seek bankruptcy protection, the strength or weakness of the retail industry in general and of apparel purchases in particular, our ability to successfully manage our various business initiatives, our ability to successfully manage, retain and expand our leased department and international franchise relationships and marketing partnerships, future sales trends in our various sales channels, unusual weather patterns, changes in consumer spending patterns, raw material price increases, overall economic conditions and other factors affecting consumer confidence, demographics and other macroeconomic factors that may impact the level of spending for maternity apparel (such as fluctuations in pregnancy rates and birth rates), our ability to anticipate and respond to fashion trends and consumer preferences, unanticipated fluctuations in our operating results, the impact of competition and fluctuations in the price, availability and quality of raw materials and contracted products, availability of suitable store locations, our ability to develop and source merchandise, our ability to receive production from foreign sources on a timely basis, the trading liquidity of our common stock, changes in market interest rates, our compliance with certain tax incentive and abatement programs, war or acts of terrorism and other factors referenced in this Quarterly Report on Form 10-Q and 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. Except as required by applicable law, including the securities laws of the United States and the rules and regulations of the SEC, 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.

Presentation of Financial Information

Comparable sales figures represent sales at retail locations (which does not include licensed brand or international franchise relationships) that have been in operation by us for at least 13 full months, as well as Internet sales. Our comparable sales figures generally do not include: 1) retail locations which change location type or format, 2) retail locations which are expanded, contracted or relocated if the square footage of the retail location has changed by 20% or more, or, if in the judgment of management, such expansion, contraction or relocation materially alters the comparability of the retail location (either with respect to the manner of its operation or otherwise), 3) in the case of relocations only, retail locations which are not in the same immediate geographical vicinity (such as, without limitation, the same mall, the same part of a mall, or the same street) after the relocation, 4) retail locations that have temporarily closed for any reason for 30 days or more, or 5) retail locations which, in the judgment of management, have undergone other significant changes which materially alter the comparability of the retail location (either with respect to the manner of its operation or otherwise) (such as, for example only, in the case of closure of retail locations in connection with the cessation of a leased department relationship where the manner of operation of such retail location has been materially altered prior to closure, or in the case of construction in, on or near a retail location, which significantly interferes with the customer traffic, visibility or operation of a retail location). Comparable sales exclude the 53^rd week of sales for 53-week fiscal years. In the 52-week fiscal year subsequent to a 53-week fiscal year, we exclude the sales in the non-comparable week from the comparable sales calculation. There may be variations in the way in which other retailers calculate comparable sales. As a result, data in this quarterly report regarding our comparable sales may not be comparable to similar data made available by other retailers.

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Use of Non-GAAP Measures

In assessing the performance of our business, we consider a variety of operational and financial measures. The key measures for determining how our business is performing are net income (loss) determined in accordance with GAAP (“net income (loss)”) and the corresponding net income (loss), (or earnings (loss)) per share (diluted), net income (loss) before certain charges or credits, when applicable, such as other charges, loss on extinguishment of debt, and certain infrequent income tax adjustments (“adjusted net income (loss)”) and the corresponding earnings (loss) per share (diluted), Adjusted EBITDA (defined below), Adjusted EBITDA before other charges, net sales, and comparable sales. Adjusted EBITDA represents operating income (loss) before deduction for the following non-cash charges: 1) depreciation and amortization expense, 2) loss on impairment of tangible and intangible assets, 3) loss on disposal of assets, and 4) stock-based compensation expense.

Our management believes that each of the non-GAAP financial measures presented by us provides useful information about our results of operations and/or financial position to both investors and management. Each non-GAAP financial measure is provided because management believes it is an important measure of financial performance used in the retail industry to measure operating results, to determine the value of companies within the industry and to define standards for borrowing from institutional lenders. We use each of these non-GAAP financial measures as a measure of our performance. In addition, certain of our cash and equity incentive compensation plans are based on our level of achievement of Adjusted EBITDA before other charges, which is substantially identical to our non-GAAP financial measure of Adjusted EBITDA before certain other deductions.

We provide these various non-GAAP financial measures to investors to assist them in performing their analysis of our historical operating results. Each of these non-GAAP financial measures reflects a measure of our operating results before consideration of certain charges and consequently, none of these measures should be construed as an alternative to net income (loss) or operating income (loss) as an indicator of our operating performance, or as an alternative to cash flows from operating activities as a measure of our liquidity, as determined in accordance with GAAP. We may calculate each of these non-GAAP financial measures differently than other companies.

With respect to the non-GAAP financial measures discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, we have provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures in this Quarterly Report.

Overview

          We are the leading designer and retailer of maternity apparel in the United States with 937 retail locations, including 446 stores in the United States, Canada and Puerto Rico, and 491 leased departments located within department stores and baby specialty stores throughout North America. We also sell merchandise on the Internet, primarily through our Motherhood.com, APeaInThePod.com and Destinationmaternity.com websites. We also sell our merchandise through our Canadian website, MotherhoodCanada.ca, through Amazon.com in the United States, and through websites of certain of our retail partners, including Macys.com.  We have store franchise and product supply relationships in South Korea, Mexico and Israel. As of August 3, 2019, we have 120 international franchised locations, including 8 stand-alone stores operated under one of our retail nameplates and 112 shop-in-shop locations.

Insurance Claim

In January 2019, a ship carrying five containers of Company merchandise experienced a fire while in transit to a domestic port.  The merchandise was subsequently received and inspected, and it was determined that three of the containers of merchandise were a total loss.  The Company insures merchandise in transit at average selling price and has received a payment for merchandise in the three damaged containers in the amount of $2,546,000. For the three months ended August 3, 2019 the Company recorded other income in the amount of $1,917,000 which represents the amount by which the $2,546,000 payment received exceeded the carrying value of the damaged merchandise (the “Insurance Claim”). The remaining two containers of merchandise are still in the process of being inspected.  

Management and Organizational Changes

We have engaged in a series of management and organizational changes over the last several years. Through these actions, we are attempting to identify further opportunities to become more profitable in the near future, by increasing both revenue and gross margins while reducing expenses.

During the six months ended August 3, 2019 and August 4, 2018 we recognized $2.5 million and $0.9 million, respectively, of charges related to management and organizational changes.

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Proxy Solicitation

In the first quarter of fiscal 2018, we received notification from a stockholder group of the nomination of a slate of alternative nominees for election to our Board of Directors at the 2018 Annual Meeting of Stockholders that was held on May 23, 2018 (the “Proxy Solicitation”). At our 2018 Annual Meeting of Stockholders the Company’s stockholders replaced the incumbent board in its entirety and elected a new Board of Directors. During the six months ended August 4, 2018, we incurred $2.1 million of charges related to the Proxy Solicitation.

Presented below is a summary of our results for the second quarter and first six months of fiscal 2019 regarding each of the key measures noted below:

Second Quarter Fiscal 2019 Financial Results

First Six Months of Fiscal 2019 Financial Results

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Results of Operations

The following table sets forth certain operating data as a percentage of net sales and as a percentage change for the three and six months ended August 3, 2019 and August 4, 2018: