10-K 1 d412020d10k.htm FORM 10-K Form 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

(Mark One)

 

  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2012

or

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

Commission file number 0-21196

 

 

Destination Maternity Corporation

(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 Fifth Street,

Philadelphia, PA

  19123

(Address of principal executive offices)

  (Zip Code)

(215) 873-2200

(Registrant’s telephone number, including area code)

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

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $.01 per share   The NASDAQ Stock Market LLC

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

Series B Junior Participating Preferred Stock Purchase Rights

(Title of class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

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

 

Large accelerated filer  ¨

   Accelerated filer  x   Non-accelerated filer  ¨    Smaller reporting company  ¨
    

(Do not check if a smaller
reporting company)

  

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed using $18.57, the price at which the common equity was last sold as of March 31, 2012 (the last business day of the Registrant’s most recently completed second fiscal quarter), was approximately $241,000,000.

On December 3, 2012, there were 13,487,694 shares of the Registrant’s common stock, $.01 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Stockholders, expected to be held in the second quarter of fiscal 2013, are incorporated by reference into Part III of this Form 10-K.

 

 

 

 


PART I.

Our fiscal year ends on September 30. All references in this report to our fiscal years refer to the fiscal year ended on September 30 in the year mentioned. For example, our “fiscal 2012” ended on September 30, 2012. Unless otherwise indicated, operating data referred to in this report is as of September 30, 2012. As used in this report, the term “retail locations” includes our stores and leased departments and excludes locations where Kohl’s® sells our products under an exclusive product and license agreement, and international franchise locations. As used in this report, “stores” means our stand-alone stores in the United States, Puerto Rico and Canada which we operate.

 

Item 1. Business

Overview

Destination Maternity Corporation (the “Company”, “we”, “us”, “our”) is the leading designer and retailer of maternity apparel in the United States and is the only nationwide chain of maternity apparel specialty stores. As of September 30, 2012, we operate 2,008 retail locations, including 625 stores in all 50 states, Puerto Rico and Canada, and 1,383 leased departments located within department stores and baby specialty stores throughout the United States and Puerto Rico. We are also the exclusive provider of maternity apparel to Kohl’s, which operates approximately 1,146 stores throughout the United States. We operate our 625 stores under three retail nameplates: Motherhood Maternity®, A Pea in the Pod® and Destination Maternity®. In addition to our 625 stores, we operate 1,383 maternity apparel departments, which we refer to as leased departments, within leading retailers such as Macy’s®, Sears®, Gordmans® and Boscov’s®. We are the exclusive maternity apparel provider in each of our leased department relationships. In fiscal 2012 we also operated leased departments in Babies“R”Us® stores. However, in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc., (which we announced in May 2012) we discontinued operation of our 124 remaining leased departments in Babies“R”Us in late October 2012 and opened leased departments in select buybuy BABY® stores. As of November 30, 2012 we operate 10 leased departments in buybuy BABY stores. As of August 25, 2012, Bed Bath & Beyond Inc. had 71 buybuy BABY stores. Over time, we expect to significantly increase the number of buybuy BABY stores in which we have a maternity apparel leased department.

We also have expanded internationally and have entered into exclusive store franchise and product supply relationships in the Middle East, India and South Korea. As of September 30, 2012, we have 119 international franchised locations, comprised of 16 stand-alone stores in the Middle East, South Korea and India operated under the Destination Maternity retail nameplate, and 103 shop-in-shop locations in India and South Korea, in which we have a Company branded department operated under retail nameplates owned by our franchise partners. Finally, we also sell merchandise on the Internet, primarily through DestinationMaternity.com and our various brand-specific websites.

We maintain our leading position across all major price points of maternity apparel through our four distinct merchandise brands, which enable us to reach a broad range of maternity customers. Through our 625 stores and certain of our leased departments, we offer maternity apparel under our two primary merchandise brands, Motherhood Maternity (“Motherhood” or “Motherhood Maternity”) at value prices and A Pea in the Pod (“Pea” or “A Pea in the Pod”) at both contemporary and luxury prices. Our A Pea in the Pod Collection® (“Pea Collection”) is the distinctive premier maternity apparel line within the A Pea in the Pod brand, featuring exclusive designer label product at luxury prices. We also have two additional value-priced maternity apparel brands: our Oh Baby by Motherhood® collection, which we sell exclusively through Kohl’s, and our Two Hearts® Maternity by Destination Maternity® collection, available exclusively at Sears stores. Our brands are the exclusive maternity apparel offering in each of these chains.

We believe that one of our key competitive advantages is our ability to fulfill, in a high-service store environment, all of an expectant or nursing mother’s clothing needs, including casual and career wear, formal attire, lingerie, sportswear and outerwear, in sizes that cover all trimesters of the maternity cycle. We believe that our vertically-integrated business model enables us to offer the broadest assortment of in-stock, fashionable

 

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maternity apparel. We design and contract for the production of over 90% of the merchandise we sell using sewing factories located throughout the world, predominantly outside of the United States.

In recent years, we have developed and introduced new multi-brand store concepts to offer merchandise from our various brands in a single location, in order to provide a broader product assortment at multiple price ranges to our customers and to increase average store sales and profitability. We believe the continued rollout of our multi-brand store initiative provides the opportunity for us to improve store operating profit margins over time by reducing store operating expense percentages through economies of scale, and may increase overall sales in the geographical markets they serve. Our multi-brand stores are operated under our Destination Maternity nameplate, which includes Destination Maternity combo stores (carrying Motherhood Maternity and A Pea in the Pod merchandise) and Destination Maternity superstores, which also carry both our Motherhood and Pea merchandise brands, as well as a significant array of maternity-related products and customer service features. These Destination Maternity stores are larger and have historically had higher average sales than our average store. Opening these Destination Maternity stores will typically involve closing two or more smaller stores and may result in one-time store closing costs resulting primarily from early lease terminations. In fiscal 2012 we closed 12 stores in connection with the opening of Destination Maternity nameplate stores and, from fiscal 2005 through fiscal 2012, we have closed 129 stores in connection with the opening of Destination Maternity nameplate stores.

In recent years, in addition to having closed some stores in connection with the opening of Destination Maternity nameplate stores, we have also evaluated our retail store base to identify and, in many cases, close underperforming stores (referred to as “prunings”) where we can do so without disproportionate exit cost. These prunings typically add to our profitability by eliminating the operating expense of an underperforming store while also typically transferring some of the sales from the closed store to other stores and/or leased departments we operate in that geographical area. In fiscal 2012 we closed 29 underperforming stores and, from fiscal 2005 through fiscal 2012, we have closed 263 underperforming stores.

We plan to open approximately 14 – 20 new retail stores during fiscal 2013, of which we expect approximately 7 – 10 will be new Destination Maternity combo or superstores. We estimate that we will close approximately 34 – 51 stores in fiscal 2013, with approximately 14 – 20 of these store closings related to the opening of new Destination Maternity stores, and the remainder of these store closings related to prunings.

Currently, we operate 34 Motherhood stores in Canada and a Motherhood website under a Canadian URL (MotherhoodCanada.ca). In addition, we believe there is a significant opportunity to continue to develop international sales beyond Canada. We currently have franchise agreements in place in the Middle East, India and South Korea. The initial franchise stores through our arrangement in the Middle East opened during 2009 and, as of September 30, 2012, there are 13 of our franchise stores operating in the Middle East. Beginning during fiscal 2009, we began offering our Motherhood Maternity branded merchandise in maternity shop-in-shops located in our India franchisee’s Mom & Me® stores and in franchise stores. As of September 30, 2012, our merchandise is offered in 90 Mom & Me stores and one franchise store in India. Beginning during fiscal 2011, we began offering our Motherhood Maternity branded merchandise in maternity shop-in-shops located in our South Korea franchisee’s Nextmom® stores and in franchise stores. As of September 30, 2012, our merchandise is offered in 13 Nextmom stores and two franchise stores in South Korea.

We believe that our customers, particularly first-time mothers, are entering a new life stage that drives widespread changes in purchasing needs and behavior, thus making our maternity customer and her family a highly-valued demographic for a range of consumer products and services companies. As a result, we have been able to expand and leverage the relationship we have with our customers and generate incremental revenues and earnings by offering other value-added baby and parent-related products and services through a variety of marketing partnership programs utilizing our extensive opt-in customer database and various in-store marketing initiatives.

The Company was founded in 1982 as a mail-order maternity apparel catalog. We began operating retail stores in 1985 and completed our initial public offering in 1993. To address multiple price points in maternity apparel and improve operating productivity, we acquired Motherhood and A Pea in the Pod in 1995 and

 

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eSpecialty Brands, LLC, or iMaternity™, in October 2001. Since the acquisitions of Motherhood and A Pea in the Pod, we have developed and grown these brands along with growing our Destination Maternity brand. Also, since the 1990s we have partnered with other retailers to sell our products through maternity apparel departments within their stores. On December 8, 2008, we changed our corporate name from “Mothers Work, Inc.” to “Destination Maternity Corporation” and our Nasdaq® symbol from “MWRK” to “DEST” coincident with the name change.

Industry Overview

We are unaware of any reliable external data on the size of the maternity apparel business. We believe that there is an opportunity to grow our business by selling maternity clothes to those pregnant women who currently purchase loose-fitting or larger-sized non-maternity clothing as a substitute or partial substitute for maternity wear. We also believe that our business can grow by reducing the amount of “hand-me-down” and “borrowing” associated with maternity apparel, particularly in the value-priced segment. Additionally, although we are not wholly unaffected by external factors (such as fluctuations in the birth rate), we believe that the demand for maternity apparel is relatively stable when compared to non-maternity apparel. Expectant mothers continue to need to replace most of their wardrobe and the current rate of approximately four million United States births per year has remained relatively stable over the last decade, although the number of births has declined by approximately 8.8% in the United States from 2007 to mid-2012, the period of latest available information. Also, although we are affected by fashion trends, we believe that maternity apparel is less fashion sensitive than women’s specialty apparel in general, as demand is driven primarily by the need to replace wardrobe basics as opposed to a desire to add to one’s wardrobe in order to meet current fashion trends.

Our Competitive Strengths

We are the leader in maternity apparel.     We are the leading designer and retailer of maternity apparel in the United States and are the only nationwide chain of maternity apparel specialty stores. We believe that our brands are the most recognized in maternity apparel. We have established a broad distribution network, with stores in a wide range of geographic areas and retailing venues. In addition, we have a leading position across all major price points of maternity apparel through our retail store nameplates and our merchandise brands. Our exclusive focus on maternity apparel and our leadership position enable us to gain a comprehensive understanding of the needs of our maternity customers and keep abreast of fashion and product developments. We further enhance our leadership position, increase market penetration and build our brands by distributing our products under exclusive leased department and licensed relationships. We are also using the strength of our products, brands and store nameplates in the United States to expand internationally. As of September 30, 2012, we operate 34 stores in Canada and we have 119 international franchised locations, comprised of 16 stand-alone stores in the Middle East, South Korea and India operated under our Destination Maternity retail nameplate, and 103 shop-in-shop locations in India and South Korea, in which we have a Company branded department operated under retail nameplates owned by our franchise partners.

We offer a comprehensive assortment of maternity apparel and accessories.    A primary consideration for expectant mothers shopping for maternity clothes is product assortment, as pregnant women typically need to replace almost their entire wardrobe. We believe that we offer the widest selection of merchandise in the maternity apparel business. We also offer product for multiple seasons, as pregnant women’s clothing needs vary depending on their due date. Our ability to offer a broad assortment of product is due, in large part, to our vertically-integrated business model, which includes our extensive in-house design and contract manufacturing capabilities, as well as our rapid inventory replenishment system.

We are vertically integrated.     We design and contract manufacture over 90% of the merchandise we sell. We believe that vertical integration enables us to offer the broadest assortment of maternity apparel, to respond quickly to fashion trends and to optimize in-stock levels. We combine our in-house design expertise, domestic and international sourcing capabilities, a rapid inventory replenishment process and extensive proprietary systems to enhance operational and financial results.

 

 

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We utilize a rapid inventory replenishment system.     We are able to offer a wide selection of merchandise in our retail locations due, in large part, to our rapid inventory replenishment system. Our proprietary inventory replenishment system enables us to offer our customers a much broader selection than any of our competitors, without dedicating retail space to “back-stock” storage. We coordinate the rapid replenishment of inventory for all of our retail locations through our Philadelphia, Pennsylvania distribution centers to meet the individualized needs of our retail locations. Our stores receive shipments from our distribution centers between one and seven times per week. This enables us to maintain a high percentage in-stock merchandise position in each of our stores.

We have proprietary systems that support our business.     In order to support our vertically-integrated business model and inventory replenishment system, we have developed a fully integrated, proprietary enterprise resource planning (“ERP”) system. This system includes our point-of-sale systems, our merchandise analysis and planning systems, our materials requirement planning system, and our web-based, global sourcing and logistics systems. These systems also support our automated picking and sorting systems and other aspects of our logistics infrastructure. We believe that our proprietary systems enable us to offer a broad product assortment, rapidly replenish inventory in our retail locations, and respond quickly to fashion trends.

We are able to obtain prime real estate locations.     We believe our ability to lease attractive real estate locations is enhanced due to the brand awareness of our concepts, our multiple price point approach, our highly sought after maternity customer and our real estate management and procurement capabilities. We are the only maternity apparel retailer to provide mall operators with differently priced retail concepts, depending on the mall’s target demographics. We are also able to provide a Destination Maternity multi-brand store for malls whose maternity customers seek a wide range of price alternatives. In addition, in the case of multi-mall operators, we have the flexibility to provide several stores across multiple malls. As a result, we have been able to locate stores in many of what we believe are the most desirable shopping malls in the country and are able to obtain attractive locations within these malls.

We are able to enhance our leadership position by distributing our products under exclusive leased department and licensed relationships.     As of September 30, 2012, we operate 1,383 leased departments within leading retailers such as Macy’s, Sears, Gordmans and Boscov’s. We are also the exclusive provider of maternity apparel to Kohl’s pursuant to an exclusive licensed relationship. We believe that we have an opportunity to continue to increase the sales we generate from these ongoing relationships through expanding our relationships with our current partners as well as developing relationships with new partners. In fiscal 2012, we also operated leased departments in Babies“R”Us stores. However, in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc., (which we announced in May 2012) we discontinued operation of our 124 remaining leased departments in Babies“R”Us in late October 2012 and opened leased departments in select buybuy BABY stores. As of November 30, 2012 we operate 10 leased departments in buybuy BABY stores. As of August 25, 2012, Bed Bath & Beyond Inc. had 71 buybuy BABY stores. Over time, we expect to significantly increase the number of buybuy BABY stores in which we have a maternity apparel leased department.

We have a highly experienced management team.     We have a management team with significant experience in all aspects of the retail and apparel business, including our Chief Executive Officer (“CEO”), Ed Krell, who has served as a senior executive of the Company for over 10 years and has over 25 years of business experience encompassing apparel, retail, finance and overall management, and our President, Chris Daniel, who has over 20 years of women’s apparel merchandising experience.

 

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Merchandise Brands

We believe that our brands are the most recognized brands in the maternity apparel business. We sell our merchandise under the following four distinct brands:

 

Brand

 

Brand Positioning

  Typical
Apparel
Price Range

Motherhood Maternity

  Broad assortment of the latest fashions, offering great quality merchandise at everyday low prices   $10 – $  45

A Pea in the Pod

  Contemporary, fashion—forward and luxury, offering sophisticated career, as well as fun casual merchandise, including exclusive designer labels   $18 – $395

Two Hearts Maternity by Destination Maternity

  Select assortment of the latest fashions, offering great quality merchandise at value price points   $  8 – $  36

Oh Baby by Motherhood

  Select assortment of the latest fashions, offering great quality merchandise at value price points        $  8 – $  36 (1)

 

 

(1) Kohl’s, which sells our Oh Baby by Motherhood brand under an exclusive product and license agreement, sets the prices for this merchandise.

Motherhood Maternity.     Our Motherhood Maternity brand serves the value-priced portion of the maternity apparel business, which has the greatest number of customers. The Motherhood brand is positioned with a broad assortment of quality fashion at everyday low prices. We believe that the Motherhood customer shops at moderate-priced department stores and discount stores when she is not expecting.

A Pea in the Pod.     Our A Pea in the Pod brand serves both the medium-priced (or “better”) portion and, through our A Pea in the Pod Collection line, the luxury portion of the maternity apparel business. The Pea brand is generally positioned as contemporary, fashion-forward and luxury, with prices ranging from affordable mid-priced to true luxury prices, offering the mom-to-be exceptional contemporary maternity pieces that reflect her uncompromising sense of style in both casual and career apparel. The Pea Collection is the distinctive premier maternity luxury line within the Pea brand, featuring a selection of extraordinary styles along with exclusive designer labels. In our stores which carry A Pea in the Pod brand merchandise, we also offer exclusive maternity versions of select styles from well-known designer and contemporary brands, where we have assisted in developing these maternity versions. We believe that the typical Pea customer shops at department stores and specialty apparel chains when she is not expecting, with the Pea Collection customer typically shopping at higher-end department stores and luxury designer boutiques when she is not expecting. We believe the Pea brand is the leading luxury maternity brand in the United States. Publicity, including celebrities wearing our clothes, is an important part of the marketing and positioning of the Pea brand.

Two Hearts Maternity by Destination Maternity.     Our Two Hearts Maternity by Destination Maternity collection is available at over 500 Sears locations throughout the United States through an exclusive leased department relationship. This collection delivers the latest in career and casual sportswear as well as dresses, swimwear, lingerie and nursing-friendly sleepwear, all specially designed to compliment the pregnant silhouette, with most items selling for under $25.

Oh Baby by Motherhood.     Our Oh Baby by Motherhood collection is available at over 1,100 Kohl’s stores throughout the United States and on Kohls.com. The Oh Baby by Motherhood collection is available at all Kohl’s stores under an exclusive product and license agreement. The collection features a modern assortment of quality fashions, with most items having initial prices (before price promotions) under $40.

 

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Retail Nameplates

We sell maternity apparel through the stores, leased departments and licensed relationships identified in the table below.

 

Store Nameplate

 

Description of
Target Location

 

Brand(s) Carried

  Typical
Apparel
Price Range
      Average
Size (Sq. Ft.)

Stores:

         

Motherhood Maternity

  Mid-priced and moderate regional malls, strip and power centers, and central business districts   Motherhood   $10 – $  45     1,800

A Pea in the Pod

  Mid-priced and high-end regional malls, lifestyle centers, central business districts and some stand-alone stores in affluent street locations   Pea (including, in some cases, Pea Collection)   $18 – $395     2,100

Destination Maternity

 

Combo stores located in mid-priced regional malls and lifestyle centers

  Motherhood;
Pea (including, in some cases, Pea Collection)
  $10 – $395     Combo stores

2,900

 

Superstores located primarily in outdoor and power centers and central business districts

        Superstores

6,200

Leased Departments:

         

Macy’s

  Mid-priced regional malls   Motherhood; Pea   $10 – $240    

Sears

  Mid-priced and moderate regional malls   Two Hearts Maternity by Destination Maternity   $  8 – $  36    

Gordmans

  Big box power centers   Motherhood   $10 – $  45    

Boscov’s

  Mid-priced and moderate regional malls   Motherhood   $10 – $  45    

buybuy BABY (1)

  Big box power centers   Motherhood; Pea   $10 – $200    

Exclusive Licensed Relationship:

         

Kohl’s

  Big box power centers   Oh Baby by Motherhood   $  8 – $  36   (2)  

 

(1) Beginning in late October 2012 our maternity apparel is available in leased departments in select buybuy BABY stores through our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc.

 

(2) Kohl’s, which sells our Oh Baby by Motherhood brand under an exclusive product and license agreement, sets the apparel price range for this merchandise.

 

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The following table sets forth our store count by nameplate as of September 30, 2012.

 

     Store Count as of
September 30, 2012
 

Motherhood Maternity

     507   

A Pea in the Pod

     36   

Destination Maternity:

  

Combo stores

     50   

Superstores

     32   
  

 

 

 

Total Destination Maternity stores

     82   
  

 

 

 

Total stores (1)

     625   
  

 

 

 

 

  (1) Excludes (i) leased departments, (ii) locations where Kohl’s sells our products under an exclusive product and license agreement and (iii) international franchised locations.

Major regional malls with several department stores and a wide range of price points may be able to accommodate a Destination Maternity store, or more than one maternity store. Our retail nameplates provide us with the ability to address multiple price alternatives at a given mall. As of September 30, 2012, we had two of our store concepts in nine major regional malls. Our preference is, over time and assuming we can obtain a suitable location under acceptable financial terms, to operate one larger-sized multi-brand store under the Destination Maternity nameplate in or near these malls, rather than two smaller single-brand stores.

Motherhood Maternity Stores.     Motherhood Maternity is our largest chain with 507 stores as of September 30, 2012. Motherhood is positioned with a broad assortment of quality fashion at everyday low prices. Motherhood stores average approximately 1,800 square feet and are located primarily in mid-priced and moderate regional malls, strip and power centers, and central business districts. Motherhood stores include 84 outlet locations that carry Motherhood-branded merchandise as well as some closeout merchandise. In fiscal 2012, we opened two new Motherhood outlets and closed 30 Motherhood stores and outlets, with eight of these store closings related to Destination Maternity store openings. As of September 30, 2012, we operated 34 Motherhood stores in Canada and believe that market opportunities may permit us to open additional stores in Canada in the future.

A Pea in the Pod Stores.     As of September 30, 2012, we had 36 A Pea in the Pod stores, averaging approximately 2,100 square feet. Certain of the A Pea in the Pod stores are located in mid-priced regional malls, lifestyle centers and central business districts while others are located in upscale venues, including Beverly Hills, Water Tower Place, South Coast Plaza and Newbury Street. In fiscal 2012, we closed seven Pea stores, with four of these store closings related to Destination Maternity store openings.

Destination Maternity Stores.     As of September 30, 2012, we had 82 Destination Maternity stores averaging approximately 4,200 square feet, including 50 Destination Maternity combo stores and 32 Destination Maternity superstores.

Destination Maternity Combo Stores.     As of September 30, 2012, we had 50 Destination Maternity combo stores. Our combo stores are larger (average of approximately 2,900 square feet) than our single-brand stores, generally have higher average sales volume than our average store and provide the opportunity to improve store operating profit margins over time. A new combo store often involves closing two stores (often one Motherhood store and one Pea store), although we sometimes close only one store in a given geographical market in situations where we believe we can expand sales through replacing a single-brand store with a Destination Maternity combo store. Store closings will sometimes involve one-time store closing costs resulting primarily from early lease terminations. Based on our internal research, we believe that over the next several years we have the potential to expand the Destination Maternity combo store chain to 70 or more total Destination Maternity combo stores in the United States. In fiscal 2012, we opened two Destination Maternity combo stores and closed four Destination Maternity combo stores.

 

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Destination Maternity Superstores.     As of September 30, 2012, we had 32 Destination Maternity superstores. Destination Maternity superstores currently carry both of our primary merchandise brands (Motherhood and Pea), plus a greatly expanded line of maternity-related accessories, nursing products, health and fitness products, books, and body and nutritional products. Our Destination Maternity superstores also typically feature a dedicated “learning center” area for maternity-related classes, a “relax area” for husbands and shoppers alike, and an inside play area for the pregnant mom’s toddlers and young children, with seven of our superstores also having our edamame® Maternity Spa®. These elements combine to give our Destination Maternity superstore not only the largest assortment of maternity apparel and accessories available, but also a unique and engaging atmosphere and experience for the maternity customer. A new Destination Maternity superstore typically involves closing at least two, and sometimes more, single-brand stores, is expected to decrease store operating expense percentages through economies of scale, and may increase overall sales in the geographical areas it serves. Destination Maternity superstores range from nearly 3,700 square feet to approximately 11,400 square feet, with an average of approximately 6,200 square feet for the 32 stores open as of September 30, 2012. In February 2006, we opened our flagship Destination Maternity superstore on the corner of 57th Street and Madison Avenue in New York City’s Manhattan borough. This is the largest maternity apparel store in the world, spanning three floors and including our edamame Maternity Spa, all of our primary apparel brands, prenatal education and yoga classes, a juice bar with Internet access, relax area and children’s play area. As the only national apparel retailer that is solely focused on maternity, we are further differentiating ourselves as the ultimate maternity apparel destination with these large, well-assorted, “must visit” superstores. We opened four Destination Maternity superstores during fiscal 2012. Based on our internal research, we believe that over the next several years we have the potential to expand the Destination Maternity superstore chain to 50 or more total Destination Maternity superstores in the United States.

Leased Departments.     In addition to the stores we operate, we have arrangements with department stores and baby specialty stores, including Macy’s, Sears, buybuy BABY, Gordmans and Boscov’s, to operate maternity apparel departments in their stores. We are the exclusive maternity apparel provider in each of our leased department locations. We staff these leased departments at varying levels and maintain control of the pricing terms and the timing and degree of the markdowns of our merchandise that is sold in the leased departments. We operate our leased departments during the same hours and days as the host store and are responsible for replenishment of the merchandise in the leased departments. These leased departments typically involve the lease partner collecting all of the revenue from the leased department. The revenue is remitted to us, less a fixed percentage of the net sales earned by the lease partner as stipulated in each agreement.

The following table sets forth our leased department count by lease partner as of September 30, 2012.

 

     Leased Department
Count as of
September 30, 2012
 

Macy’s

     621   

Sears

     515   

Babies“R”Us

     124  (1) 

Gordmans

     83   

Boscov’s

     40   
  

 

 

 

Total leased departments (2)(3)

     1,383   
  

 

 

 

 

  (1) During October 2012 we closed all 124 remaining Babies“R”Us leased department locations.

 

  (2) Excludes (i) locations where Kohl’s sells our products under an exclusive product and license agreement and (ii) international franchised locations.

 

  (3)

Beginning in late October 2012 our maternity apparel is available in leased departments in select buybuy BABY stores through our new broad-based partnership with Bed Bath & Beyond Inc. and its

 

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  subsidiary, Buy Buy Baby, Inc. As of August 25, 2012, Bed Bath & Beyond Inc. had 71 buybuy BABY stores, including 10 stores as of November 30, 2012, in which we operate leased departments. Over time, we expect to significantly increase the number of buybuy BABY stores in which we have a maternity apparel leased department.

Exclusive Licensed Relationship.     Our Oh Baby by Motherhood collection is available at all Kohl’s stores under an exclusive product and license agreement. The collection was launched in February 2005 at Kohl’s stores throughout the United States and on Kohls.com. As of September 30, 2012, Kohl’s operated approximately 1,146 stores throughout the United States.

International.     Currently, we operate 34 Motherhood stores in Canada and a Motherhood website under a Canadian URL (MotherhoodCanada.ca).

In October 2008, we announced our planned expansion into six key markets in the Middle East through an international franchise agreement with Multi Trend, a member of the Al-Homaizi Group, to introduce our brands into the Middle East. The initial franchise stores through our arrangement in the Middle East opened during 2009 and, as of September 30, 2012, there are 13 of our franchise stores operating in the Middle East.

In April 2009, we announced our planned expansion into India through an international franchise agreement with Mahindra Retail, part of the Mahindra Group, to introduce our brands into India. We have initially made our Motherhood Maternity product available for sale in maternity shop-in-shops located in Mahindra Retail’s Mom & Me stores (which carry infant and children’s apparel and non-apparel merchandise, as well as maternity apparel) and in franchise stores in India. As of September 30, 2012, our Motherhood Maternity merchandise is offered in 90 Mom & Me stores and one franchise store in India.

In June 2011, we announced our expansion into South Korea through an international franchise agreement with Agabang & Company, to introduce our brands into South Korea. We have initially made our Motherhood Maternity and A Pea in the Pod product available for sale in maternity shop-in-shops located in Agabang & Company’s Nextmom stores (which carry infant and children’s apparel and non-apparel merchandise, as well as maternity apparel) and in franchise stores in South Korea. As of September 30, 2012, our Motherhood Maternity and A Pea in the Pod merchandise is offered in 13 Nextmom stores and two franchise stores in South Korea.

We continue to evaluate other international sales opportunities. As our Middle East, India and South Korea franchise relationships demonstrate, we anticipate that our initial international strategy will consist primarily of franchising, licensing or similar arrangements with foreign partners. Our longer term strategy may include licensing arrangements with foreign partners, as well as potentially entering into wholesale business arrangements, entering into joint ventures or developing our own operations in certain countries.

Internet Operations

We sell our merchandise on the Internet primarily at our DestinationMaternity.com website and our brand-specific websites such as Motherhood.com and APeaInThePod.com. We also sell our merchandise through our Canadian website, MotherhoodCanada.ca. We believe that many pregnant women use the Internet to find maternity-related information and to purchase maternity clothes. Our websites are therefore important tools for educating existing and potential customers about our brands and driving traffic to our stores. Our DestinationMaternity.com website contains maternity advice and information, related baby product information and editorial content. Our marketing and technology capabilities and the replenishment capabilities of our distribution centers and stores enable us to incorporate Internet design, operations and fulfillment into our existing operations. We believe that our Internet operations represent a continued growth opportunity for the Company both by increasing Internet sales and by using the Internet to drive store sales. Our Internet sales increased 26% in fiscal 2012 and 114% over the last three fiscal years, and we look to continue to increase sales driven by our Internet operations in the future.

 

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Marketing Partnerships

We believe our customers, particularly first-time mothers, are entering a new life stage that drives widespread changes in purchasing needs and behavior, thus making our maternity customer and her family a highly-valued demographic for a range of consumer products and services companies. We have been able to leverage the relationship we have with our customers to earn incremental revenues and expect to expand these revenues through additional marketing partnerships.

We expect to continue to expand and leverage the relationship we have with our customers and earn incremental revenues through a variety of marketing partnership programs utilizing our extensive opt-in customer database and various in-store marketing initiatives, which help introduce our customers to various baby and parent-related products and services offered by leading third-party consumer products companies.

Operations

Brand-Specific Operations Teams.     To obtain maximum efficiencies, we are organized primarily along functional lines, such as store operations, merchandising, design and production. Our business consists of four merchandise brands, which each require decisions on a brand-specific basis. As such, we have built business teams by brand where the functional leaders within each brand work together. Each brand team is led by the head merchant and includes a brand-specific head designer, head planner and distributor, key production manager, and, where applicable, a director of stores. These teams also include visual, fabric purchasing and other necessary professionals.

Store Operations.     The typical maternity customer, especially the first-time mother, seeks more advice and assistance than the typical non-maternity customer. Therefore, we aim to employ skilled and motivated store team members who are trained to provide the high level of service and reassurance needed by our customers. We attempt to provide a boutique level of attentive service that differentiates us from our competitors. Our centralized merchandising and store operations also enable our store team members to focus primarily on selling and maintaining the appearance of the stores. In addition, visual merchants coordinate with the merchandising department to develop floor-sets, design store display windows and define and enhance the product presentation.

The field/store management reporting structure for each chain consists of a director, regional managers, district managers and store managers. These members of field/store management are each eligible to receive incentive-based compensation related to store, district, regional and chain-level performance.

Merchandising, Design and Inventory Planning and Allocation

Merchandising.     We strive to maintain an appropriate balance between new merchandise and proven styles, as well as between basic and fashion items. Our merchandising decisions are based on current fashion trends, as well as input from our designers and outside vendors. This information is used in conjunction with the item-specific sales data provided by our proprietary merchandising and replenishment system. Each brand has its own team of merchants, designers and planners. These teams are led by the head merchant of the brand who each report to our President.

Design.     Our design department creates and produces samples and patterns for our contract-manufactured products under the guidance of the merchandising department. The design of our products begins with a review of European and New York runway trends, current non-maternity retail fashion trends, fashion reporting service information and fabric samples. The designers review our best selling items from prior seasons and integrate current fashion ideas from the non-maternity apparel business.

Inventory Planning and Allocation.     Our inventory planning and allocation department is responsible for planning future inventory purchases and markdowns, as well as targeting overall inventory levels and turnover. We establish target inventories for each store using our inventory planning system with the goals of optimizing our merchandise assortment and turnover, maintaining adequate depth of merchandise by style and managing closeout and end-of-season merchandise consolidation. Our proprietary capabilities enable us to continually monitor and respond quickly to consumer demand and are integral to our inventory management program. These

 

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capabilities are facilitated by our customized merchandise analysis and planning system, which provides daily product sell-through data and merchandising information.

Production and Distribution

We design and contract for the production of over 90% of the merchandise we sell using sewing factories located throughout the world, predominantly outside of the United States, and we continue to seek additional contractors for our sourcing needs. No individual contractor represents a material portion of our sewing. A majority of our merchandise is purchased “full package” as finished product made to our specifications, typically utilizing our designs. Fabric, trim and other supplies are obtained from a variety of sources. Substantially all of the merchandise produced outside of the United States is paid for in United States dollars.

Our production personnel monitor production at contractor facilities in the United States and work with our buying representatives abroad to ensure quality control, compliance with our design specifications and timely delivery of finished goods. This quality control effort is enhanced by our worldwide Internet-based contracting and logistics systems, which include advanced features such as measurement specifications and digital photography. We also use a third-party consulting firm to help monitor working conditions at our contractors’ facilities on a worldwide basis.

We operate our distribution centers in Philadelphia, Pennsylvania. We own our primary distribution center in Philadelphia, Pennsylvania and lease a facility located in the Philadelphia Naval Business Center in Philadelphia, Pennsylvania, which we use for warehousing, distribution and raw material cutting.

Finished garments from contractors and other manufacturers are received at our primary distribution center in Philadelphia, Pennsylvania. Garments are inspected using statistical sampling methods and stored for picking. Our primary distribution center utilizes sophisticated fulfillment technology to serve as a replenishment center, as opposed to solely a distribution center. This distribution center sends selections from our overall inventory that meet the specific needs of each individual retail location, with shipments sent to each retail location between one and seven times per week. Retail location replenishment decisions are made automatically based upon target inventories established by the planning and allocation department and individual retail location sales data. Our primary distribution center uses several automated systems, including our pick-to-light system for flat-packed goods and our hanging garment sortation system, which speed up deliveries to our retail locations and reduce costs. Freight is routed through zone-skipping, over-the-road carriers and delivered locally by a variety of carriers, and is supplemented by a small percentage of second-day air, providing one to three day delivery to our retail locations.

Since 2003 we have been certified to participate in Customs-Trade Partnership Against Terrorism (“C-TPAT”), a United States Department of Homeland Security sponsored program, with United States Customs and Border Protection (“U.S. Customs”), through which we implement and monitor our procedures to manage the security of our supply chain as part of the effort to protect the United States and our imported products against potential acts of terrorism. Since 2005 we have been certified to participate in the Importer Self-Assessment Program (“ISA”), a U.S. Customs program available only to C-TPAT participants with strong internal controls. Through our participation in the ISA program, we assume responsibility for monitoring our own compliance activities with applicable U.S. Customs regulations in exchange for certain benefits, which may help increase efficiency in importing. These benefits include exemption from certain government audits, increased speed of cargo release from U.S. Customs, front of the line access to U.S. Customs cargo exams, enhanced prior disclosure rights from U.S. Customs in the event of alleged trade violations, availability of voluntary additional compliance guidance from U.S. Customs, and less intrusive government oversight of trade compliance. In 2010, we were granted Tier 3 Status within the C-TPAT program, the highest level of recognition currently available.

In 2007 we were accepted to participate in the U.S. Customs and Border Protection’s Drawback Compliance Program. The benefits of this program include (i) waiver of prior notice where we do not have to notify U.S. Customs at the time of export of product to Canada and (ii) accelerated payment privileges, with respect to

 

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goods we export from the United States, which we previously imported into the United States, to receive drawback refunds of United States import duties previously paid within 30 days of filing the claim for refund.

Management Information and Control Systems

We believe that our proprietary systems are instrumental to our ability to offer the broadest assortment of maternity apparel merchandise and accomplish rapid replenishment of inventory. We continuously develop, maintain and upgrade our systems and we employ an in-house team of programmers. Our stores have point-of-sale terminals that provide information used in our customized merchandise analysis and planning system. This system provides daily financial and merchandising information that is integral to monitoring trends and making merchandising decisions. Our systems have numerous features designed to integrate our retail operations with our design, manufacturing and financial functions. These features include custom merchandise profiles for each store, rapid inventory replenishment, item-tracking providing daily updated selling information for every style, classification open-to-buy and inventory control, as well as the daily collection of customer payment data, including cash, check, credit card, debit card and gift card sales data.

As part of our proprietary ERP system, we employ a comprehensive materials requirement planning (“MRP”) system to manage our production inventories, documentation, work orders and scheduling. This system provides a perpetual inventory of raw materials, actual job costing, scheduling and bill of materials capabilities. The foundation of our proprietary ERP system is a perpetual inventory of finished goods by stock keeping unit (“SKU”) and location across all of our retail locations, which interfaces directly with our distribution facility.

Our proprietary, Internet-based point-of-sale system provides real-time access to financial and merchandising information in addition to rapid credit authorization. This point-of-sale system significantly reduces the amount of training required for new sales associates and store managers. In addition, we regularly add new features and functionality to the system, and the system improves our customer relationship management capabilities by enhancing our ability to create customized promotional and marketing strategies.

Given the importance of our management information systems, we have taken extensive measures to ensure their responsiveness and security. Our hardware and communications systems are based on a redundant and multiprocessing architecture, which allows their continued operation on a parallel system in the event that there is a disruption within the primary system. Our main computer system, located at our headquarters in Philadelphia, Pennsylvania, is duplicated by a fully mirrored system in a separate part of the building with a separate power source that is designed to assume full operations should disruption in the primary system occur. In addition, our software programs and data are backed up and securely stored off-site. Our communications links come from two telephone frame rooms and are delivered through underground and aboveground feeds.

Advertising and Marketing

We believe that we drive traffic into our stores through the power of our brands, referrals to friends and family from current and prior customers, our various websites and, perhaps most importantly, our convenient, high-traffic locations in various types of shopping malls and, to a much lesser extent, street locations. Therefore, we have modest advertising and marketing expenditures. Our marketing efforts include publicity, e-mail marketing, web-based advertising, in-store marketing and prenatal consumer-targeted advertising. For our Destination Maternity superstores, we advertise locally prior to each grand opening and continue to advertise both nationally and, at times, locally after the store opens. We advertise one or more of our brands in pregnancy-targeted publications, such as Fit Pregnancy, Pregnancy & Newborn, BabyTalk-Pregnancy Planner, Parenting Early Years, New Parent and American Baby. For our luxury A Pea in the Pod brand, we advertise in high-fashion publications, such as InStyle. In addition, we utilize our publicity efforts to generate free editorial coverage for all of our brands on broadcast television, radio, social media, the Internet and in magazines and newspapers.

Competition

Our business is highly competitive and characterized by low barriers to entry. The following are several factors important to competing successfully in the retail apparel industry: breadth of selection in sizes, colors and

 

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styles of merchandise; product procurement and pricing; ability to anticipate fashion trends and customer preferences; inventory control; reputation; quality of merchandise; store design and location; visual presentation and advertising; and customer service. We face competition in our maternity apparel lines from various sources, including department stores, specialty retail chains, discount stores, independent retail stores and catalog and Internet-based retailers, from both new and existing competitors. Many of our competitors are larger and have substantially greater financial and other resources than us. Our mid- and luxury-priced merchandise faces a highly fragmented competitive landscape that includes locally based, single unit retailers, as well as a handful of multi-unit maternity operations, none of which we believe has more than 10 stores nationwide. In the value-priced maternity apparel business, we currently face competition on a nationwide basis from retailers such as Gap®, H&M®, Old Navy®, Target® and Wal-Mart®. In addition, with our exit from Babies“R”Us in late October 2012 (in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc.), in November 2012, Toys “R” Us, Inc. announced that it had entered into a partnership with Thyme Maternity, a Canada based company, for a collection of maternity apparel and accessories to be featured in approximately 150 Babies“R”Us stores in the United States. Substantially all of these competitors also sell maternity apparel on their websites.

Employees

As of September 30, 2012, we had approximately 1,800 full-time and 2,900 part-time employees. None of our employees are covered by a collective bargaining agreement. We consider our employee relations to be good.

Executive Officers of the Company

The following table sets forth the name, age and position of each of our executive officers:

 

Name

   Age     

Position

Edward M. Krell

     50       Chief Executive Officer

Christopher F. Daniel

     55       President

Judd P. Tirnauer

     44       Executive Vice President & Chief Financial Officer

Ronald J. Masciantonio

     35       Executive Vice President, Chief Administrative Officer & General Counsel

Edward M. Krell has served as our Chief Executive Officer and a director since October 2008. From August 2010 to May 2011, Mr. Krell also served as the Company’s President. From July 2008 until October 2008, Mr. Krell served as our Chief Operating Officer and from May 2007 to July 2008, Mr. Krell served as our Chief Operating Officer & Chief Financial Officer. From November 2003 to May 2007, Mr. Krell served as our Executive Vice President—Chief Financial Officer, having served as Senior Vice President—Chief Financial Officer from the time he joined us in January 2002 until November 2003. Prior to joining us, Mr. Krell served in various senior financial management positions, including having served as Chief Financial Officer of London Fog Industries, Inc., a wholesale and retail distributor of rainwear and outerwear. Mr. Krell began his career as an investment banker with Kidder, Peabody & Co. Incorporated and earned a Masters of Business Administration degree from Stanford University and a Bachelor of Arts degree from Harvard University. In 2010, Mr. Krell was named Citizen of the Year by the March of Dimes, Southeast Pennsylvania Division. In 2012, Mr. Krell was honored by Dignity U Wear as one of Dignity’s Champions for his leadership role in facilitating our partnership with this charitable organization benefitting disadvantaged women.

Christopher F. Daniel has served as our President since June 2011. Prior to joining us, Mr. Daniel served as President of Torrid, a division of Hot Topic, from November 2006. Mr. Daniel has also served in executive and management positions in merchandising and product development at Mervyn’s and Dayton-Hudson (divisions of Target Corporation), Structure (a division of Limited Brands), and Charming Shoppes. Mr. Daniel holds a Bachelor of Arts degree in English Literature from the University of Richmond.

Judd P. Tirnauer has served as our Executive Vice President & Chief Financial Officer since November 2011. From July 2008 to November 2011, Mr. Tirnauer served as our Senior Vice President & Chief Financial

 

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Officer, having previously served as our Vice President—Finance from June 2005 to July 2008, Vice President—Financial Planning & Analysis from October 2003 to June 2005, and Director of Financial Planning & Analysis from the time he joined us in November 2001 until October 2003. Mr. Tirnauer has earned both a Masters of Business Administration degree and a Juris Doctorate legal degree, and has earned a Certified Public Accountant designation.

Ronald J. Masciantonio has served as our Executive Vice President & General Counsel since November 2011 and was named to the additional position of Chief Administrative Officer in November 2012. From April 2010 to November 2011, Mr. Masciantonio served as our Senior Vice President & General Counsel, having previously served as our Vice President & General Counsel since August 2006. In August 2006, Mr. Masciantonio rejoined us, after having previously served as our Assistant General Counsel from February 2004 to May 2005. From May 2005 to August 2006, Mr. Masciantonio was Assistant General Counsel, North America for Taylor Nelson Sofres, N.A., a market research company with global headquarters in London, England. Prior to joining us originally in February 2004, Mr. Masciantonio was an Associate at the law firm of Pepper Hamilton LLP in Philadelphia, Pennsylvania from September 2001 to February 2004. Mr. Masciantonio received his Juris Doctorate legal degree from Temple University School of Law in Philadelphia, Pennsylvania.

Our executive officers are appointed annually by our Board of Directors and serve at the discretion of the Board. There are no family relationships among any of our executive officers.

Intellectual Property

We own trademark and service mark rights that we believe are sufficient to conduct our business as currently operated. We own several trademarks, including Destination Maternity Corporation®, A Pea in the Pod®, A Pea in the Pod Collection®, Motherhood®, Motherhood Maternity®, Destination Maternity®, edamame® Maternity Spa®, Two Hearts® Maternity, Oh Baby by Motherhood® and Motherhood Maternity Outlet®. Additionally, we own the marks Secret Fit Belly®, Mimi Maternity® and Maternity Redefined®.

In addition, from time to time, we may pursue patent protection for certain maternity apparel related technologies that we develop. For example, in October 2010 and March 2011 we were granted patents for our Secret Fit Belly. The Secret Fit Belly is made of seamless super stretch fabric that can form part of nearly any type of bottom (such as jeans, pants, shorts and skirts) to provide a better, more comfortable fit and a seamless look. In October 2012 we filed a lawsuit against Target Corporation and others for infringement of our proprietary patented Secret Fit Belly® technology.

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 peak Spring selling season. Given the historically higher sales level in our third fiscal quarter and the relatively fixed nature of most of our operating expenses and interest expense, we have typically generated a very significant percentage of our full year operating income and net income during our third fiscal 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, increases or decreases in comparable sales, the timing of new store openings and new leased department openings, net sales and profitability contributed by new stores and leased departments, 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.

Securities and Exchange Commission Filings

Our Securities and Exchange Commission (“SEC”) filings are available free of charge on our website, investor.destinationmaternity.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are posted on our website as soon as practicable after we furnish such materials to the SEC.

 

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Item 1A. Risk Factors

You should consider carefully all of the information set forth or incorporated by reference in this document and, in particular, the following risk factors associated with our business and forward-looking information in this document (see also “Forward-Looking Statements” included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations). The risks described below are not the only ones 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 below actually occur, our business, results of operations, cash flows or financial condition could suffer.

Our performance may be affected by general economic conditions and the continued global financial difficulties.

Our performance is subject to worldwide economic conditions and their impact on levels of consumer spending. Over the past four years economic conditions have deteriorated significantly followed by a weak recovery and such economic conditions may remain depressed, or be subject to further deterioration. Some of the factors that are having an impact on discretionary consumer spending include general economic conditions, employment, consumer debt, reductions in net worth based on securities market declines, residential real estate and mortgage markets, taxation, healthcare costs, fuel and energy prices, interest rates, credit availability, consumer confidence and other macroeconomic factors.

The worldwide apparel industry is heavily influenced by general economic cycles. Apparel retailing is a cyclical industry that is heavily dependent upon the overall level of consumer spending. Purchases of specialty apparel and related goods tend to be highly correlated with the cycles of the levels of disposable income of consumers. As a result, any substantial deterioration in general economic conditions could materially and adversely affect our net sales and results of operations. Downturns, or the expectation of a downturn, in general economic conditions could materially and adversely affect consumer spending patterns, our sales and our results of operations.

Consumer purchases of discretionary items generally decline during recessionary periods and other periods where disposable income is adversely affected. The downturn in the economy may continue to affect consumer purchases of our merchandise and have an adverse impact on our sales, results of operations and cash flow. Because apparel generally is a discretionary purchase, declines in consumer spending may have a more negative effect on apparel retailers than on other retailers. We may not be profitable if there is a decline in consumer spending.

The turmoil in the financial markets in 2008-2009 resulted in extreme volatility in security prices and diminished liquidity and credit availability, and there can be no assurance that our liquidity will not be affected by changes in the financial markets and the global economy. Tightening of the credit markets and future turmoil in the financial markets could also make it more difficult for us to access funds, to refinance our existing indebtedness (if necessary), to enter into agreements for new indebtedness, or to obtain funding through the issuance of our securities.

In addition, the effect from the 2008-2009 credit crisis had a significant negative impact on businesses around the world, and the potential impact of this crisis, or potential future crises, on our suppliers cannot be predicted. The inability of suppliers to access liquidity, or the insolvency of suppliers, could lead to their failure to deliver our merchandise. Worsening economic conditions could also result in difficulties for financial institutions (including bank failures) and other parties that we may do business with, which could potentially impair our ability to access financing under existing arrangements or to otherwise recover amounts as they become due under our other contractual arrangements. Additionally, either as a result of, or independent of, the current financial difficulties and economic weakness in the United States, material fluctuations in currency exchange rates could have a negative impact on our business.

 

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Our comparable sales and quarterly operating results have fluctuated in the past and can be expected to continue to fluctuate in the future and, as a result, the market price of our common stock may fluctuate or decline substantially.

Our comparable sales and quarterly results of operations have fluctuated in the past and can be expected to continue to fluctuate in the future and are affected by a variety of factors, including:

 

   

the opening of new stores, the closing of existing stores, and the success of our leased department and licensed relationships;

 

   

the timing of new store openings and leased department and licensed brand business openings;

 

   

the timing of the fulfillment of purchase orders under our product and license arrangements;

 

   

the extent of cannibalization of sales volume of some of our existing retail locations by our new retail locations opened in the same geographic markets or by our Internet sales;

 

   

changes in our merchandise mix;

 

   

any repositioning of our brands;

 

   

general economic conditions and, in particular, the retail sales environment;

 

   

calendar shifts, including shifts of holiday or seasonal periods, or shifts in the number of weekend days occurring in a given calendar period;

 

   

changes in pregnancy rates and birth rates;

 

   

actions of competitors;

 

   

the level of success and/or actions of anchor tenants where we have stores or leased department and licensed relationships;

 

   

fashion trends; and

 

   

weather conditions and seasonality.

If, at any time, our comparable sales or quarterly results of operations decline or do not meet the expectations of investors, the price of our common stock could decline substantially.

Our share price may be volatile and could decline substantially.

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

 

   

actual or anticipated variations in the financial results and prospects of our business or other companies in the retail business;

 

   

changes in financial estimates by Wall Street research analysts;

 

   

actual or anticipated changes in the United States economy or the retailing environment;

 

   

changes in the market valuations of other specialty apparel or retail companies;

 

   

announcements by our competitors or us;

 

   

additions and departures of key personnel;

 

   

changes in accounting principles;

 

   

the passage of legislation or other developments affecting us or our industry;

 

   

the trading volume of our common stock in the public market;

 

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changes in economic conditions;

 

   

financial market conditions;

 

   

natural disasters, terrorist acts, acts of war or periods of civil unrest; and

 

   

the realization of some or all of the risks described in this section entitled “Risk Factors.”

In addition, the stock markets have experienced significant price and trading volume fluctuations from time to time, and the market prices of the equity securities of retailers have been extremely volatile and are sometimes subject to sharp price and trading volume changes. These broad market fluctuations may materially and adversely affect the market price of our common stock.

We may not be successful in maintaining and expanding our business and opening new retail locations.

Any future growth depends significantly on:

 

   

our ability to successfully establish and operate new stores (including Destination Maternity combo stores and superstores) on a profitable basis;

 

   

our ability to successfully establish new, and to maintain our current, leased department and licensed relationships, and to operate such leased department and licensed relationships on a profitable basis; and

 

   

the success and profitability of our international business, including our ability to successfully establish new, and to maintain our current, international franchising relationships.

This growth, if it occurs, will place increased demands on our management, operational and administrative resources. These increased demands and operating complexities could cause us to operate our business less effectively, which, in turn, could cause a deterioration in our financial performance and negatively impact our growth. Any planned growth will also require that we continually monitor and upgrade our management information and other systems, as well as our distribution infrastructure.

Our ability to establish and operate new stores and our leased department and licensed relationships successfully depends on many factors, including, among others, our ability to:

 

   

identify and obtain suitable store locations, including mall locations, the availability of which is outside of our control;

 

   

retain existing, expand existing and establish new leased department and licensed relationships;

 

   

negotiate favorable lease terms for stores, including desired tenant improvement allowances;

 

   

negotiate favorable lease terminations for existing store locations in markets where we intend to open new Destination Maternity combo stores or superstores;

 

   

source sufficient levels of inventory to meet the needs of new stores and our leased department and licensed relationships;

 

   

successfully address competition, merchandising and distribution challenges; and

 

   

hire, train and retain a sufficient number of qualified store personnel.

The success and profitability of our international business depends on many factors, including, among others:

 

   

our ability to retain our current international franchisees and our ability to identify and reach agreement with new international franchisees;

 

   

the ability of our franchisees to identify and obtain suitable store locations, including mall locations, the availability of which is outside of their control;

 

   

the ability of our franchisees to negotiate favorable lease terms for stores, including desired tenant improvement allowances;

 

   

our ability to source sufficient levels of inventory to meet the needs of our franchisees’ international operations;

 

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our ability and the ability of our franchisees to successfully address competition, merchandising and distribution challenges; and

 

   

the ability of our franchisees to hire, train and retain a sufficient number of qualified store personnel.

There can be no assurance that we will be able to grow our business and achieve our goals. Even if we succeed in establishing new stores, further developing our leased department and licensed relationships and further expanding our international relationships, we cannot assure that these initiatives will achieve planned revenue or profitability levels in the time periods estimated by us, or at all. If any of these initiatives fails to achieve or is unable to sustain acceptable revenue and profitability levels, we may incur significant costs. For example, in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc., (which we announced in May 2012) we discontinued operation of our 124 remaining leased departments in Babies“R”Us in October 2012 and opened leased departments in select buybuy BABY stores. Although we are confident that the new relationship with Bed Bath & Beyond Inc. and Buy Buy Baby, Inc. will be a profitable one for our Company and our stockholders, there is no guarantee of success.

Our business, financial condition and results of operations may be materially and adversely impacted at any time by a significant number of competitors.

We operate in a highly competitive environment characterized by few barriers to entry. We compete against department stores, specialty retail chains, discount stores, independent retail stores and catalog and Internet-based retailers. Many of our competitors are larger and have substantially greater financial and other resources than us. Further, we do not typically advertise using television and radio media and thus do not reach customers through means our competitors may use. Our mid- and luxury-priced merchandise faces a highly fragmented competitive landscape that includes locally based, single unit retailers, as well as a handful of multi-unit maternity operations, none of which we believe have more than 10 stores nationwide. In the value-priced maternity apparel business, we face competition on a nationwide basis from retailers such as Gap, H&M, Old Navy, Target and Wal-Mart. In addition, with our exit from Babies“R”Us in late October 2012 (in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc.), in November 2012, Toys“R”Us, Inc. announced that it had entered into a partnership with Thyme Maternity, a Canada based company, for a collection of maternity apparel and accessories to be featured in approximately 150 Babies“R”Us stores in the United States. Substantially all of these competitors also sell maternity apparel on their websites. Our business, financial condition and results of operations may be materially and adversely affected by this competition, including the potential for increased competition in the future. For example, the maternity apparel business has previously experienced oversupply conditions due to increased competition in the maternity apparel business, which resulted in a greater level of industry-wide markdowns and markdowns recognized by us on sales from our retail locations. There can be no assurance that these conditions will not occur again or worsen.

Our relationships with third-party retailers may not be successful.

We cannot guarantee successful results from or the continuation of our leased department and licensed relationships with third-party retailers such as Macy’s, Sears, buybuy BABY, Gordmans, Boscov’s and Kohl’s. Under our agreement with Kohl’s, subject to certain notice obligations, Kohl’s is not obligated to purchase any maternity apparel from us and we are not obligated to sell any maternity apparel to them. We do not control the pricing terms or the timing or degree of the markdowns at Kohl’s. Under our agreements with our leased department partners, those partners do not make any promises or representations as to the potential amount of business we can expect from the sale of our product in their stores. For example, as we previously announced, we discontinued offering maternity apparel in our 124 remaining Babies“R”Us locations in October 2012 in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc. The success of our leased department and licensed brand businesses is highly dependent on the actions and decisions of the third-party retailers, which are outside of our control. The retailers could limit the merchandise carried, close stores, go out of business or terminate their agreements with us. Our failure to properly manage our leased department and licensed brand businesses (including any failure by us in timely delivering goods to any third-party retailer or any failure to respond to the actions of, or changes in, business

 

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conditions at third-party retailers) would have a direct impact on the profitability and continuation of these relationships.

Our business depends on sustained demand for maternity clothing and is sensitive to birth rates, women’s fashion trends, economic conditions and consumer spending.

Our business depends upon sustained demand for maternity clothing. Our future performance will be subject to a number of factors beyond our control, including demographic changes, fashion trends, economic conditions and consumer spending. If demand for maternity clothing were to decline for any reason, such as a decrease in the number of pregnancies, our operating results could be materially and adversely affected. For example, according to the United States Census Bureau and United States Centers for Disease Control and Prevention, births declined 1.1% in calendar 2011 compared to calendar 2010, declined 3.2% in calendar 2010 compared to calendar 2009, and declined a total of 8.8% from calendar 2007 to mid-calendar 2012. If this trend were to continue it could negatively affect our business and results of operations. Additionally, our operating results could be materially and adversely affected if certain non-maternity women’s apparel fashions have a more pregnancy-friendly fit. For example, in fiscal 2007, we were negatively impacted by the popularity of certain styles in the non-maternity women’s apparel market, such as trapeze and baby-doll dresses and tops, which can more readily fit a pregnant woman early in her pregnancy than typical non-maternity fashions. Downturns, or the expectation of a downturn, in general economic conditions could materially and adversely affect consumer spending patterns, our business, financial condition and results of operations. In addition, the specialty apparel retail business historically has been subject to cyclical variations. Consumer purchases of specialty apparel products, including maternity wear, may decline during recessionary periods and at other times when disposable income is lower. Declines in consumer spending patterns may have a more negative effect on apparel retailers than some other retailers. Therefore, we may not be able to maintain our historical sales and earnings, or remain as profitable, if there is a decline in consumer spending patterns. A prolonged economic downturn could have a material adverse impact on our business and results of operations.

We may not be successful in maintaining and expanding our marketing partnership programs.

We cannot guarantee successful results from the continuation of, or the expansion of, our marketing partnership programs which utilize our opt-in customer database and various in-store marketing initiatives. The success of our marketing partnership programs is highly dependent on the actions and decisions of the third-party consumer products companies to whom we provide these services. Should these third-party consumer products companies decide to limit the services provided by us, go out of business or terminate their agreements with us, our business, financial condition and results of operations could be materially and adversely affected. Further, there is no guarantee that we will be able to expand this part of our business through agreements with new third parties. In addition, our ability to provide the services is dependent on our successful collection of opt-in customer data as well as applicable law relating to the collection and transfer of the personally identifiable information of our customers. A failure on our part to collect adequate amounts of customer data or any change in state, local or federal law which further restricts our ability to collect this information could cause us to terminate or limit the services we can provide to the third-party consumer products companies and would ultimately adversely affect our revenue from these relationships. Further, although we believe there may be an opportunity to more actively market our full customer database to a much broader range of consumer products and services companies that market to families with children, we cannot guarantee that these efforts will be successful.

We require a significant amount of cash to pay quarterly dividends as well as to fund our operations and future growth.

Our ability to pay quarterly dividends, as well as to fund our operations and future growth, depends upon our ability to generate cash. Our success in generating cash depends upon the results of our operations and the amount of cash we use in investing activities, as well as upon general economic, financial, competitive and other factors beyond our control.

 

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An inability to generate sufficient cash could have important consequences. For example, it could:

 

   

increase our vulnerability to general adverse economic and industry conditions;

 

   

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

   

place us at a competitive disadvantage compared to our competitors;

 

   

limit our ability to borrow money;

 

   

make it more difficult for us to open new stores or improve or expand existing stores;

 

   

restrict our ability to pay dividends or make distributions to our stockholders;

 

   

require us to incur significant additional indebtedness; and

 

   

make it more difficult for us to pursue strategic acquisitions, alliances and partnerships.

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Any borrowings under our new revolving credit facility, which could significantly increase in the future, would bear interest at a variable rate. We have exposure for the variable interest rate borrowings under our revolving credit facility. As a result, an increase in interest rates could result in a substantial increase in interest expense, especially if our borrowings under our revolving credit facility increase.

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

The efficient operation of our business is heavily dependent on our internally developed management information systems (“MIS”). In particular, we rely on point-of-sale terminals, which provide information to our customized merchandise analysis and planning system used to track sales and inventory, and we rely on our Internet websites through which we sell merchandise to our customers. The merchandise analysis and planning system helps integrate our design, manufacturing, distribution and financial functions, and also provides daily financial and merchandising information. Although our software programs and data are backed up and securely stored off-site, our servers and computer systems are located at our headquarters in Philadelphia, Pennsylvania. These systems and our operations are vulnerable to damage or interruption from:

 

   

fire, flood and other natural disasters;

 

   

power loss, computer systems failures, Internet and telecommunications or data network failure, operator negligence, improper operation by or supervision of employees, physical and electronic loss of data or security breaches, misappropriation and similar events; and

 

   

computer viruses.

Any disruption in the operation of our MIS, the loss of employees knowledgeable about such systems or our failure to continue to effectively modify such systems could interrupt our operations or interfere with our ability to monitor inventory, which could result in reduced net sales and affect our operations and financial performance. In addition, any interruption in the operation of our Internet websites could cause us to lose sales due to the inability of customers to purchase merchandise from us through our websites during such interruption.

We also need to ensure that our systems are consistently adequate to handle our anticipated business growth and are upgraded as necessary to meet our needs. The cost of any such system upgrades or enhancements could be significant. As a result, our business, financial condition and results of operations could be materially and adversely affected if our servers and systems were inoperable or inaccessible.

From time to time, we improve and upgrade our MIS and the functionality of our Internet websites. If we are unable to maintain and upgrade our systems or Internet websites, or to integrate new and updated systems or changes to our Internet websites in an efficient and timely manner, our business, financial condition and results of operations could be materially and adversely affected.

 

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A cybersecurity incident could have a negative impact.

A cyber attack may bypass the security for our MIS causing an MIS security breach and leading to a material disruption of our MIS and/or the loss of business information and/or Internet sales. Such a cyber attack could result in any of the following:

 

   

theft, destruction, loss, misappropriation or release of confidential data or intellectual property;

 

   

operational or business delays resulting from the disruption of MIS and subsequent clean-up and mitigation activities;

 

   

negative publicity resulting in reputation or brand damage with our customers, partners or industry peers; and

 

   

loss of sales generated through our Internet websites through which we sell merchandise to customers, to the extent these websites are affected by a cyber attack.

As a result, our business, financial condition and results of operations could be materially and adversely affected.

As an apparel retailer, we rely on numerous third parties in the supply chain to produce and deliver the products that we sell, and our business may be negatively impacted by disruptions in the supply chain.

If we lose the services of one or more of our significant suppliers or one or more of them fail to meet our product needs, we may be unable to obtain replacement merchandise in a timely manner. If our existing suppliers cannot meet our increased needs and we cannot locate alternative supply sources, we may be unable to obtain sufficient quantities of the most popular items at attractive prices, which could negatively impact our sales and results of operations. We obtain apparel and other merchandise from foreign sources, both purchased directly in foreign markets and indirectly through domestic vendors with foreign sources. To the extent that any of our vendors are located overseas or rely on overseas sources for a large portion of their products, any event causing a disruption of imports, including the imposition of import restrictions, could harm our ability to source product. This disruption could materially limit the merchandise that we would have available for sale and reduce our sales and earnings. The flow of merchandise from our vendors could also be materially and adversely affected by financial or political instability, or war, in or affecting any of the countries in which the goods we purchase are manufactured or through which they flow. Trade restrictions in the form of tariffs or quotas, embargoes and customs restrictions that are applicable to the products that we sell also could affect the import of those products and could increase the cost and reduce the supply of products available to us. Any material increase in tariff levels, or any material decrease in quota levels or available quota allocation, could negatively impact our business. Further, changes in tariffs or quotas for merchandise imported from individual foreign countries could lead us to shift our sources of supply among various countries. Any such shift we undertake in the future could result in a disruption of our sources of supply and/or an increase in product costs, and lead to a reduction in our sales and earnings. Supply chain security initiatives undertaken by the United States government that impede the normal flow of product could also negatively impact our business. In addition, decreases in the value of the United States dollar against foreign currencies could increase the cost of products that we purchase from overseas vendors.

We also face a variety of other risks generally associated with relying on vendors that do business in foreign markets and import merchandise from abroad, such as:

 

   

political instability or the threat of terrorism, particularly in countries where our vendors source merchandise;

 

   

enhanced security measures at United States and foreign ports, which could delay delivery of imports;

 

   

imposition of new or supplemental duties, taxes and other charges on imports;

 

   

delayed receipt or non-delivery of goods due to the failure of foreign-source suppliers to comply with applicable import regulations;

 

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delayed receipt or non-delivery of goods due to organized labor strikes or unexpected or significant port congestion at United States ports; and

 

   

local business practice and political issues, including issues relating to compliance with domestic or international labor standards, which may result in adverse publicity.

The United States may impose new initiatives that adversely affect the trading status of countries where apparel is manufactured. These initiatives may include retaliatory duties or other trade sanctions that, if enacted, would increase the cost of products imported from countries where our vendors acquire merchandise. Any of these factors could have a material adverse effect on our business, financial condition and results of operations.

We could be materially and adversely affected if our distribution operations were disrupted.

To support our distribution of product throughout the world, we operate our main distribution facility and one significantly smaller distribution facility, both in Philadelphia, Pennsylvania. Finished garments from contractors and other manufacturers are inspected and stored for distribution. We do not have other distribution facilities to support our distribution needs. If our main Philadelphia distribution facility were to shut down or otherwise become inoperable or inaccessible for any reason (such as, for example, due to natural disasters, like the recent Hurricane Sandy, which affected our region in early fiscal 2013), we could incur significantly higher costs and longer lead times associated with the distribution of our products to our stores and to our third-party retailers during the time it takes to reopen or replace this facility. In light of our strategic emphasis on rapid replenishment as a competitive strength, a distribution disruption might have a disproportionately adverse effect on our operations and profitability relative to other retailers. In addition, the loss or material disruption of service from any of our shippers for any reason, whether due to freight difficulties, strikes, natural disaster or other difficulties at our principal transport providers or otherwise, could have a material adverse impact on our business, financial condition and results of operations.

We could be materially and adversely affected if we are unable to obtain sufficient raw materials or maintain satisfactory manufacturing arrangements.

We do not own any manufacturing facilities and therefore depend on third parties to manufacture our products. We place our orders for production of merchandise and raw materials by purchase order and do not have any long-term contracts with any manufacturer or supplier. We compete with many other companies for production facilities and raw materials. Furthermore, we have received in the past, and may receive in the future, shipments of products from manufacturers that fail to conform to our quality control standards or environmental standards. In such event, unless we are able to obtain replacement products in a timely manner, we may lose sales. We have no ability to control the environmental compliance (including compliance with climate change requirements) of these third-party manufacturers. If we fail to maintain favorable relationships with these third parties, or if we cannot obtain an adequate supply of quality raw materials on commercially reasonable terms, it could have a material adverse impact on our business, financial condition and results of operations.

Fluctuations in commodity prices could result in an increase in component costs, delivery costs, and overall product costs.

The results of our business operations could suffer due to significant increases or volatility in the prices of certain commodities, including but not limited to cotton, wool and other ingredients used in the production of fabric and accessories, as well as fuel, oil and natural gas. In addition, increases in the price of food and food commodities may result in increased labor rates related to textile and apparel production. Increases in prices of these commodities or other inflationary pressures may result in significant cost increases for our raw materials, product components and finished products, as well as increases in the cost of distributing merchandise to our retail locations and shipping products to our customers. For example, in the latter part of fiscal 2011 and for most of fiscal 2012, we experienced product cost of sales increases due, in part, to the increased cost of cotton as well as, to a lesser extent, increased labor rates in certain production countries. To the extent we are unable to offset any such increased costs through value engineering and similar initiatives, or through price increases, our profitability, cash flows and financial condition may be materially and adversely impacted. If we choose to increase prices to offset the increased costs, our unit sales volumes could be adversely impacted.

 

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Our stores are heavily dependent on the customer traffic generated by shopping malls.

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

The success of all of our mall stores will depend, in part, on the ability of each mall’s anchor tenants, such as large department stores, other tenants and area attractions to generate consumer traffic in the vicinity of our stores, and the continuing popularity of malls as shopping destinations. Many traditional enclosed malls are experiencing significantly lower levels of customer traffic than in the past, driven by overall poor economic conditions as well as the closure of certain mall anchor tenants. Sales volume and mall traffic may be materially and adversely affected by economic downturns in a particular area, the closing of anchor tenants or competition from non-mall retailers and other malls where we do not have stores.

Our success depends on our ability to identify and rapidly respond to fashion trends.

The apparel industry is subject to rapidly changing fashion trends and shifting consumer demands. Accordingly, our success depends on the priority that our target customers place on fashion and our ability to anticipate, identify and capitalize upon emerging fashion trends. Our ability or our failure to anticipate, identify or react appropriately to changes in styles or trends could lead to, among other things, excess inventories and higher markdowns, as well as the decreased appeal of our brands. Particular fashion trends, or an inaccuracy of our forecasts regarding fashion trends, could have a material adverse effect on our business, financial condition and results of operations. For example, in fiscal 2007 we were negatively impacted from the popularity of certain styles in the non-maternity women’s apparel market, such as trapeze and baby-doll dresses and tops, which can more readily fit a pregnant woman early in her pregnancy than typical non-maternity fashions.

The failure to attract and retain highly skilled and qualified senior management personnel could have a material adverse impact on our business, financial condition and results of operations.

Our business requires disciplined execution at all levels of our organization in order to timely deliver and display fashionable merchandise in appropriate quantities in our stores. This execution requires experienced and talented management. We currently have a management team with a great deal of experience with us and in apparel retailing. If we were to lose the benefit of this experience, our business, financial condition and results of operations could be materially and adversely affected.

In addition, as our business expands, we believe that our success will depend greatly on our continued ability to attract and retain highly skilled and qualified personnel. There is a high level of competition for personnel in the retail industry. Like most retailers, we experience significant employee turnover rates, particularly among store sales associates and managers, and our continued growth will require us to hire and train even more new personnel. We therefore must continually attract, hire and train new personnel to meet our staffing needs. We constantly compete for qualified personnel with companies in our industry and in other industries. A significant increase in the turnover rate among our sales associates and managers would increase our recruiting and training costs and could decrease our operating efficiency and productivity. If we are unable to retain our employees or attract, train, assimilate or retain other skilled personnel in the future, we may not be able to service our customers as effectively, which could impair our ability to increase sales and could otherwise harm our business.

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

Our business, like that of other retailers, is seasonal. 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, increases or decreases in comparable sales, the timing of new retail location openings, the timing of retail location closings, net sales and profitability contributed by new retail locations, the timing of the fulfillment of purchase orders under our product and license arrangements, adverse weather conditions, shifts

 

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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. Our quarterly net sales have historically been highest in our third fiscal quarter, corresponding to the peak Spring selling season. Given the historically higher sales level in our third fiscal quarter and the relatively fixed nature of most of our operating expenses and interest expense, we have typically generated a very significant percentage of our full year operating income and net income during our third fiscal quarter. Thus, any factors which result in a material reduction of our sales for the third quarter could have a material adverse effect on our results of operations for our fiscal year as a whole. Seasonal fluctuations in sales also affect our inventory levels, as we usually order merchandise in advance of peak selling periods and sometimes before new fashion trends are confirmed by customer purchases. We must carry a significant amount of inventory, especially before the peak Spring selling season. If we are not successful in selling our inventory during this period, we may be forced to rely on markdowns or promotional sales to sell the excess inventory or we may not be able to sell the inventory at all, which could have a material adverse effect on our business, financial condition and results of operations.

If an independent manufacturer violates labor or other laws, or is accused of violating any such laws, or if their labor practices diverge from those generally accepted as ethical, it could harm our business and brand image.

While we maintain policies and guidelines with respect to labor practices that independent manufacturers that produce goods for us are contractually required to follow, and while we have an independent firm and Company employees inspect certain manufacturing sites to monitor compliance, we cannot control the actions of such manufacturers or the public’s perceptions of them, nor can we assure that these manufacturers will conduct their businesses using ethical or legal labor practices. Apparel companies can be held jointly liable for the wrongdoings of the manufacturers of their products. While many of our independent manufacturers are routinely monitored by buying representatives, who assist us in the areas of compliance, garment quality and delivery, we do not control the manufacturers’ business practices or their employees’ employment conditions, and manufacturers act in their own interest which may be in a manner that results in negative public perceptions of us, and/or employee allegations against us, or court determinations that we are jointly liable. Violations of law by our importers, buying agents, manufacturers or distributors could result in delays in shipments and receipt of goods and could subject us to fines or other penalties, any of which could restrict our business activities, increase our operating expenses or cause our sales to decline.

We may be unable to protect our trademarks and other intellectual property and may be subject to liability if we are alleged to have infringed on another party’s intellectual property.

We believe that our trademarks, service marks and other intellectual property are important to our continued success and our competitive position due to their recognition with our customers. We devote substantial resources to the establishment and protection of our trademarks, service marks and other intellectual property. Although we actively protect our intellectual property, there can be no assurance that the actions that we have taken to establish and protect our trademarks, service marks and other intellectual property, including our rights in our management information systems and our proprietary rights in products for which we have applied for or received patent protection (for example, our Secret Fit Belly® innovation), will be adequate to prevent imitation of our marks, products or services by others or to prevent others from seeking to block sales of our products as a violation of their trademarks, service marks or other proprietary rights. For example, in October 2012 we filed a lawsuit against Target Corporation and others for infringement of our proprietary patented Secret Fit Belly technology. There is no guarantee that this effort to enforce our rights will be successful. Also, others may assert rights in, or ownership of, our trademarks and other proprietary rights or may allege that we have or are infringing on their intellectual property rights and we may not be able to successfully resolve these types of conflicts. In addition, the laws of certain foreign countries may not protect our trademarks and proprietary rights to the same extent as do the laws of the United States. We cannot assure you that these registrations will prevent imitation of our name, merchandising concept, store design or private label merchandise, or the infringement of our other intellectual property rights by others. Imitation of our name, concept, store design or merchandise in a manner that projects lesser quality or carries a negative connotation of our brand image could have a material adverse effect on our business, financial condition and results of operations. Additionally, the high expense in

 

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both prosecuting and defending against, and potential liability related to, alleged infringements of intellectual property rights could be substantial and could have a material adverse effect on our business, financial condition and results of operations.

If climate change laws or regulations were to become applicable to our business, or if any third party with whom we have a leased or licensed relationship imposed reporting or other obligations on us due to their own compliance programs, we could incur additional expense to meet the requirements and our failure to comply could have a material adverse effect on our business.

With respect to manufacturing within the United States, United States Environmental Protection Agency (“EPA”) greenhouse gas (“GHG”) emission reporting rules require certain United States manufacturers to report GHG emissions. These rules are unlikely to require reporting of our third-party contract apparel manufacturers because the amount of emissions from retail stores and apparel manufacturing facilities are currently estimated to be below the EPA reporting threshold. With respect to manufacturing outside of the United States, international treaties, such as the Kyoto Protocol and the Copenhagen Protocol, do not currently require the countries in which our non-United States contract apparel manufacturers are located to control GHG emissions and it is unlikely that climate change requirements in the foreseeable future will require significant GHG emission reductions on our non-United States contract apparel manufacturers. Our manufacturers are required to follow all applicable laws, including climate change laws. If domestic or international laws or regulations were expanded to require GHG emission reporting or reduction by us or our third-party contract apparel manufacturers, or if we engage third-party contract manufacturers in countries that have existing GHG emission reporting or reduction laws or regulations, we would need to expend financial and other resources to comply with such regulations and/or monitor our third-party contract apparel manufacturers’ compliance with such regulations. In addition, we cannot control the actions of our third-party manufacturers or the public’s perceptions of them, nor can we assure that these manufacturers will conduct their businesses using climate change proactive or sustainable practices. Violations of climate change laws or regulations by third parties with whom we do business could result in negative public perception of us and/or delays in shipments and receipt of goods, and could subject us to fines or other penalties, any of which could restrict our business activities, increase our operating expenses or cause our sales to decline.

Some retailers have adopted “sustainability” or other policies that encourage or require suppliers to report and/or reduce GHG emissions. No third party with whom we have a leased or licensed relationship currently requires us to report GHG emissions to them. However, we expect that certain of these third parties may do so in the future, which would require us to expend financial and other resources to comply with such requirements. In addition, if such requirements are imposed on us, our relationship with such third parties could be damaged if we were unable to comply.

Changes in the health care regulatory environment could cause us to incur additional expense and our failure to comply with related legal requirements could have a material adverse effect on our business.

In 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 were signed into law in the United States. This legislation expands health care coverage to many uninsured individuals and expands coverage to those already insured. The changes required by this legislation could cause us to incur additional health care and other costs, but we do not expect any material short-term impact on our financial results as a result of the legislation.

The costs and other effects of other new legal requirements cannot be determined with certainty. For example, new legislation or regulations may result in increased costs directly for our compliance or indirectly to the extent such requirements increase prices of goods and services because of increased compliance costs or reduced availability of raw materials.

War or acts of terrorism or the threat of either may negatively impact availability of merchandise and otherwise adversely impact our business.

In the event of war or acts of terrorism, or if either is threatened, our ability to obtain merchandise available for sale and consumer demand for our merchandise may be negatively affected. A substantial portion of our

 

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merchandise is imported from other countries. In addition, we not only generate sales in the United States and Canada through our own retail locations, but also in foreign countries through our international franchise relationships. If goods become difficult or impossible to import into the United States, and if we cannot obtain such merchandise from other sources at similar costs, our sales and profit margins may be materially and adversely affected. Further, if consumer demand in any country where we do business is negatively affected, our sales in such country would suffer. In the event that commercial transportation is curtailed or substantially delayed, our business may be materially and adversely impacted, as we may have difficulty shipping merchandise to our main distribution facility and retail locations, as well as fulfilling Internet orders.

The terms of our debt instruments impose financial and operating restrictions.

Our new credit facility contains restrictive covenants that limit our ability to engage in activities that may be in our long term best interests. These covenants limit or restrict, among other things, our ability to:

 

   

incur additional indebtedness;

 

   

pay dividends or make other distributions in respect of our equity securities, or purchase or redeem capital stock, or make certain investments;

 

   

have our subsidiaries pay dividends, make loans or transfer assets to us;

 

   

sell assets, including the capital stock of our subsidiaries;

 

   

enter into any transactions with our affiliates;

 

   

transfer any capital stock of any subsidiary or permit any subsidiary to issue capital stock;

 

   

create liens;

 

   

enter into certain sale/leaseback transactions;

 

   

effect a consolidation or merger or transfer of all or substantially all of our assets; and

 

   

engage in other lines of business unless reasonably related to our existing business.

These limitations and restrictions may materially and adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our best interests. In addition, our ability to borrow under the credit facility is subject to borrowing base requirements. If we breach any of the covenants in our credit facility, we may be in default under our credit facility. If we default, the lender under our credit facility could declare all borrowings owed to them, including accrued interest and other fees, to be due and payable.

Our charter documents contain certain anti-takeover provisions, and we are entitled to certain other protective provisions under Delaware law.

We are a Delaware corporation and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of the Company, even if a change of control would be beneficial to our existing stockholders. We also have adopted a stockholder rights plan, commonly known as a “poison pill,” that entitles our stockholders to acquire additional shares of us, or a potential acquirer of us, at a substantial discount to their market value in the event of an attempted takeover. In addition, our amended and restated certificate of incorporation and bylaws contain provisions that may discourage, delay or prevent a merger or acquisition involving us that our stockholders may consider favorable by, among other things:

 

   

authorizing the issuance of preferred stock, the terms of which may be determined at the discretion of our Board of Directors;

 

   

restricting the ability of stockholders to call special meetings of stockholders; and

 

   

establishing advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted on by stockholders at meetings.

These provisions may also reduce the market value of our common stock.

 

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If we are unable to pay quarterly dividends at intended levels or if our Board of Directors decides to reduce the level of our dividend, our reputation and stock price may be harmed.

Our quarterly cash dividend is currently $0.175 per common share. The dividends declared and paid by us to date meet all requirements under the terms of our debt agreements and applicable law; however, any future payment of dividends will be at the discretion of our Board of Directors and the ability to pay any such future dividends, or to pay such dividends at the current level, will be based upon certain restrictive financial covenants, earnings, capital requirements and our financial condition, among other factors, at the time any such dividend is considered. In addition, our ability or decision to pay dividends at all or at the current level may be subject to certain economic, financial, competitive and other factors (such as the level of taxation of dividends) that are beyond our control. Our Board of Directors may, at its discretion, decrease the intended level of dividends or entirely discontinue the payment of dividends at any time. Any failure to pay dividends after we have announced our intention to do so may negatively impact our reputation and investor confidence in us, and may also negatively impact our stock price.

The increase in our sales and marketing efforts that target markets outside the United States and Canada expose us to additional risks associated with international operations.

Although an immaterial amount of our sales are currently derived from international sales outside of Canada, we are actively seeking to expand our international presence, and we have begun to do so through franchise arrangements in the Middle East, India and South Korea. We may not be successful in these efforts. International operations and sales subject us to risks and challenges that we would otherwise not face if we conducted our business only in the United States. For example, we may depend on third parties to market our products through foreign sales channels, and we may be challenged by laws and business practices favoring local competitors. In addition, our ability to succeed in foreign markets will depend on our ability to protect our intellectual property. We must also adapt our pricing structure to address different pricing environments and may face difficulty in enforcing revenue collection internationally. Emerging markets are a significant focus of our international growth strategy. The developing nature of these markets presents a number of risks. Deterioration of social, political, labor or economic conditions in a specific country or region and difficulties in staffing and managing foreign operations may also materially and adversely affect our operations or financial results or those of our franchisees. Operations outside the United States may be affected by changes in trade protection laws, policies and measures, and other regulatory requirements affecting trade and investment, including the Foreign Corrupt Practices Act and local laws prohibiting corrupt payments. To the extent we achieve significant sales outside of the United States in the future, we may have significant exposure to fluctuating foreign currency exchange rates.

We could have failures in our system of internal controls causing us to inaccurately report our financial results or to fail to prevent fraud.

We maintain a documented system of internal controls which is reviewed and monitored by management, who meet regularly with our Audit Committee of the Board of Directors. We believe we have a well-designed system to maintain adequate internal controls over the business. We cannot assure you that there will not be any control deficiencies in the future. Should we become aware of any control deficiencies, we would report them to the Audit Committee and, if significant, recommend prompt remediation. We devote significant resources to document, test, monitor and improve our internal controls and will continue to do so; however, we cannot be certain that these measures will ensure that our controls are adequate in the future or that adequate controls will be effective in preventing fraud. If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. Any failures in the effectiveness of our internal controls could have a material adverse effect on our financial condition or operating results or cause us to fail to meet reporting obligations.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

28


Item 2. Properties

We own our principal executive offices and distribution facility, which is located at 456 North Fifth Street, Philadelphia, Pennsylvania. This facility consists of approximately 318,000 square feet, of which approximately 45,000 square feet is dedicated to office space and the remaining square footage is used for finished goods warehousing and distribution. In August 2002, we entered into a ten-year lease, with renewal options for two successive five year terms, for a facility located at 2001 Kitty Hawk Avenue, Philadelphia, Pennsylvania in the Philadelphia Naval Business Center. In May 2012, we amended the lease to extend the initial term for one additional year to August 2013. The area leased at this facility, which we use for some finished goods warehousing and distribution, raw material cutting and warehousing, and office space consists of approximately 69,000 square feet of space, of which 8,000 square feet is dedicated to office space. From time to time we may also utilize third-party warehousing services in the Philadelphia, Pennsylvania area when we have increased storage requirements. These services essentially operate on a month-to-month basis. We believe that these facilities will be adequate to support our anticipated distribution needs for the near term and, potentially, longer. In the event we need additional space to meet our future distribution needs, we believe that such space would be readily available. Our facilities are subject to state and local regulations that range from building codes to health and safety regulations.

We lease our store premises for initial terms averaging from five to ten years. Certain leases allow us to terminate or reduce our obligations at specified points in time in the event that the applicable store does not achieve a specified sales volume. Some of our store leases also provide for contingent payments based on sales volume, escalations of the base rent, as well as increases in operating costs, marketing costs and real estate taxes.

As of September 30, 2012, the following numbers of store leases are set to expire as listed in the table below. We do not expect the expiration of any leases to have a material adverse impact on our business or operations.

 

Fiscal Year Leases Expire

   Number
of Stores
 

2013

     145   

2014

     163   

2015

     91   

2016

     53   

2017

     47   

2018 and later

     126   
  

 

 

 

Total

     625   
  

 

 

 

In addition to the stores we operate, we have arrangements with department and specialty stores, including Macy’s, Sears, buybuy BABY, Gordmans and Boscov’s to operate maternity apparel departments in their stores. These leased departments typically involve the lease partner collecting all of the revenue from the leased department. The revenue is remitted to us, less a fixed percentage of the net sales earned by the lease partner as stipulated in the agreement. We provide at least some amount of staffing for each of the leased departments, with the amount varying depending on the specific arrangement. Generally, under each of our leased department agreements, our lease partner has the right to terminate any or all of our rights to operate our leased departments in their stores subject to varying notice requirements.

 

Item 3. Legal Proceedings

From time to time, we are named as a defendant in legal actions arising from our 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, we do not believe that the resolution of any pending action will have a material adverse effect on our financial position, results of operations or liquidity.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

29


PART II.

 

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

Our common stock is traded on the Nasdaq Global Market under the symbol “DEST.” On January 26, 2011, we announced that our Board of Directors approved a two-for-one split of our common stock in the form of a stock dividend, pursuant to which on March 1, 2011, stockholders of record at the close of business on February 16, 2011 received one additional common share for every share held. In accordance with the provisions of our equity award plans and as determined by our Board of Directors, the number of shares available for issuance, the number of shares subject to outstanding equity awards and the exercise prices of outstanding stock option awards were also adjusted to equitably reflect the effect of the two-for-one stock split. All share and per share amounts give effect to the stock split and have been adjusted retroactively for all periods presented.

The following table sets forth for the periods indicated below the reported high and low sales prices of our common stock, as reported on the Nasdaq Global Market, and the per share amount of cash dividends paid on our common stock:

 

     Market Prices      Dividends
Declared
and Paid
 
     High      Low     

Fiscal Year Ended September 30, 2012:

        

Quarter ended December 31, 2011

   $ 17.79       $ 12.17       $ 0.175   

Quarter ended March 31, 2012

     19.15         14.38         0.175   

Quarter ended June 30, 2012

     22.17         18.00         0.175   

Quarter ended September 30, 2012

     22.53         16.32         0.175   

Fiscal Year Ended September 30, 2011:

        

Quarter ended December 31, 2010

   $ 19.50       $ 15.93       $   

Quarter ended March 31, 2011

     23.33         18.92         0.175   

Quarter ended June 30, 2011

     25.28         15.66         0.175   

Quarter ended September 30, 2011

     21.14         12.58         0.175   

As of December 3, 2012, there were 1,366 holders of record and 2,208 estimated beneficial holders of our common stock.

On January 26, 2011, we announced the initiation of a regular quarterly cash dividend. During fiscal 2012 and 2011 we paid cash dividends of approximately $9.3 million (reflecting four quarterly dividend payments or a total of $0.70 per share) and $6.9 million (reflecting three quarterly dividend payments or a total of $0.525 per share), respectively. On November 8, 2012 we declared a quarterly cash dividend of $0.175 per share payable on December 28, 2012, which will require approximately $2.4 million of available cash. Based on our current quarterly dividend rate of $0.175 per share, we project we will pay approximately $9.4 million of cash dividends for fiscal 2013. The terms of our new credit facility provide certain restrictions on our ability to declare dividends and limit the amount of dividends we may pay on our common stock. The dividends declared and paid by us met all requirements under the terms of our prior credit facility and our prior senior secured Term Loan B (the “Term Loan”); however, any future payment of dividends will be at the discretion of our Board of Directors and will be based upon certain restrictive financial covenants in our new credit facility, earnings, capital requirements and our financial condition, among other factors (including tax considerations), at the time any such dividend is considered.

Under our Amended and Restated 2005 Equity Incentive Plan (the “2005 Plan”), awards may be granted in the form of options, stock appreciation rights, restricted stock or restricted stock units. Up to 2,000,000 shares of our common stock may be issued in respect of awards under our 2005 Plan, with no more than 1,000,000 of those shares permitted to be issued in respect of restricted stock or restricted stock units granted under the 2005 Plan.

 

30


The following table provides information about purchases by us during the quarter ended September 30, 2012 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:

 

Period

  Total
Number of
Shares
Purchased (1)
    Average Price
Paid per Share
     Total Number of
Shares Purchased
as Part of a
Publicly
Announced
Program (2)
     Maximum
Approximate Dollar
Value of Shares that
May Yet Be  Purchased
Under the Program (2)
 

July 1 to July 31, 2012

                         $ 10,000,000   

August 1 to August 31, 2012

                         $ 10,000,000   

September 1 to September 30, 2012

    237      $ 18.64               $ 10,000,000   
 

 

 

         

Total

    237      $ 18.64               $ 10,000,000   
 

 

 

         

 

(1) Represents shares repurchased directly from an employee to satisfy income tax withholding obligations for such employee in connection with a restricted stock award that vested during the period.

 

(2) In July 2008, our Board of Directors approved a program to repurchase up to $7.0 million of our outstanding common stock. Under the program, we may repurchase shares from time to time through solicited or unsolicited transactions in the open market or in negotiated or other transactions. In July 2012, our Board of Directors extended its authorization of the program from July 31, 2012 to July 31, 2014, and increased the amount of our outstanding stock authorized to be repurchased from $7.0 million to $10.0 million.

 

31


Stock Price Performance Graph

The graph below compares the cumulative total stockholder return on our common stock for the period from September 30, 2007 to September 30, 2012, with the cumulative total return of the Standard & Poor’s 500 Index and the Standard & Poor’s 500 Apparel Retail Index. The comparison assumes $100 was invested on September 30, 2007 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among Destination Maternity Corporation, the S&P 500 Index

and the S&P 500 Apparel Retail Index

 

LOGO

 

 

* $100 invested on September 30, 2007 in stock or index—including reinvestment of dividends.

Fiscal year ending September 30:

 

     2007      2008      2009      2010      2011      2012  

Destination Maternity Corporation

   $ 100.00       $ 74.34       $ 97.11       $ 176.33       $ 142.06       $ 214.23   

S&P 500 Index

   $ 100.00       $ 78.02       $ 72.63       $ 80.01       $ 80.93       $ 105.37   

S&P 500 Apparel Retail Index

   $ 100.00       $ 87.41       $ 101.13       $ 119.70       $ 150.55       $ 234.28   

 

32


Item 6. Selected Consolidated Financial and Operating Data

The following tables set forth selected consolidated statement of operations data, operating data, other consolidated financial data, and consolidated balance sheet data as of and for the periods indicated. The selected consolidated statement of operations and balance sheet data for each of the five fiscal years presented below are derived from our consolidated financial statements. You should read this information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this report.

 

     Year Ended September 30,  
     2012      2011      2010      2009     2008  
     (in thousands, except per share amounts)  

Consolidated Statement of Operations Data:

             

Net sales

   $ 541,476       $ 545,394       $ 531,192       $ 531,251      $ 564,602   

Cost of goods sold

     250,765         248,497         240,166         248,476        281,561   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Gross profit

     290,711         296,897         291,026         282,775        283,041   

Selling, general and administrative expenses

     255,623         257,421         251,653         259,552        271,592   

Store closing, asset impairment and asset disposal expenses

     1,983         1,039         2,282         536        2,916   

Restructuring and other charges

             193         5,658         1,557        3,461   

Goodwill impairment expense

                             50,389          
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Operating income (loss)

     33,105         38,244         31,433         (29,259     5,072   

Interest expense, net

     1,215         2,233         3,300         4,720        6,974   

Loss on extinguishment of debt

     22         37         51         123        97   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     31,868         35,974         28,082         (34,102     (1,999

Income tax provision (benefit)

     12,496         12,986         11,253         6,580        (610
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 19,372       $ 22,988       $ 16,829       $ (40,682   $ (1,389
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per share—Basic

   $ 1.48       $ 1.79       $ 1.37       $ (3.39   $ (0.12
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Average shares outstanding—Basic

     13,096         12,820         12,304         11,985        11,849   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per share—Diluted

   $ 1.46       $ 1.75       $ 1.33       $ (3.39   $ (0.12
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Average shares outstanding—Diluted

     13,267         13,120         12,691         11,985        11,849   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

33


     Year Ended September 30,  
     2012     2011     2010     2009     2008  
    

(unaudited; in thousands, except operating data,

ratios and per share amounts)

 

Operating Data:

          

Comparable sales (decrease) increase (1)(2)

     (0.3 )%      0.1     (3.4 )%      (4.6 )%      0.9

Internet sales increase (decrease)

     26.4     22.0     32.3     (8.7 )%      15.9

Average net sales per gross square foot (3)

   $ 270      $ 275      $ 273      $ 290      $ 302   

Average net sales per store (3)

   $ 575,000      $ 566,000      $ 551,000      $ 573,000      $ 588,000   

Gross store square footage at period end (4)

     1,330,000        1,376,000        1,445,000        1,462,000        1,492,000   

Gross retail location square footage at period end (5)

     1,959,000        2,078,000        1,750,000        1,619,000        1,623,000   

Number of retail locations at period end:

          

Motherhood Maternity stores

     507        535        567        591        616   

Mimi Maternity stores (6)

                                 89   

A Pea in the Pod stores (6)

     36        43        56        67        30   

Destination Maternity stores (6)

     82        80        75        66        19   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stores

     625        658        698        724        754   

Leased departments

     1,383        1,694        1,027        360        278   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total retail locations

     2,008        2,352        1,725        1,084        1,032   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Consolidated Financial Data:

          

Adjusted EBITDA (7)(8)

   $ 49,898      $ 54,395      $ 48,347      $ 38,762      $ 25,501   

Adjusted EBITDA margin (adjusted EBITDA as a percentage of net sales) (8)

     9.2     10.0     9.1     7.3     4.5

Ratio of total debt to Adjusted EBITDA (8)

     0.3     0.6     0.9     1.5     3.1

Ratio of Adjusted EBITDA to interest expense, net (8)

     41.1     24.4     14.7     8.2     3.7

Adjusted EBITDA before restructuring and other charges (7)(8)

     49,898        54,588        54,005        40,191        28,717   

Adjusted EBITDA margin before restructuring and other charges (8)

     9.2     10.0     10.2     7.6     5.1

Adjusted net income (loss), before goodwill impairment expense (8)

     19,372        22,988        16,829        9,707        (1,389

Adjusted net income (loss) per share—Diluted, before goodwill impairment expense (8)

     1.46        1.75        1.33        0.80        (0.12

Adjusted net income, before goodwill impairment expense stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt (8)

     20,858        24,598        21,585        12,004        2,273   

Adjusted net income per share—Diluted, before goodwill impairment expense, stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt (8)

     1.57        1.87        1.70        0.99        0.19   

Cash flows provided by operating activities

     42,697        21,443        25,974        42,525        27,822   

Cash flows used in investing activities

     (9,521     (11,079     (12,241     (12,455     (13,347

Cash flows used in financing activities

     (26,073     (19,699     (9,726     (21,592     (12,457

Capital expenditures

     (9,256     (12,270     (10,448     (12,639     (15,688

Consolidated Balance Sheet Data (at end of period):

          

Cash and cash equivalents

   $ 22,376      $ 15,285      $ 24,633      $ 20,626      $ 12,148   

Working capital

     63,316        75,984        63,650        50,580        61,611   

Total assets

     199,644        198,772        205,154        196,007        256,248   

Total debt

     15,257        31,342        45,161        57,409        78,646   

Net cash (debt) (8)(9)

     7,119        (16,057     (20,528     (36,783     (66,498

Stockholders’ equity

     104,972        92,695        71,598        49,800        89,468   

 

34


 

(1) Comparable sales figures represent comparable store sales and Internet sales.

 

(2) Comparable store sales figures represent sales at retail locations (which does not include licensed or franchised relationships) that have been in operation by us for at least twelve full months at the beginning of the period for which such data is presented. Comparable store sales figures do not include retail locations opened during a period even if such location was opened in connection with the closure of other retail locations in the same geographic area (including, for example, the opening of a new Destination Maternity combo store or superstore). Also, our comparable store sales figures generally do not include: (i) retail locations which change store nameplate, location type or format; (ii) 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); (iii) 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; or (iv) 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).

 

(3) Based on stores in operation by us during the entire twelve-month period (which does not include leased department, licensed or franchised relationships).

 

(4) Based on stores in operation by us at the end of the period.

 

(5) Based on all retail locations in operation at the end of the period (which does not include licensed or franchised relationships).

 

(6) In fiscal 2009, as part of our merchandise brand and store nameplate restructuring, we renamed our single-brand Mimi Maternity stores as A Pea in the Pod, and we renamed our multi-brand Mimi Maternity stores as Destination Maternity.

 

(7) Adjusted EBITDA represents operating income (loss) before deduction for the following non-cash charges: (i) depreciation and amortization expense; (ii) loss on impairment of tangible and intangible assets; (iii) loss (gain) on disposal of assets; and (iv) stock-based compensation expense. We have presented Adjusted EBITDA to enhance your understanding of our operating results.

 

(8)

Other Consolidated Financial and Consolidated Balance Sheet Data contain non-GAAP financial measures and ratios within the meaning of the SEC’s Regulation G, including: (i) Adjusted EBITDA; (ii) Adjusted EBITDA margin; (iii) Ratio of total debt to Adjusted EBITDA; (iv) Ratio of Adjusted EBITDA to interest expense, net; (v) Adjusted EBITDA before restructuring and other charges; (vi) Adjusted EBITDA margin before restructuring and other charges; (vii) Adjusted net income (loss), before goodwill impairment expense; (viii) Adjusted net income (loss) per share-Diluted, before goodwill impairment expense; (ix) Adjusted net income, before goodwill impairment expense, restructuring and other charges, stock-based compensation expense and loss on extinguishment of debt; (x) Adjusted net income per share-Diluted, before goodwill impairment expense, restructuring and other charges, stock-based compensation expense and loss on extinguishment of debt; and (xi) Net cash (debt). We believe that each of these non-GAAP financial measures and ratios provides useful information about our results of operations and/or financial position to both investors and management. Each non-GAAP financial measure and ratio is provided because we believe 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 and ratios as a measure of the performance of the Company. We provide these non-GAAP financial measures and ratios to investors to assist them in performing their analysis of our historical operating results. The non-GAAP

 

35


  financial measures and ratios included in Other Consolidated Financial Data reflect a measure of our operating results before consideration of certain charges and consequently, none of these measures and ratios 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 generally accepted accounting principles. We may calculate each of these non-GAAP financial measures and ratios differently than other companies. With respect to the non-GAAP financial measures included in Other Consolidated Financial Data, we have presented below a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures.

 

(9) Net cash (debt) represents cash and cash equivalents minus total debt.

Reconciliation of Net Income (Loss) to Adjusted EBITDA

and Adjusted EBITDA Before Restructuring and Other Charges

(in thousands)

(unaudited)

 

     Year Ended September 30,  
     2012     2011     2010     2009     2008  

Net income (loss)

   $ 19,372      $ 22,988      $ 16,829      $ (40,682   $ (1,389

Add: income tax provision (benefit)

     12,496        12,986        11,253        6,580        (610

Add: interest expense, net

     1,215        2,233        3,300        4,720        6,974   

Add: loss on extinguishment of debt

     22        37        51        123        97   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     33,105        38,244        31,433        (29,259     5,072   

Add: depreciation and amortization expense

     12,445        12,769        12,917        14,982        15,974   

Add: loss on impairment of long-lived assets

     1,876        768        1,865        667        1,628   

Add: goodwill impairment expense

                          50,389          

Add: loss (gain) on disposal of assets

     115        270        196        (48     546   

Add: stock-based compensation expense

     2,357        2,344        1,936        2,031        2,281   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

     49,898        54,395        48,347        38,762        25,501   

Add: restructuring and other charges (1)

            193        5,658        1,429        3,216   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA before restructuring and other charges

   $ 49,898      $ 54,588      $ 54,005      $ 40,191      $ 28,717   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA margin

     9.2     10.0     9.1     7.3     4.5

Adjusted EBITDA margin before restructuring and other charges

     9.2     10.0     10.2     7.6     5.1

 

 

(1) Excludes accelerated depreciation expense of $128 and $245 for the years ended September 30, 2009 and 2008, respectively, included in depreciation and amortization expense above.

 

36


Reconciliation of Net Income (Loss) to Adjusted Net Income (Loss), Before Goodwill

Impairment Expense and Adjusted Net Income, Before Goodwill Impairment Expense,

Stock-Based Compensation Expense, Restructuring and Other Charges, and Loss on

Extinguishment of Debt, and Net Income (Loss) Per Share—Diluted to Adjusted Net Income

(Loss) Per Share—Diluted, Before Goodwill Impairment Expense and Adjusted Net Income

Per Share—Diluted, Before Goodwill Impairment Expense, Stock-Based Compensation Expense, Restructuring and Other Charges, and Loss on Extinguishment of Debt

(in thousands, except per share amounts)

(unaudited)

 

     Year Ended September 30,  
     2012      2011      2010      2009     2008  

Net income (loss), as reported

   $ 19,372       $ 22,988       $ 16,829       $ (40,682   $ (1,389

Add: goodwill impairment expense, net of tax

                             50,389          
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted net income (loss), before goodwill impairment expense

     19,372         22,988         16,829         9,707        (1,389

Add: stock-based compensation expense, net of tax

     1,472         1,467         1,210         1,253        1,430   

Add: restructuring and other charges, net of tax

             120         3,514         968        2,171   

Add: loss on extinguishment of debt, net of tax

     14         23         32         76        61   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted net income, before goodwill impairment expense, stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt

   $ 20,858       $ 24,598       $ 21,585       $ 12,004      $ 2,273   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per share—Diluted, as reported

   $ 1.46       $ 1.75       $ 1.33       $ (3.39   $ (0.12
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Average shares outstanding—Diluted, as reported (1)

     13,267         13,120         12,691         11,985        11,849   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted net income (loss) per share—Diluted, before goodwill impairment expense

   $ 1.46       $ 1.75       $ 1.33       $ 0.80      $ (0.12
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Average shares outstanding—Diluted (1)

     13,267         13,120         12,691         12,135        11,849   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted net income per share—Diluted, before goodwill impairment expense, stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt

   $ 1.57       $ 1.87       $ 1.70       $ 0.99      $ 0.19   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Average shares outstanding—Diluted

     13,267         13,120         12,691         12,135        12,096   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

 

(1) For fiscal years with net loss or adjusted net loss, diluted shares reflect the elimination of the dilutive impact of outstanding stock options and restricted stock.

 

37


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion should be read in conjunction with the consolidated financial statements and their related notes included elsewhere in this report.

We are the leading designer and retailer of maternity apparel in the United States with 2,008 retail locations, including 625 stores in all 50 states, Puerto Rico and Canada, and 1,383 leased departments located within department stores and baby specialty stores throughout the United States and Puerto Rico. We are also the exclusive provider of maternity apparel to Kohl’s, which operates approximately 1,146 stores throughout the United States. We operate our stores under the Motherhood Maternity, A Pea in the Pod and Destination Maternity retail nameplates. We are the exclusive maternity apparel provider in each of our leased department relationships. We have expanded internationally and have entered into exclusive store franchise and product supply relationships in the Middle East, India and South Korea. As of September 30, 2012, we have 119 international franchised locations, comprised of 16 stand-alone stores in the Middle East, South Korea and India operated under one of our retail nameplates, and 103 shop-in-shop locations in India and South Korea in which we have a Company branded department operated under retail nameplates owned by our franchise partners. Finally, we also sell merchandise on the Internet, primarily through DestinationMaternity.com and our various brand-specific websites. We design and contract manufacture over 90% of the merchandise we sell using sewing factories located throughout the world, predominantly outside of the United States. Substantially all of the merchandise produced outside of the United States is paid for in United States dollars.

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 determined in accordance with generally accepted accounting principles (“GAAP net income”) and the corresponding net income (or earnings) per share (diluted), net income before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt (“Non-GAAP adjusted net income”) and the corresponding earnings per share (diluted), Adjusted EBITDA, net sales, and comparable sales (which consists of comparable store sales and Internet sales). Adjusted EBITDA represents operating income before deduction for the following non-cash charges: (i) depreciation and amortization expense; (ii) loss on impairment of tangible and intangible assets; (iii) loss on disposal of assets; and (iv) stock-based compensation expense.

Following is a summary of our fiscal 2012 results with regard to each of the key measures noted above:

Fiscal 2012 Financial Results

 

   

GAAP net income for fiscal 2012 was $19.4 million, a 16% decrease compared to GAAP net income of $23.0 million for fiscal 2011. GAAP diluted earnings per share for fiscal 2012 was $1.46, a 17% decrease compared to GAAP diluted earnings per share of $1.75 for fiscal 2011.

 

   

Non-GAAP adjusted net income for fiscal 2012 was $20.9 million, a 15% decrease compared to comparably adjusted Non-GAAP net income of $24.6 million for fiscal 2011. Non-GAAP diluted earnings per share for fiscal 2012 was $1.57, a 16% decrease compared to Non-GAAP diluted earnings per share of $1.87 for fiscal 2011.

 

   

Adjusted EBITDA was $49.9 million for fiscal 2012, an 8% decrease compared to $54.4 million of Adjusted EBITDA for fiscal 2011.

 

   

Net sales for fiscal 2012 decreased 0.7% to $541.5 million from $545.4 million for fiscal 2011.

 

   

Comparable sales for fiscal 2012 decreased 0.3% versus a comparable sales increase of 0.1% for fiscal 2011.

 

38


Results of Operations

The following table sets forth certain operating data from our consolidated statements of income as a percentage of net sales and as a percentage change for the periods indicated:

 

     % of Net Sales (1)     % Period to Period
Favorable (Unfavorable)
 
     Year Ended September 30,     Year Ended September 30,  
     2012     2011     2010     2012 vs. 2011     2011 vs. 2010  

Net sales

     100.0     100.0     100.0     (0.7 )%      2.7

Cost of goods sold (2)

     46.3        45.6        45.2        (0.9     (3.5
  

 

 

   

 

 

   

 

 

     

Gross profit

     53.7        54.4        54.8        (2.1     2.0   

Selling, general and administrative expenses (3)

     47.2        47.2        47.4        0.7        (2.3

Store closing, asset impairment and asset disposal expenses

     0.4        0.2        0.4        (90.9     54.5   

Restructuring and other charges

            0.0        1.1        100.0        96.6   
  

 

 

   

 

 

   

 

 

     

Operating income

     6.1        7.0        5.9        (13.4     21.7   

Interest expense, net

     0.2        0.4        0.6        45.6        32.3   

Loss on extinguishment of debt

     0.0        0.0        0.0        40.5        27.5   
  

 

 

   

 

 

   

 

 

     

Income before income taxes

     5.9        6.6        5.3        (11.4     28.1   

Income tax provision

     2.3        2.4        2.1        3.8        (15.4
  

 

 

   

 

 

   

 

 

     

Net income

     3.6     4.2     3.2     (15.7 )%      36.6
  

 

 

   

 

 

   

 

 

     

 

 

(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), and store opening expenses.

The following tables set forth certain information regarding the number of our retail locations and international franchised locations, for the fiscal years indicated. Retail locations include stores and leased maternity apparel departments and exclude locations where Kohl’s sells our products under an exclusive product and license agreement and international franchised locations.

 

    Year Ended September 30,  
    2012     2011     2010  

Retail Locations (1)

  Stores     Leased
Departments
    Total
Retail
Locations
    Stores     Leased
Departments
    Total
Retail
Locations
    Stores     Leased
Departments
    Total
Retail
Locations
 

Beginning of period

    658        1,694        2,352        698        1,027        1,725        724        360        1,084   

Opened

    8        13        21        12        694        706        11        680        691   

Closed

    (41     (324     (365     (52     (27     (79     (37     (13     (50
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

    625        1,383        2,008        658        1,694        2,352        698        1,027        1,725   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

(1) Excludes (i) locations where Kohl’s sells our products under an exclusive product and license agreement, and (ii) international franchised locations.

 

39


    Year Ended September 30,  
    2012     2011     2010  

International
Franchised Locations

  Stores     Shop-in-Shop
Locations
    Total
International
Franchised
Locations
    Stores     Shop-in-Shop
Locations
    Total
International
Franchised
Locations
    Stores     Shop-in-Shop
Locations
    Total
International
Franchised
Locations
 

Beginning of period

    15        51        66        8        23        31        1        7        8   

Opened

    2        54        56        7        29        36        7        16        23   

Closed

    (1     (2     (3            (1     (1                     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

    16        103        119        15        51        66        8        23        31   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In fiscal 2012 we also operated leased departments in Babies“R”Us stores. However, in connection with our new broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc., (which we announced in May 2012) we discontinued operation of our 124 remaining leased departments in Babies“R”Us in late October 2012 and opened leased departments in select buybuy BABY stores. As of November 30, 2012 we operate 10 leased departments in buybuy BABY stores. As of August 25, 2012, Bed Bath & Beyond Inc. had 71 buybuy BABY stores. Over time, we expect to significantly increase the number of buybuy BABY stores in which we have a maternity apparel leased department.

Year Ended September 30, 2012 Compared to Year Ended September 30, 2011

Net Sales.    Our net sales for fiscal 2012 decreased by 0.7% or $3.9 million, to $541.5 million from $545.4 million for fiscal 2011. Comparable sales decreased 0.3% during fiscal 2012 versus a comparable sales increase of 0.1% during fiscal 2011. The decrease in total reported sales for fiscal 2012 compared to fiscal 2011 resulted primarily from decreased sales related to our continued efforts to close underperforming stores and decreased sales from our licensed relationship, partially offset by increased sales due to the full-year impact of the expansion of our maternity apparel leased department relationship with Macy’s in the second quarter of fiscal 2011.

As of September 30, 2012, we operated a total of 625 stores and 2,008 total retail locations: 507 Motherhood Maternity stores (including 84 Motherhood Maternity Outlet stores), 36 A Pea in the Pod stores, 82 Destination Maternity stores, and 1,383 leased maternity apparel departments, of which 515 were in Sears stores under the Two Hearts Maternity brand and the balance were in other department stores and baby specialty stores, primarily under the Motherhood brand. In addition, our Oh Baby by Motherhood collection is available at Kohl’s stores throughout the United States. In comparison, as of September 30, 2011, we operated a total of 658 stores and 2,352 total retail locations: 535 Motherhood Maternity stores (including 85 Motherhood Maternity Outlet stores), 43 A Pea in the Pod stores, 80 Destination Maternity stores, and 1,694 leased maternity apparel departments. The decrease in leased department locations at September 30, 2012 versus September 30, 2011 predominantly reflects the closing of our remaining 291 Kmart leased department locations in October 2011. As of September 30, 2012, our store total included 82 Destination Maternity multi-brand stores, including 50 Destination Maternity combo stores and 32 Destination Maternity superstores. In comparison, as of September 30, 2011, we operated 80 Destination Maternity multi-brand stores, including 52 Destination Maternity combo stores and 28 Destination Maternity superstores. During fiscal 2012, we opened eight stores, including six Destination Maternity stores, and closed 41 stores, with 12 of these store closings related to Destination Maternity store openings. In addition, during fiscal 2012, we opened 13 leased department locations and closed 324 leased department locations, reflecting the closing of our remaining 291 Kmart leased department locations in October 2011.

Gross Profit.     Our gross profit for fiscal 2012 decreased by 2.1%, or $6.2 million, to $290.7 million compared to $296.9 million for fiscal 2011, and our gross profit as a percentage of net sales (gross margin) for fiscal 2012 was 53.7% compared to 54.4% for fiscal 2011. The decrease in gross profit for fiscal 2012 compared to fiscal 2011 was due primarily to our lower gross margin, and to a lesser extent, lower gross profit due to our decreased sales. The decrease in gross margin for fiscal 2012 compared to fiscal 2011 was primarily due to lower

 

40


merchandise margin driven by higher product costs and somewhat higher levels of promotional activity and markdowns.

Selling, General and Administrative Expenses.     Our selling, general and administrative expenses for fiscal 2012 decreased by 0.7%, or $1.8 million, to $255.6 million from $257.4 million for fiscal 2011. As a percentage of net sales, selling, general and administrative expenses was 47.2% for both fiscal 2012 and fiscal 2011. The slight decrease in expense for fiscal 2012 compared to fiscal 2011 resulted primarily from lower expenses related to our continued efforts to close underperforming stores (primarily payroll and occupancy costs), our continued tight expense controls, and lower variable incentive compensation expense, substantially offset by higher expenses related to the operation of our additional Macy’s leased department locations (primarily payroll and employee benefit costs, and percentage of net sales occupancy payments to Macy’s) and higher advertising and marketing expenses.

Store Closing, Asset Impairment and Asset Disposal Expenses.     Our store closing, asset impairment and asset disposal expenses for fiscal 2012 increased by approximately $1.0 million, to $2.0 million from $1.0 million for fiscal 2011, which primarily reflected higher impairment charges for write-downs of long-lived assets.

Restructuring and Other Charges.     In fiscal 2011, we incurred pretax expense of $0.2 million for relocation costs in connection with the hiring of our new President. We did not incur any restructuring and other charges in fiscal 2012.

Operating Income.     Our operating income for fiscal 2012 decreased by 13.4%, or $5.1 million, to $33.1 million from $38.2 million for fiscal 2011. Operating income as a percentage of net sales for fiscal 2012 decreased to 6.1% from 7.0% for fiscal 2011. The decrease in operating income and operating income percentage was primarily due to our lower gross profit and lower gross margin.

Interest Expense, Net.     Our net interest expense for fiscal 2012 decreased by 45.6%, or $1.0 million, to $1.2 million from $2.2 million in fiscal 2011. This decrease was due to our lower debt level, primarily as a result of the $15.0 million of Term Loan prepayments we made in fiscal 2012 and the $12.6 million of Term Loan prepayments we made in fiscal 2011, and to a lesser extent, lower interest rates. During fiscal 2012 and 2011, we did not have any direct borrowings under our credit facility and we did not have any direct borrowings outstanding as of September 30, 2012.

Loss on Extinguishment of Debt.     During fiscal 2012, we prepaid $15.0 million principal amount of our outstanding Term Loan, which resulted in pretax charges of $22,000, representing the write-off of unamortized deferred financing costs. During fiscal 2011, we prepaid $12.6 million principal amount of our outstanding Term Loan, which resulted in pretax charges totaling $37,000.

Income Taxes.     For fiscal 2012, our effective tax rate was 39.2% compared to 36.1% for fiscal 2011. Our effective tax rate for fiscal 2012 was higher than the statutory federal tax rate of 35% primarily due to the effect of state income taxes, net of federal tax benefit, and to a lesser extent, additional income tax expense (including interest and penalties) recognized as required by the accounting standard for uncertain income tax positions. Our effective tax rate for fiscal 2011 was slightly higher than the statutory federal tax rate of 35% primarily due to the effect of state income taxes, net of federal benefit, on our pretax income for fiscal 2011, partially offset by reductions of state income tax expense, net of federal expense, of $0.9 million recorded in the second quarter of fiscal 2011, which were related to settlements of uncertain income tax positions. See Note 15 of the Notes to Consolidated Financial Statements, included elsewhere in this report, for the reconciliation of the statutory federal income tax rate to our effective tax rate.

Net Income.     Net income for fiscal 2012 decreased by 15.7%, to $19.4 million from $23.0 million for fiscal 2011. Net income per share (diluted) for fiscal 2012 decreased by 16.6%, to $1.46 per share from $1.75 per share in fiscal 2011. Net income for fiscal 2012 includes (net of tax) stock-based compensation expense of $1.5 million and loss on extinguishment of debt of $14,000. Net income for fiscal 2011 includes (net of tax) stock-based compensation expense of $1.5 million, restructuring and other charges of $0.1 million, and loss on extinguishment of debt of $23,000. Before stock-based compensation expense, restructuring and other charges,

 

41


and loss on extinguishment of debt, our fiscal 2012 net income was $20.9 million or $1.57 per share (diluted) compared to $24.6 million or $1.87 per share (diluted) for fiscal 2011.

Our average diluted shares outstanding of 13.3 million for fiscal 2012 was 1.1% higher than the 13.1 million average diluted shares outstanding for fiscal 2011. The increase in average shares outstanding reflects the higher shares outstanding in fiscal 2012 compared to fiscal 2011, primarily as a result of the exercise of stock options and vesting of restricted stock, slightly offset by lower dilutive impact of outstanding stock options and restricted stock for fiscal 2012 compared to fiscal 2011.

Following is a reconciliation of net income and net income per share (diluted) (“Diluted EPS”) to net income and Diluted EPS before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt for the years ended September 30, 2012 and 2011 (in thousands, except per share amounts):

 

     Year Ended
September 30, 2012
     Year Ended
September 30, 2011
 
     Net
Income
     Diluted
Shares
     Diluted
EPS
     Net
Income
     Diluted
Shares
     Diluted
EPS
 

As reported

   $ 19,372         13,267       $ 1.46       $ 22,988         13,120       $ 1.75   

Add: stock-based compensation expense, net of tax

     1,472                    1,467              

Add: restructuring and other charges, net of tax

                        120              

Add: loss on extinguishment of debt, net of tax

     14                    23              
  

 

 

    

 

 

       

 

 

    

 

 

    

As adjusted before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt

   $ 20,858         13,267       $ 1.57       $ 24,598         13,120       $ 1.87   
  

 

 

    

 

 

       

 

 

    

 

 

    

Year Ended September 30, 2011 Compared to Year Ended September 30, 2010

Net Sales.    Our net sales for fiscal 2011 increased by 2.7% or $14.2 million, to $545.4 million from $531.2 million for fiscal 2010. Comparable sales increased 0.1% during fiscal 2011 versus a comparable sales decrease of 3.4% during fiscal 2010. The increase in total reported sales for fiscal 2011 compared to fiscal 2010 resulted primarily from increased sales due to the expansion of our maternity apparel leased department relationship with Macy’s, partially offset by decreased sales related to our continued efforts to close underperforming stores.

As of September 30, 2011, we operated a total of 658 stores and 2,352 total retail locations: 535 Motherhood Maternity stores (including 85 Motherhood Maternity Outlet stores), 43 A Pea in the Pod stores, 80 Destination Maternity stores, and 1,694 leased maternity apparel departments, of which 821 were in Sears and Kmart stores under the Two Hearts Maternity brand and the balance were in other department stores and baby specialty stores, primarily under the Motherhood brand. In addition, our Oh Baby by Motherhood collection is available at Kohl’s stores throughout the United States. In comparison, as of September 30, 2010, we operated a total of 698 stores and 1,027 total retail locations: 567 Motherhood Maternity stores (including 84 Motherhood Maternity Outlet stores), 56 A Pea in the Pod stores, 75 Destination Maternity stores, and 1,027 leased maternity apparel departments. The increase in leased department locations at September 30, 2011 versus September 30, 2010 predominantly reflects the opening of 516 leased department locations in January and February 2011 for our Macy’s expansion, and an additional 168 Sears and Kmart leased department locations in October 2010. As of September 30, 2011, our store total included 80 Destination Maternity multi-brand stores, including 52 Destination Maternity combo stores and 28 Destination Maternity superstores. In comparison, as of September 30, 2010, we operated 75 Destination Maternity multi-brand stores, including 49 Destination Maternity combo stores and 26 Destination Maternity superstores. During fiscal 2011, we opened 12 stores, including 7 Destination Maternity stores, and closed 52 stores, with 11 of these store closings related to Destination Maternity store openings. In addition, during fiscal 2011, we opened 694 leased department locations and closed 27 leased department locations.

Gross Profit.     Our gross profit for fiscal 2011 increased by 2.0%, or $5.9 million, to $296.9 million compared to $291.0 million for fiscal 2010, and our gross profit as a percentage of net sales (gross margin) for

 

42


fiscal 2011 was 54.4% compared to 54.8% for fiscal 2010. The increase in gross profit for fiscal 2011 compared to fiscal 2010 was primarily due to our increased sales, partially offset by the slightly lower gross margin, which resulted primarily from higher promotional activity and markdowns, and to a much lesser extent, from higher product costs for Fall 2011 merchandise.

Selling, General and Administrative Expenses.     Our selling, general and administrative expenses for fiscal 2011 increased by 2.3%, or approximately $5.7 million, to $257.4 million from $251.7 million for fiscal 2010. As a percentage of net sales, selling, general and administrative expenses for fiscal 2011 decreased to 47.2% compared to 47.4% for fiscal 2010. The increase in expense for fiscal 2011 compared to fiscal 2010 resulted primarily from higher expenses related to the launch and operation of our additional Macy’s leased department locations (primarily payroll and employee benefit costs, and percentage of net sales occupancy payments to Macy’s) and increased legal expenses, partially offset by lower variable incentive compensation expense and our continued expense control initiatives. The decrease in expense percentage for fiscal 2011 reflects the favorable leverage from our increased sales and our continued expense control initiatives.

Store Closing, Asset Impairment and Asset Disposal Expenses.     Our store closing, asset impairment and asset disposal expenses for fiscal 2011 decreased by approximately $1.3 million, to $1.0 million from $2.3 million for fiscal 2010, which primarily reflected lower impairment charges for write-downs of long-lived assets.

Restructuring and Other Charges.     In fiscal 2011, we incurred pretax expense of $0.2 million from our management transition. In fiscal 2010, we incurred pretax expense of $5.7 million from our strategic restructuring, cost reduction and other initiatives, and our management transition. See “Restructuring and Other Charges” in this Item 7 below for a detailed description of these charges.

Operating Income.     Our operating income for fiscal 2011 increased by 21.7%, or $6.8 million, to $38.2 million from $31.4 million for fiscal 2010. Operating income as a percentage of net sales for fiscal 2011 increased to 7.0% from 5.9% for fiscal 2010. The increase in operating income was primarily due to our higher gross profit and significantly lower restructuring and other charges, partially offset by higher selling, general and administrative expenses. The increase in operating income percentage was primarily due to our significantly lower restructuring and other charges.

Interest Expense, Net.     Our net interest expense for fiscal 2011 decreased by 32.3%, or $1.1 million, to $2.2 million from $3.3 million in fiscal 2010. This decrease was due to our lower debt level, primarily as a result of the $12.6 million of Term Loan prepayments we made in fiscal 2011 and the $11.0 million of Term Loan prepayments we made in fiscal 2010, and to a much lesser extent, lower interest rates. During fiscal 2011, we did not have any direct borrowings under our credit facility and we did not have any direct borrowings outstanding as of September 30, 2011. During fiscal 2010, our average daily level of direct borrowings under our credit facility was $0.4 million.

Loss on Extinguishment of Debt.     During fiscal 2011, we prepaid $12.6 million principal amount of our outstanding Term Loan, which resulted in pretax charges of $37,000, representing the write-off of unamortized deferred financing costs. During fiscal 2010, we prepaid $11.0 million principal amount of our outstanding Term Loan, which resulted in pretax charges totaling $51,000.

Income Taxes.     For fiscal 2011, our effective tax rate was 36.1% compared to 40.1% for fiscal 2010. Our effective tax rate for fiscal 2011 was slightly higher than the statutory federal tax rate of 35% primarily due to the effect of state income taxes, net of federal benefit, on our pretax income for fiscal 2011, partially offset by reductions of state income tax expense, net of federal expense, of $0.9 million recorded in the second quarter of fiscal 2011, which were related to settlements of uncertain income tax positions. Our effective tax rate for fiscal 2010 was higher than the statutory federal tax rate of 35% primarily due to the effect of state income taxes, net of federal benefit, and additional income tax expense (including interest and penalties) recognized as required by the accounting standard for uncertain income tax positions. See Note 15 of the Notes to Consolidated Financial Statements, included elsewhere in this report, for the reconciliation of the statutory federal income tax rate to our effective tax rate.

Net Income.     Net income for fiscal 2011 increased by 36.6%, to $23.0 million from $16.8 million for fiscal 2010. Net income per share (diluted) for fiscal 2011 increased by 31.6%, to $1.75 per share from $1.33 per share

 

43


in fiscal 2010. Net income for fiscal 2011 includes (net of tax) stock-based compensation expense of $1.5 million, restructuring and other charges of $0.1 million, and loss on extinguishment of debt of $23,000. Net income for fiscal 2010 includes (net of tax) stock-based compensation expense of $1.2 million, restructuring and other charges of $3.5 million, and loss on extinguishment of debt of $32,000. Before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt, our fiscal 2011 net income was $24.6 million or $1.87 per share (diluted) compared to $21.6 million or $1.70 per share (diluted) for fiscal 2010.

Our average diluted shares outstanding of 13.1 million for fiscal 2011 was 3.4% higher than the 12.7 million average diluted shares outstanding for fiscal 2010. The increase in average shares outstanding reflects the higher shares outstanding in fiscal 2011 compared to fiscal 2010, primarily as a result of the exercise of stock options and vesting of restricted stock, slightly offset by lower dilutive impact of outstanding stock options and restricted stock for fiscal 2011 compared to fiscal 2010.

Following is a reconciliation of net income and Diluted EPS to net income and Diluted EPS before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt for the years ended September 30, 2011 and 2010 (in thousands, except per share amounts):

 

     Year Ended
September 30, 2011
     Year Ended
September 30, 2010
 
     Net
Income
     Diluted
Shares
     Diluted
EPS
     Net
Income
     Diluted
Shares
     Diluted
EPS
 

As reported

   $ 22,988         13,120       $ 1.75       $ 16,829         12,691       $ 1.33   

Add: stock-based compensation expense, net of tax

     1,467                    1,210              

Add: restructuring and other charges, net of tax

     120                    3,514              

Add: loss on extinguishment of debt, net of tax

     23                    32              
  

 

 

    

 

 

       

 

 

    

 

 

    

As adjusted before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt

   $ 24,598         13,120       $ 1.87       $ 21,585         12,691       $ 1.70   
  

 

 

    

 

 

       

 

 

    

 

 

    

Restructuring and Other Charges

In July 2008, we announced that we were streamlining our merchandise brands and store nameplates and implementing cost reductions in order to simplify our business model, reduce overhead costs and improve and tighten our merchandise assortments, and during fiscal 2009 we began to implement actions to achieve further cost reductions. The objectives of our restructuring and cost reduction program were to improve and simplify critical processes, consolidate activities and infrastructure, and reduce our expense structure. As of September 30, 2010, we had completed the planned activities of these initiatives and we incurred $3.9 million of pretax expense substantially related to these initiatives in fiscal 2010, primarily for consulting services. These initiatives resulted in approximate pretax savings of $12 million in fiscal 2009, with incremental pretax savings of approximately $11 million in fiscal 2010 and an additional approximately $6 million in fiscal 2011. Thus we estimated that we realized total pretax savings of approximately $29 million in fiscal 2011 as a result of our cost reduction initiatives, which included the savings realized in fiscal 2009 and fiscal 2010.

After his retirement on September 30, 2008, Dan Matthias, our former Chief Executive Officer (“Former CEO”), agreed to continue to serve us as a director and as non-executive Chairman of the Board of Directors and agreed to remain available to us in an advisory capacity through September 2012. For these services, we agreed to pay the Former CEO an annual retainer of $200,000 through September 2012. In November 2009, the Former CEO entered into a letter agreement with us, which confirmed that he would not seek reelection to the Board of Directors (and, therefore, would no longer serve as our non-executive Chairman of the Board) after the expiration of his term in January 2010. The letter agreement did not change the terms of payment under the annual retainer for advisory services, however we incurred a pretax charge of $0.6 million in fiscal 2010, representing the amount due for the remaining term of the arrangement.

 

 

44


In connection with the retirement of Rebecca Matthias, our former President and Chief Creative Officer, at the end of fiscal 2010, we incurred a pretax charge of $0.9 million in fiscal 2010. The charge reflects benefit costs related to an amendment to the executive’s supplemental retirement agreement with us.

In April 2011, we announced the hiring of Chris Daniel as our President effective June 1, 2011. In connection with our efforts to hire a new President, we incurred pretax charges of $0.2 million in fiscal 2011 for relocation costs and $0.3 million in fiscal 2010, primarily for executive recruiting costs.

Liquidity and Capital Resources

Our cash needs have primarily been for: (i) debt service, including principal prepayments, (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 business. In addition, during the second quarter of fiscal 2011, we initiated a regular quarterly cash dividend. We have historically financed our capital requirements from cash flows from operations, borrowings under our credit facilities or available cash balances.

Cash and cash equivalents increased by $7.1 million during fiscal 2012 compared to a decrease of $9.3 million during fiscal 2011.

Cash provided by operations of $42.7 million for fiscal 2012 increased by $21.3 million from $21.4 million for fiscal 2011. This increase in cash provided by operations versus the prior year was the result of net working capital changes that provided cash in fiscal 2012 versus cash used in fiscal 2011, partially offset by lower net income in fiscal 2012 compared to fiscal 2011. The net working capital changes were primarily (i) an increase in accounts payable, accrued expenses and other liabilities in fiscal 2012, compared to a fiscal 2011 decrease that was primarily due to a $4.2 million supplemental executive retirement plan (“SERP”) benefit payment made in December 2010, and (ii) a decrease in inventories in fiscal 2012 compared to an increase in fiscal 2011, which reflects our efforts to tightly control our inventory levels in fiscal 2012 and the significant number of additional Macy’s leased department locations opened in fiscal 2011.

During fiscal 2012 we used cash provided by operations to fund repayments of long-term debt, to pay our quarterly cash dividends, and to pay for capital expenditures. Our $16.1 million of repayments of long-term debt in fiscal 2012 consisted predominantly of $15.0 million in optional prepayments of our Term Loan. In fiscal 2012, we paid $9.3 million in quarterly cash dividends. For fiscal 2012, we also spent $9.3 million on capital expenditures, including $7.1 million for leasehold improvements, fixtures and equipment for new store facilities, as well as improvements to existing stores, and $2.2 million for our information systems and distribution and corporate facilities. The remaining cash provided by operations during fiscal 2012 was used primarily to increase our available cash.

Cash provided by operations of $21.4 million for fiscal 2011 decreased by approximately $4.6 million from $26.0 million for fiscal 2010. This decrease in cash provided by operations versus the prior year was primarily the result of net working capital changes that used a greater amount of cash in fiscal 2011 than in fiscal 2010, partially offset by higher pretax income in fiscal 2011 compared to fiscal 2010. The net working capital changes were primarily (i) a decrease in accounts payable, accrued expenses and other liabilities in fiscal 2011, primarily due to the $4.2 million SERP benefit payment made in December 2010 and lower accrued variable incentive compensation expense, compared to a small increase in fiscal 2010, and (ii) a larger increase in inventories in fiscal 2011 compared to fiscal 2010, which reflects our increased number of leased department locations during fiscal 2011 and somewhat weaker than planned sales during fiscal 2011, partially offset by (iii) a smaller increase in trade receivables in fiscal 2011 than in fiscal 2010.

In addition to our cash provided by operations in fiscal 2011, we withdrew $1.5 million from our grantor trust, which was used to partially fund the $4.2 million December 2010 SERP benefit payment, and we generated $2.3 million of cash from the proceeds of option exercises. During fiscal 2011 we used cash provided by operations, cash provided by option exercises, and the withdrawal from the Grantor Trust to fund repayments of

 

45


long-term debt, to pay for capital expenditures, and to pay our quarterly cash dividends. Our $13.8 million of repayments of long-term debt in fiscal 2011 consisted predominantly of $12.6 million of prepayments of our Term Loan, including a $2.6 million prepayment required under the annual excess cash flow provision of the Term Loan. For fiscal 2011 we spent $12.3 million on capital expenditures, including $8.2 million for leasehold improvements, fixtures and equipment principally for new store facilities, as well as improvements to existing stores, and $4.1 million for our information systems and distribution and corporate facilities.

On November 1, 2012, we entered into a five-year $61.0 million senior secured revolving credit facility (the “Credit Facility”), which replaced our former $55.0 million credit facility. The Credit Facility consists of two tranches: (a) a senior secured revolving credit and letter of credit facility of up to $55.0 million, (“Tranche A”) and (b) a senior secured first-in-last-out revolving credit facility of up to $6.0 million (“Tranche A-1”). The Credit Facility will mature on November 1, 2017. Upon our request and with the consent of the lender, permitted borrowings under Tranche A may be increased up to an additional $15.0 million, in increments of $2.5 million, up to a Tranche A maximum limit of $70 million. Proceeds from advances under the Credit Facility, with certain restrictions, may be used to repay our existing term loan or other debt, and to provide financing for working capital, letters of credit, capital expenditures, dividends, share repurchases and other general corporate purposes.

Under the Credit Facility, we are required to maintain minimum Excess Availability (as defined in the related Credit Facility agreement) equal to 10% of the Borrowing Base (as defined in the related Credit Facility agreement). The Credit Facility is secured by a security interest in our trade receivables, inventory, equipment, real estate interests, letter of credit rights, cash, intangibles and certain other assets.

Prior to entering into the Credit Facility, we had in place a senior secured revolving credit facility (the “Prior Credit Facility”), which was amended on July 25, 2011 to decrease the maximum available for borrowings from $65.0 million to $55.0 million and to extend its maturity date from March 13, 2012 to January 13, 2013. The amendment also increased our effective interest rate on borrowings, if any, by approximately 0.75% per annum. There were no financial covenant requirements under the Prior Credit Facility provided that Excess Availability (as defined in the related Prior Credit Facility agreement) did not fall below 10% of the Borrowing Base (as defined in the related Prior Credit Facility agreement). If Excess Availability fell below 10% of the Borrowing Base, we would have been required to meet a specified minimum Fixed Charge Coverage Ratio (as defined in the related Prior Credit Facility agreement). Since the inception of the Prior Credit Facility, we have exceeded the minimum requirements for Excess Availability under the Prior Credit Facility and therefore, have not been subject to any financial covenants.

As of September 30, 2012, we had no outstanding borrowings under the Prior Credit Facility and $7.1 million in letters of credit, with $47.9 million of availability under our Prior Credit Facility, compared to no outstanding borrowings and $7.5 million in letters of credit, with $47.5 million of availability under our Prior Credit Facility, as of September 30, 2011. Borrowings under the Prior Credit Facility as of September 30, 2012 would have borne interest at a rate of between approximately 1.97% and 4.00% per annum. During fiscal 2012 and 2011, we did not have any direct borrowings under the Prior Credit Facility. We may have borrowings under our new Credit Facility during certain periods of fiscal 2013, reflecting seasonal and other timing variations in cash flow. Also, in November 2012 we had average outstanding borrowings of $2.5 million under the Credit Facility that resulted from our need to deposit $7.1 million with the agent bank for the Prior Credit Facility as cash collateral on an interim basis while letters of credit issued under the Prior Credit Facility are replaced with letters of credit issued under the Credit Facility (see Commercial Commitments below).

As of September 30, 2012, we had in place an agreement (the “Term Loan Agreement”) for our Term Loan. On November 1, 2012, we prepaid the remaining Term Loan balance of $13.4 million in connection with the execution of our new Credit Facility. The interest rate on the Term Loan was equal to, at our election, either (i) the prime rate plus 1.00%, or (ii) a LIBOR rate plus an applicable margin. The applicable margin was initially fixed at 2.50% through and including the fiscal quarter ended September 30, 2007. Thereafter, the applicable margin for LIBOR rate borrowings was either 2.25% or 2.50%, depending on our Consolidated Leverage Ratio (as defined in the Term Loan Agreement). Based upon our applicable quarterly Consolidated Leverage Ratios, the applicable margin for LIBOR rate borrowings was 2.50% prior to December 30, 2009 and was reduced to

 

46


2.25% effective from December 30, 2009. We were required to make minimum repayments of the principal amount of the Term Loan in quarterly installments of $225,000 each. We were also required to make an annual principal repayment equal to 25% or 50% of Excess Cash Flow (as defined in the Term Loan Agreement) in excess of $5.0 million for each fiscal year, with the 25% or 50% factor depending on our Consolidated Leverage Ratio. There was no required principal repayment related to fiscal 2011 results. Additionally, the Term Loan could be prepaid at our option, in part or in whole, at any time without any prepayment premium or penalty. For fiscal 2012 we made the following prepayments: $5.0 million in the first quarter and $10.0 million in the third quarter. For fiscal 2011 we made the following prepayments: $2.6 million in the first quarter, representing the prepayment required under the annual excess cash flow provision of the Term Loan, and $10.0 million in the third quarter. At September 30, 2012, our indebtedness under the Term Loan Agreement was $13.4 million, which was prepaid on November 1, 2012 as described above.

The Term Loan Agreement contained quarterly financial covenants that required us to maintain a specified maximum permitted Consolidated Leverage Ratio and a specified minimum permitted Consolidated Interest Coverage Ratio (as defined in the Term Loan Agreement). Since the inception of the Term Loan Agreement we were in compliance with all covenants of our Term Loan Agreement.

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 Term Loan proceeds were received, and expired on April 18, 2012. The interest rate swap agreement enabled us to effectively convert a significant portion of the Term Loan (equal to the notional amount of the interest rate swap) from a floating interest rate (LIBOR plus 2.50% prior to December 30, 2009, reduced to LIBOR plus 2.25% effective from December 30, 2009, based on our specified leverage ratios), to a fixed interest rate (7.50% prior to December 30, 2009, reduced to 7.25% effective from December 30, 2009, based on our specified leverage ratios). The notional amount of the interest rate swap was $75.0 million at the inception of the swap agreement and decreased over time to a notional amount of $5.0 million at the expiration date of April 18, 2012.

We have $1.8 million outstanding under an Industrial Revenue Bond (“IRB”) at September 30, 2012. The IRB has a variable interest rate that may be converted to a fixed interest rate at our option. At any time prior to conversion to a fixed interest rate structure, bondholders may put back to us (i.e. require us to repurchase) all or part of the IRB upon notice to the bond trustee, after which the remarketing agent would attempt to resell to third parties the put portion of the IRB. If the remarketing agent is unsuccessful in reselling the put portion of the IRB, the bond trustee may then draw on a letter of credit issued under the Credit Facility to repurchase the put bonds from bondholders on our behalf. During fiscal 2012 and 2011 bondholders put $1.4 million and $0.1 million, respectively, of the IRB back to us, and these put bonds were successfully resold by the remarketing agent to third parties. The letter of credit issued to secure the bonds has never been drawn upon. In the event that the bondholders put the bonds back to us and the remarketing agent fails to resell the bonds, which we believe is unlikely, we expect the acceleration of the payment of the bonds would not have a material adverse effect on our financial position or liquidity.

In March 2007, we entered into Supplemental Executive Retirement Agreements, which have been periodically amended (the “SERP Agreements”), with Dan and Rebecca Matthias (the “SERP Executives”). We also have a grantor trust, which was established for the purpose of accumulating assets in anticipation of our payment obligations under the SERP Agreements (the “Grantor Trust”). Our agreements with the SERP Executives and the trustee for the Grantor Trust (the “Trustee”) allow us to make cash deposits to the Grantor Trust, or provide an irrevocable standby letter of credit (the “ SERP Letter of Credit”) to the Trustee, in lieu of any deposits otherwise required, for funding obligations under the SERP Agreements. In December 2009, in connection with the additional vesting and scheduled payment of SERP Executives’ benefits in 2010, we made a partial cash contribution to the Grantor Trust of $1.5 million, with a corresponding reduction of the SERP Letter of Credit to a total of $4.4 million as of December 31, 2009. In December 2010, we received a distribution of the remaining assets in the Grantor Trust totaling $1.5 million. The amount withdrawn was used to partially fund the $4.2 million December 2010 lump sum payment of SERP benefits to Ms. Matthias. As of September 30, 2012, the SERP Letter of Credit was $150,000, which was equal to the remaining SERP benefits paid to Mr. Matthias on October 1, 2012.

 

47


On January 26, 2011, we announced the initiation of a regular quarterly cash dividend. During fiscal 2012 and 2011 we paid cash dividends of $9.3 million (reflecting four quarterly dividend payments or a total of $0.70 per share) and $6.9 million (reflecting three quarterly dividend payments or a total of $0.525 per share), respectively. On November 8, 2012 we declared a quarterly cash dividend of $0.175 per share payable on December 28, 2012, which will require approximately $2.4 million of available cash. Based on our current quarterly dividend rate of $0.175 per share, we project that we will pay approximately $9.4 million of cash dividends during fiscal 2013.

Our management believes that our current cash and working capital positions, expected operating cash flows and available borrowing capacity will be sufficient to fund our cash requirements for working capital, capital expenditures, debt repayments and dividend payments, as well as to fund stock repurchases and debt prepayments, if any, for at least the next twelve months.

Contractual Obligations and Commercial Commitments

We have entered into agreements that create contractual obligations and commercial commitments. These obligations and commitments will have an impact on future liquidity and the availability of capital resources. The tables below set forth a summary of these obligations and commitments as of September 30, 2012 (in thousands):

Contractual Obligations:

 

            Payments Due by Period  

Description

   Total
Obligations (1)
     Less
Than One
Year
     One
to Three
Years
     Three
to Five
Years
     After
Five
Years
 

Long-term debt (2)(3)

   $ 15,257       $ 15,257       $       $       $   

Interest related to long-term debt (2)(3)

     62         62                           

Operating leases (4)

     165,912         45,787         59,268         32,788         28,069   

Purchase obligations (5)

     86,366         86,366                           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual cash obligations

   $ 267,597       $ 147,472       $ 59,268       $ 32,788       $ 28,069   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The amounts in this table exclude obligations under employment and retirement agreements. For a discussion of the compensation of our executive officers, see the information contained under the caption “Executive Compensation” in our Proxy Statement, which will be filed with the SEC in connection with the Annual Meeting of Stockholders expected to be held in the second quarter of fiscal 2013.

 

(2) Long-term debt includes $13,427 due under our Term Loan at September 30, 2012, which was prepaid on November 1, 2012 in connection with the execution of our new Credit Facility. Interest includes the actual interest paid subsequent to September 30, 2012.

 

(3) Long-term debt includes $1,830 due under an IRB at September 30, 2012, which is classified as a current liability in the Consolidated Balance Sheet (See Note 10 of the Notes to Consolidated Financial Statements, included elsewhere in this report). Interest on the floating rate IRB was estimated for one year using the interest rate in effect as of September 30, 2012.

 

(4) Includes store operating leases, which generally provide for payment of direct operating costs in addition to rent. The amounts reflected include future minimum lease payments and exclude such direct operating costs.

 

(5) Our purchase orders with contract manufacturers are cancelable by us at any time prior to our acceptance of the merchandise, subject to negotiated payment of certain of vendors’ nonrecoverable costs. The amount in this table excludes purchase orders for supplies in the normal course of business.

 

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Commercial Commitments:

 

            Amount of Commitment Per Period  

Description

   Total
Obligations
     Less
Than One
Year
     One
to Three
Years
     Three
to Five
Years
     After
Five
Years
 

Credit facility (1)

   $ 7,084       $ 7,084       $     —       $     —       $     —   

Other standby letters of credit

                                       
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial commitments

   $ 7,084       $ 7,084       $       $       $   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Consists of outstanding letter of credit commitments under our Prior Credit Facility at September 30, 2012. As of November 1, 2012, $6.9 million of letters of credit outstanding under the Prior Credit Facility were in the process of being replaced with letters of credit issued under the new Credit Facility. On November 1, 2012 the Company deposited $7.1 million with the agent bank for the Prior Credit Facility as cash collateral during the transition process. A prorata portion of the cash collateral will be released to the Company after each of the original letters of credit are returned to the agent bank and cancelled.

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 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” included elsewhere in this report. 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, as well as applied product-related overhead. 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 determine the net realizable value of our inventories and the related level of required inventory reserves 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 twelve 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 September 30, 2012 and 2011 totaled $88.8 million and $90.4 million, respectively, representing 44.5% and 45.5% 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.

 

49


Long-Lived Assets.     Our long-lived assets consist principally of store leasehold improvements and furniture and equipment (included in “property, plant and equipment, net” in our consolidated balance sheets) and, to a much lesser extent, patent and lease acquisition costs (included in “other intangible assets, net” 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 September 30, 2012 and 2011 totaled $52.4 million and $57.1 million, respectively, representing 26.3% and 28.7% 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, Pea 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 $1.9 million and $0.8 million during fiscal 2012 and fiscal 2011, respectively.

Self-Insurance Reserves.     We are primarily self-insured for most workers’ compensation claims, general liability and automotive liability losses, and for healthcare claims. We have purchased insurance coverage in order to establish certain limits to our exposure on a per claim basis and on an aggregate basis. Our accrued insurance expense, which was primarily for self-insurance reserves, as of September 30, 2012 and 2011 totaled $5.3 million and $4.6 million, respectively, representing 2.7% and 2.3% of total assets, respectively. The estimated reserves for our self-insured liabilities and our reported operating results could be significantly affected if future occurrences and claims differ from the factors noted below.

We determine the estimated reserve required for workers’ compensation claims, general liability and automotive liability losses in each accounting period. This requires that we determine estimates of the costs of claims incurred (including claims incurred but not yet reported) and accrue for such expenses in the period in which the claims are incurred (including claims incurred but not yet reported). Actual workers’ compensation claims, and general liability and automotive liability losses, are reported to us by third party administrators. The third party administrators also report initial estimates of related loss reserves. The open claims and initial loss reserves and estimates of claims incurred but not yet reported are subjected to examination by us utilizing a consistent methodology which involves various assumptions, judgment and other factors. Such factors include, but are not limited to, the probability of settlement, the amount at which settlement can be achieved, the probable duration of the claim, the cost development pattern of the claim and the applicable cost development factor. In addition, we utilize a cooperative arrangement with a number of other companies to assist in managing these insurance risks for certain occurrences prior to March 1, 2010. Based on this arrangement, our expenses could be impacted by the loss history associated with the cooperative as a whole for the years for which we remain a participant. The liabilities associated with claims for workers’ compensation, general liability and automotive liability are measured through the use of actuarial methods to project an estimate of ultimate cost for claims incurred.

We record an accrual for the estimated amount of self-insured healthcare claims incurred but not yet reported using a method based on our historical claims experience. The most significant factors in addition to our historical claims experience that impact the determination of the required accrual are the historical timing of claims processing, medical cost trends and inflation, employer-employee cost sharing factors and changes in plan benefits. We continually monitor historical experience and cost trends, and accruals are adjusted when warranted by changes in facts and circumstances.

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 (including interest and penalties) together with assessing

 

50


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 establish reserves for certain tax positions that we believe are supportable, but are potentially subject to successful challenge by the applicable taxing authority. We determine our provision for income taxes based on federal, state and foreign tax laws and regulations currently in effect, some of which have been recently revised. Legislation changes in jurisdictions 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 income tax expense and our 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 September 30, 2012 and 2011 totaled $18.2 million and $17.7 million, respectively, representing 9.1% and 8.9% of total assets at September 30, 2012 and 2011, 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 applicable accounting standards, which require 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. 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

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU No. 2011-05 requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of stockholders’ equity. The standard does not change the items which must be reported in other comprehensive income. ASU No. 2011-05 is effective for financial statements issued for annual reporting periods beginning after December 15, 2011 and interim periods within those years. Because this guidance impacts presentation only, the adoption of the new requirements of ASU No. 2011-05 will not have any impact on our consolidated financial position or results of operations.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in ASU No. 2011-04 result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs and change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. ASU No. 2011-04 is effective during interim and annual periods beginning after December 15, 2011. The adoption of the new requirements of ASU No. 2011-04 did not have any impact on our consolidated financial position or results of operations.

 

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Off Balance Sheet Arrangements

None.

Inflation

We do not believe that inflation has had a material effect on our net sales or profitability in the periods presented. However, there can be no assurance that our business will not be affected by inflation in the future.

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 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 continuation of economic recovery of the retail industry in general and of apparel purchases in particular, our ability to successfully manage our various business initiatives, the success of our international business and its expansion, our ability to successfully manage, retain and expand our leased department and licensed 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), expense savings initiatives, 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, continued availability of capital and financing, our ability to hire and develop senior management and sales associates, our ability to develop and source merchandise, our ability to receive production from foreign sources on a timely basis, potential stock repurchases, the continuation of the regular quarterly cash dividend, the trading liquidity of our common stock, changes in market interest rates, war or acts of terrorism and other factors referenced in this report, including those set forth under the caption “Item 1A. 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.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The Company 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 September 30, 2012, we had cash equivalents of $19.5 million. Our cash equivalents consist of investments in money market funds that bear interest at variable rates. A change in market interest rates earned

 

52


on our investments 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. The impact on our future interest income resulting from changes in investment yields will depend largely on the gross amount of our investment portfolio at that time. However, based upon the conservative nature of our investment portfolio and current experience, we do not believe a decrease in investment yields would have a material negative effect on our interest income.

As of September 30, 2012, the principal components of our debt portfolio were the $13.4 million Term Loan and the $55.0 million Prior Credit Facility, both of which were denominated in United States dollars. On November 1, 2012, we entered into a new $61.0 million Credit Facility, which replaced our Prior Credit Facility.

Both our Prior Credit Facility and our new Credit Facility have variable interest rates that are tied to market indices. As of September 30, 2012, we had no direct borrowings and $7.1 million of letters of credit outstanding under our Prior Credit Facility. Borrowings under the Prior Credit Facility would have resulted in interest at a rate between approximately 1.97% and 4.00% per annum as of September 30, 2012. As of September 30, 2012, if the new Credit Facility had been in place at that date, Tranche A borrowings under the new Credit Facility would have resulted in interest at a rate between approximately 1.72% and 3.75% per annum, and Tranche A-1 borrowings under the new Credit Facility would have resulted in interest at a rate between approximately 3.22% and 5.25% per annum. Interest on 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 our debt portfolio would impact the interest expense incurred and cash flows.

On November 1, 2012, we prepaid the remaining Term Loan balance of $13.4 million in connection with the execution of the new Credit Facility. Based on the limited other variable rate debt included in our debt portfolio as of September 30, 2012, a 100 basis point 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 8. Financial Statements and Supplementary Data

Our Consolidated Financial Statements appear on pages F-1 through F-34, as set forth in Item 15.

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

None.

 

Item 9A. 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 SEC’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 September 30, 2012. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2012, these controls and procedures were effective.

 

53


Internal Control over Financial Reporting

(a)    Management’s Annual Report on Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of the Company’s financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Management assessed the Company’s internal control over financial reporting as of September 30, 2012, the end of the Company’s fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and the Company’s overall control environment.

Based on its assessment, management has concluded that the Company’s internal control over financial reporting was effective as of the end of the fiscal year to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. The results of management’s assessment were reviewed with the Audit Committee of the Company’s Board of Directors.

KPMG LLP independently assessed the effectiveness of the Company’s internal control over financial reporting. KPMG LLP has issued an attestation report, which is included below.

(b)    Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Destination Maternity Corporation:

We have audited Destination Maternity Corporation’s internal control over financial reporting as of September 30, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Destination Maternity Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting presented above. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting

 

54


includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Destination Maternity Corporation maintained, in all material respects, effective internal control over financial reporting as of September 30, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Destination Maternity Corporation and subsidiaries as of September 30, 2012 and 2011, and the related consolidated statements of income, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended September 30, 2012 and the related financial statement schedule, and our report dated December 14, 2012 expressed an unqualified opinion on those consolidated financial statements and the related financial statement schedule.

/s/ KPMG LLP

Philadelphia, Pennsylvania

December 14, 2012

(c)    Change in Internal Control over Financial Reporting

There have been no changes in internal control over financial reporting identified in connection with management’s evaluation that occurred during the last fiscal quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

None

 

55


PART III.

 

Item 10. Directors, Executive Officers and Corporate Governance

Information concerning directors and corporate governance, appearing under the captions “Corporate Governance,” “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement, is incorporated herein by reference in response to this Item 10. Information concerning executive officers, appearing under the caption “Item 1. Business—Executive Officers of the Company” in Part I of this Form 10-K, is incorporated herein by reference in response to this Item 10.

The Board of Directors has adopted a Code of Business Conduct and Ethics, which can be found on the Company’s corporate website at investor.destinationmaternity.com. We intend to satisfy the amendment and waiver disclosure requirements under applicable securities regulations by posting any amendments of, or waivers to, the Code of Business Conduct and Ethics on our website.

 

Item 11. Executive Compensation

The information contained in the Proxy Statement from the sections titled “Compensation Discussion and Analysis,” “Reports of Committees of the Board of Directors” and “Executive Compensation” with respect to executive compensation, and in the section titled “Compensation of Directors” with respect to director compensation, is incorporated herein by reference in response to this Item 11.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information contained in the section titled “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference in response to this Item 12.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information contained in the sections titled “Corporate Governance” and “Election of Directors” in the Proxy Statement with respect to certain relationships and director independence, is incorporated herein by reference in response to this Item 13.

 

Item 14. Principal Accounting Fees and Services

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

 

56


PART IV.

 

Item 15. Exhibits and Financial Statement Schedules

 

(a)    (1) Financial Statements

 

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

 

  (2) Financial Statement Schedules

 

   Schedule II—Valuation and Qualifying Accounts.

 

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

 

  (3) Exhibits

 

   See following Index of Exhibits.

 

57


INDEX OF EXHIBITS

 

Exhibit No.

  

Description

*3.1

   Restated Certificate of Incorporation of the Company (Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended September 30, 2008).

*3.2

   Bylaws of the Company (Exhibit 3.2 to the Company’s Current Report on Form 8-K dated November 9, 2011).

*4.1

   Specimen certificate representing shares of the Company’s common stock with legend regarding Preferred Stock Purchase Rights (Exhibit 4.2 to the Company’s Current Report on Form 8-K dated October 12, 1995).

*4.2

   Amended and Restated Rights Agreement, dated as of October 9, 2005, between the Company and StockTrans, Inc., which includes the Form of Series B Rights Certificate, the Certificate of Designation of the voting powers, designations, preferences, and relative, participating, optional or other special rights and qualifications, limitations and restrictions of the Series B Junior Participating Preferred Stock, and a Summary of Rights to Purchase Preferred Stock attached thereto as Exhibits A, B and C respectively (Exhibit 4.1 to the Company’s Current Report on Form 8-K dated October 9, 2005).

†*10.1

   1994 Director Stock Option Plan (Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended September 30, 1994).

*10.2

   Loan Agreement, dated September 1, 1995, between Philadelphia Authority For Industrial Development (“PAID”) and the Company (Exhibit 10.26 to the Company’s Registration Statement on Form S-1, Registration No. 33-97318, dated October 26, 1995 (the “1995 Registration Statement”)).

*10.3

   Indenture of Trust between PAID and Society National Bank dated September 1, 1995 (Exhibit 10.29 to the 1995 Registration Statement).

*10.4

   Variable/Fixed Rate Federally Taxable Economic Development Bond (Mothers Work, Inc.), Series of 1995, in the aggregate principal amount of $4,000,000 (Exhibit 10.30 to the 1995 Registration Statement).

†*10.5

   1987 Stock Option Plan (as amended and restated) (Exhibit 4.1 to the Company’s Registration Statement on Form S-8, Registration No. 333-59529, dated July 21, 1998).

†*10.6

   Amendment to the Company’s 1987 Stock Option Plan, as amended and restated, effective as of November 13, 2002 (Exhibit 10.25 to the Company’s Form 10-Q for the quarter ended March 31, 2003).

†*10.7

   Form of Non-Qualified Stock Option Agreement under the Company’s 1987 Stock Option Plan (Exhibit 10.18 to the Company’s Annual Report on Form 10-K for the year ended September 30, 2004 (the “2004 Form 10-K”)).

†*10.8

   Form of Non-Qualified Stock Option Agreement under the Company’s 1994 Director Stock Option Plan (Exhibit 10.19 to the 2004 Form 10-K).

†*10.9

   Form of Waiver of Rights Under Company’s 1987 Stock Option Plan and 1994 Director Stock Option Plan executed by each of the Company’s Non-Management Directors (Exhibit 10.21 to the Company’s Current Report on Form 8-K dated December 29, 2005 (the “December 29, 2005 Form 8-K”)).

†*10.10

   Form of Waiver of Rights Under Company’s 1987 Stock Option Plan executed by certain of the Company’s executive officers (Exhibit 10.22 to the December 29, 2005 Form 8-K).

 

58


Exhibit No.

  

Description

†*10.11

   Form of Restricted Stock Award Agreement under the Company’s 2005 Equity Incentive Plan (Exhibit 10.28 to the Company’s Annual Report on Form 10-K for the year ended September 30, 2006 (the “2006 Form 10-K”)).

†*10.12

   Form of Non-Qualified Stock Option Agreement under the Company’s 2005 Equity Incentive Plan (Exhibit 10.29 to the 2006 Form 10-K).

†*10.13

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

†*10.14

   Second Amended and Restated Employment Agreement, dated March 2, 2007, between Dan W. Matthias and the Company (Exhibit 10.2 to the Company’s Current Report on Form 8-K dated March 2, 2007 (the “March 2, 2007 Form 8-K”).

†*10.15

   Supplemental Retirement Agreement dated as of March 2, 2007, between the Company and Rebecca C. Matthias (Exhibit 10.3 to the March 2, 2007 Form 8-K).

†*10.16

   Supplemental Retirement Agreement dated as of March 2, 2007, between the Company and Dan W. Matthias (Exhibit 10.4 to the March 2, 2007 Form 8-K).

*10.17

   Confidentiality Agreement, dated March 10, 2008, by and among the Company, Crescendo Partners II, L.P., Series K, Crescendo Investments II, LLC, Crescendo Partners III, L.P., and Crescendo Investments III, LLC. (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 10, 2008).

†*10.18

   Letter Agreement, dated March 28, 2008, between the Company and Dan W. Matthias and Rebecca C. Matthias (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 28, 2008).

†*10.19

   Letter Agreement, dated May 20, 2008, between the Company and Dan W. Matthias and Rebecca C. Matthias (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 20, 2008).

†*10.20

   Employment Agreement, dated July 23, 2008, between the Company and Judd P. Tirnauer (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated July 21, 2008 (the “July 21, 2008 Form 8-K”)).

†*10.21

   Restrictive Covenant Agreement with Judd P. Tirnauer dated July 23, 2008 (Exhibit 10.2 to the July 21, 2008 Form 8-K).

†*10.22

   Restricted Stock Award Agreement with Judd P. Tirnauer dated July 23, 2008 (Exhibit 10.3 to the July 21, 2008 Form 8-K).

†*10.23

   Transition Agreement, dated September 26, 2008, between Dan W. Matthias and the Company (Exhibit 10.2 to the Company’s Current Report on Form 8-K dated September 26, 2008).

†*10.24

   Letter Agreement, dated November 6, 2009, between Dan W. Matthias and the Company (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated November 4, 2009 (the “November 4, 2009 Form 8-K”)).

*10.25

   Letter Agreement, dated November 6, 2009, by and among the Company, Crescendo Partners II, L.P., Series K, Crescendo Investments II, LLC, Crescendo Partners III, L.P., and Crescendo Investments III, LLC. (Exhibit 10.2 to the November 4, 2009 Form 8-K).

†*10.26

   Transition Agreement, dated November 6, 2009, between Rebecca C. Matthias and the Company (Exhibit 10.3 to the November 4, 2009 Form 8-K).

†*10.27

   2005 Equity Incentive Plan (as amended and restated) (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 25, 2011).

 

59


Exhibit No.

  

Description

†*10.28

   Employment Agreement, dated April 11, 2011, between Christopher F. Daniel and the Company (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated April 11, 2011 (the “April 11, 2011 Form 8-K”)).

†*10.29

   Non-Qualified Stock Option Award Agreement between Christopher F. Daniel and the Company (Exhibit 10.44 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 (the “June 30, 2011 Form 10-Q”)).

†*10.30

   Form of Restricted Stock Award Agreement between Christopher F. Daniel and the Company (Exhibit 10.45 to the June 30, 2011 Form 10-Q).

†*10.31

   Executive Employment Agreement, dated July 16, 2009, between Ronald J. Masciantonio and the Company (Exhibit 10.4 to the April 11, 2011 Form 8-K).

†*10.32

   Amendment to Executive Employment Agreement, dated April 27, 2010, between Ronald J. Masciantonio and the Company (Exhibit 10.5 to the April 11, 2011 Form 8-K).

†*10.33

   Restrictive Covenant Agreement, dated July 16, 2009, between Ronald J. Masciantonio and the Company (Exhibit 10.6 to the April 11, 2011 Form 8-K).

†*10.34

   Amendment, dated August 10, 2011, to the Employment Agreement dated as of July 23, 2008 between Judd P. Tirnauer and the Company (Exhibit 10.2 to the Company’s Current Report on Form 8-K dated August 10, 2011 (the “August 10, 2011 Form 8-K”)).

†*10.35

   Amendment, dated August 10, 2011, to the Employment Agreement dated as of July 16, 2009 (as amended) between Ronald J. Masciantonio and the Company (Exhibit 10.3 to the August 10, 2011 Form 8-K).

†*10.36

   Amendment, dated November 22, 2011, to the Employment Agreement dated as of July 23, 2008 (as amended) between Judd P. Tirnauer and the Company (Exhibit 10.45 to the Company’s Annual Report on Form 10-K for the year ended September 30, 2011 (the “2011 Form 10-K”)).

†*10.37

   Amendment, dated November 22, 2011, to the Employment Agreement dated as of July 16, 2009 (as amended) between Ronald J. Masciantonio and the Company (Exhibit 10.46 to the 2011 Form 10-K).

†*10.38

   Form of Restricted Stock Unit Award Agreement under the Company’s 2005 Equity Incentive Plan (Exhibit 10.47 to the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011).

†*10.39

   Third Amended and Restated Employment Agreement dated March 6, 2012 between Edward M. Krell and the Company (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 6, 2012).

*10.40

   Credit Agreement, dated November 1, 2012, among the Company and Cave Springs, Inc., each as a Borrower, and Mothers Work Canada, Inc., as a Guarantor, and Wells Fargo, N.A., as the Lender and Administrative Agent (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated November 1, 2012).

†*10.41

   Amendment, dated November 15, 2012, to the Employment Agreement dated as of July 16, 2009 (as amended) between Ronald J. Masciantonio and the Company (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated November 15, 2012).

†10.42

   Non-Employee Director Compensation Policy & Equity Ownership Guidelines.

*21

   Subsidiaries of the Company (Exhibit 21 to the Company’s Annual Report on Form 10-K for the year ended September 30, 2010).

23

   Consent of KPMG LLP.

31.1

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

31.2

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

 

60


Exhibit No.

  

Description

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.

**101.INS

   XBRL Instance Document

**101.SCH

   XBRL Taxonomy Extension Schema Document

**101.CAL

   XBRL Taxonomy Extension Calculation Linkbase Document

**101.DEF

   XBRL Taxonomy Extension Definition Linkbase Document

**101.LAB

   XBRL Taxonomy Extension Label Linkbase Document

**101.PRE

   XBRL Taxonomy Extension Presentation Linkbase Document

 

* Incorporated by reference.

 

** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

Management contract or compensatory plan or arrangement.

 

61


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Philadelphia, Commonwealth of Pennsylvania, on December 14, 2012.

 

DESTINATION MATERNITY CORPORATION

By:

 

/s/  EDWARD M. KRELL        

  Edward M. Krell
 

Chief Executive Officer

(Principal Executive Officer)

By:

 

/s/  JUDD P. TIRNAUER        

  Judd P. Tirnauer
  Executive Vice President & Chief Financial Officer (Principal Financial and Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on December 14, 2012, in the capacities indicated:

 

/s/  EDWARD M. KRELL

Edward M. Krell

  

Chief Executive Officer and Director

(Principal Executive Officer)

/s/  JUDD P. TIRNAUER

Judd P. Tirnauer

  

Executive Vice President & Chief Financial Officer

(Principal Financial and Accounting Officer)

/s/  ARNAUD AJDLER

Arnaud Ajdler

  

Director

(Non-Executive Chairman of the Board)

/s/  BARRY ERDOS

Barry Erdos

   Director

/s/  JOSEPH A. GOLDBLUM

Joseph A. Goldblum

   Director

/s/  MELISSA PAYNER-GREGOR

Melissa Payner-Gregor

   Director

/s/  WILLIAM A. SCHWARTZ, JR.

William A. Schwartz, Jr.

   Director

/s/  B. ALLEN WEINSTEIN

B. Allen Weinstein

   Director

 

62


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AND FINANCIAL STATEMENT SCHEDULE

 

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Balance Sheets

   F-3

Consolidated Statements of Income

   F-4

Consolidated Statements of Stockholders’ Equity and Comprehensive Income

   F-5 to F-6

Consolidated Statements of Cash Flows

   F-7

Notes to Consolidated Financial Statements

   F-8 to F-33

Schedule Supporting the Consolidated Financial Statements:

  

Valuation and Qualifying Accounts

   F-34

 

F-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Destination Maternity Corporation:

We have audited the accompanying consolidated balance sheets of Destination Maternity Corporation and subsidiaries as of September 30, 2012 and 2011, and the related consolidated statements of income, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended September 30, 2012. In connection with our audits of the consolidated financial statements, we also have audited the related financial statement schedule, Valuation and Qualifying Accounts. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Destination Maternity Corporation and subsidiaries as of September 30, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Destination Maternity Corporation’s internal control over financial reporting as of September 30, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 14, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Philadelphia, Pennsylvania

December 14, 2012

 

F-2


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

     September 30,  
     2012     2011  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 22,376      $ 15,285   

Trade receivables, net

     13,197        11,015   

Inventories

     88,754        90,366   

Deferred income taxes

     7,557        7,572   

Prepaid expenses and other current assets

     4,220        6,797   
  

 

 

   

 

 

 

Total current assets

     136,104        131,035   
  

 

 

   

 

 

 

Property, plant and equipment, net

     51,078        55,854   
  

 

 

   

 

 

 

Other assets:

    

Deferred financing costs, net of accumulated amortization of $751 and $760

     92        158   

Other intangible assets, net of accumulated amortization of $2,123 and $2,082

     1,347        1,248   

Deferred income taxes

     10,667        10,133   

Other non-current assets

     356        344   
  

 

 

   

 

 

 

Total other assets

     12,462        11,883   
  

 

 

   

 

 

 

Total assets

   $ 199,644      $ 198,772   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Line of credit borrowings

   $      $   

Current portion of long-term debt

     15,257        2,915   

Accounts payable

     21,987        18,456   

Accrued expenses and other current liabilities

     35,544        33,680   
  

 

 

   

 

 

 

Total current liabilities

     72,788        55,051   

Long-term debt

            28,427   

Deferred rent and other non-current liabilities

     21,884        22,599   
  

 

 

   

 

 

 

Total liabilities

     94,672        106,077   
  

 

 

   

 

 

 

Commitments and contingencies (Note 16)

    

Stockholders’ equity:

    

Preferred stock, 1,656,381 shares authorized

    

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, 13,370,149 and 13,225,928 shares issued and outstanding, respectively

     134        132   

Additional paid-in capital

     95,086        92,932   

Retained earnings (accumulated deficit)

     9,786        (261

Accumulated other comprehensive loss

     (34     (108
  

 

 

   

 

 

 

Total stockholders’ equity

     104,972        92,695   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 199,644      $ 198,772   
  

 

 

   

 

 

 

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

 

F-3


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

 

     Year Ended September 30,  
     2012      2011      2010  

Net sales

   $ 541,476       $ 545,394       $ 531,192   

Cost of goods sold

     250,765         248,497         240,166   
  

 

 

    

 

 

    

 

 

 

Gross profit

     290,711         296,897         291,026   

Selling, general and administrative expenses

     255,623         257,421         251,653   

Store closing, asset impairment and asset disposal expenses

     1,983         1,039         2,282   

Restructuring and other charges

             193         5,658   
  

 

 

    

 

 

    

 

 

 

Operating income

     33,105         38,244         31,433   

Interest expense, net

     1,215         2,233         3,300   

Loss on extinguishment of debt

     22         37         51   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     31,868         35,974         28,082   

Income tax provision

     12,496         12,986         11,253   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 19,372       $ 22,988       $ 16,829   
  

 

 

    

 

 

    

 

 

 

Net income per share—Basic

   $ 1.48       $ 1.79       $ 1.37   
  

 

 

    

 

 

    

 

 

 

Average shares outstanding—Basic

     13,096         12,820         12,304   
  

 

 

    

 

 

    

 

 

 

Net income per share—Diluted

   $ 1.46       $ 1.75       $ 1.33   
  

 

 

    

 

 

    

 

 

 

Average shares outstanding—Diluted

     13,267         13,120         12,691   
  

 

 

    

 

 

    

 

 

 

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

 

F-4


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(in thousands)

 

    Common Stock     Additional
Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Total     Comprehensive
Income
 
    Number
of
Shares
    Amount            

Balance as of September 30, 2009

    12,223      $ 122      $ 84,496      $ (33,177   $ (1,641   $ 49,800     

Net income

                         16,829               16,829      $ 16,829   

Amortization of prior service cost for retirement plans, net of tax

                                88        88        88   

Retirement plan amendment, net of tax

                                281        281        281   

Change in fair value of interest rate swap, net of tax

                                692        692        692   
             

 

 

 

Comprehensive income

              $ 17,890   
             

 

 

 

Stock-based compensation

    89        1        1,935                      1,936     

Exercise of stock options, net

    466        5        1,364                      1,369     

Excess tax benefit from stock option exercises and restricted stock vesting

                  1,563                      1,563     

Repurchase and retirement of common stock

    (87     (1     (959                   (960  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance as of September 30, 2010

    12,691        127        88,399        (16,348     (580     71,598     

Net income

                         22,988               22,988      $ 22,988   

Change in fair value of interest rate swap, net of tax

                                490        490        490   

Foreign currency translation adjustments

                                (18     (18     (18
             

 

 

 

Comprehensive income

              $ 23,460   
             

 

 

 

Cash dividends

                         (6,901            (6,901  

Stock-based compensation

    117        1        2,343                      2,344     

Exercise of stock options, net

    547        5        2,280                      2,285     

Excess tax benefit from stock option exercises and restricted stock vesting

                  2,695                      2,695     

Repurchase and retirement of common stock

    (129     (1     (2,785                   (2,786  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance as of September 30, 2011

    13,226      $ 132      $ 92,932      $ (261   $ (108   $ 92,695     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

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

 

F-5


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME (Continued)

(in thousands)

 

    Common Stock     Additional
Paid-in
Capital
    Retained
Earnings
(Accumulated
Deficit)
    Accumulated
Other
Comprehensive
Loss
    Total     Comprehensive
Income
 
    Number
of
Shares
    Amount            

Balance as of September 30, 2011

    13,226      $ 132      $ 92,932      $ (261   $ (108   $ 92,695     

Net income

                         19,372               19,372      $ 19,372   

Change in fair value of interest rate swap, net of tax

                                90        90        90   

Foreign currency translation adjustments

                                (16     (16     (16
             

 

 

 

Comprehensive income

              $ 19,446   
             

 

 

 

Cash dividends

                         (9,325            (9,325  

Stock-based compensation

    91        1        2,356                      2,357     

Exercise of stock options, net

    84        1        106                      107     

Excess tax benefit from stock option exercises and restricted stock vesting

                  289                      289     

Repurchase and retirement of common stock

    (31            (597                   (597  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance as of September 30, 2012

    13,370      $ 134      $ 95,086      $ 9,786      $ (34   $ 104,972     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

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

 

F-6


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Year Ended September 30,  
     2012     2011     2010  

Operating Activities

      

Net income

   $ 19,372      $ 22,988      $ 16,829   

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

      

Depreciation and amortization

     12,445        12,769        12,917   

Stock-based compensation expense

     2,357        2,344        1,936   

Loss on impairment of long-lived assets

     1,876        768        1,865   

Loss on disposal of assets

     115        270        196   

Loss on extinguishment of debt

     22        37        51   

Deferred income tax (benefit) provision

     (1,378     2,679        (2,062

Amortization of deferred financing costs

     105        170        196   

Changes in assets and liabilities:

      

(Increase) decrease in:

      

Trade receivables

     (2,188     (680     (3,814

Inventories

     1,611        (9,632     (1,863

Prepaid expenses and other current assets

     2,577        (1,634     (1,310

Other non-current assets

     (12     (26     (4

Increase (decrease) in:

      

Accounts payable, accrued expenses and other current liabilities

     6,201        (5,525     (1,028

Deferred rent and other non-current liabilities

     (406     (3,085     2,065   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     42,697        21,443        25,974   
  

 

 

   

 

 

   

 

 

 

Investing Activities

      

Capital expenditures

     (9,256     (12,270     (10,448

Additions to intangible assets

     (265     (313     (293

Withdrawal from (contribution to) grantor trust

            1,504        (1,500
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (9,521     (11,079     (12,241
  

 

 

   

 

 

   

 

 

 

Financing Activities

      

(Decrease) increase in cash overdrafts

     (401     (1,147     550   

Repayment of long-term debt

     (16,085     (13,819     (12,248

Deferred financing costs paid

     (61     (26       

Withholding taxes on stock-based compensation paid in connection with repurchase of common stock

     (597     (2,786     (960

Cash dividends paid

     (9,325     (6,901       

Proceeds from exercise of stock options

     107        2,285        1,369   

Excess tax benefit from exercise of stock options and restricted stock vesting

     289        2,695        1,563   
  

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (26,073     (19,699     (9,726
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (12     (13       
  

 

 

   

 

 

   

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

     7,091        (9,348     4,007   

Cash and Cash Equivalents, Beginning of Year

     15,285        24,633        20,626   
  

 

 

   

 

 

   

 

 

 

Cash and Cash Equivalents, End of Year

   $ 22,376      $ 15,285      $ 24,633   
  

 

 

   

 

 

   

 

 

 

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

 

F-7


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF BUSINESS

Destination Maternity Corporation and subsidiaries (the “Company”) is a specialty designer and retailer of maternity clothing. The Company operated 2,008 retail locations as of September 30, 2012, including 625 stores and 1,383 leased departments, throughout the United States, Puerto Rico and Canada, and markets its maternity apparel on the Internet through its DestinationMaternity.com and brand-specific websites. In addition, the Company markets maternity apparel at Kohl’s® stores throughout the United States under an exclusive product and license agreement. The Company has expanded internationally and has entered into exclusive store franchise and product supply relationships in the Middle East, India and South Korea. The Company was incorporated in Delaware in 1982.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Principles of Consolidation and Basis of Financial Statement Presentation

The accompanying consolidated financial statements include the accounts of the Company and its direct and indirect wholly-owned subsidiaries: Cave Springs, Inc., Mothers Work Canada, Inc., Destination Maternity Apparel Private Limited and Mothers Work Services, Inc. All significant intercompany transactions and accounts have been eliminated in consolidation.

b. Fiscal Year-End

The Company operates on a fiscal year ending September 30 of each year. All references to fiscal years of the Company refer to the fiscal years ended on September 30 in those years. For example, the Company’s “fiscal 2012” ended on September 30, 2012.

c. Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

d. Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, cash in the bank and short-term investments with an original maturity of three months or less when purchased. Cash overdrafts of $3,452,000 and $3,853,000 were included in accounts payable as of September 30, 2012 and 2011, respectively.

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

e. Inventories

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

 

F-8


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

f. Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation and amortization are computed for financial reporting purposes on a straight-line basis, using service lives ranging principally from five to ten years for furniture and equipment and forty years for the building. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or their useful life. The cost of assets sold or retired and the related accumulated depreciation or amortization are removed from the accounts with any resulting gain or loss included in net income. Maintenance and repairs are expensed as incurred, except for the capitalization of major renewals and betterments that extend the life of the asset. Long-lived assets are reviewed for impairment whenever adverse events, or changes in circumstances or business climate, indicate that the carrying value may not be recoverable. Factors used in the evaluation include, but are not limited to, management’s plans for future operations, brand initiatives, recent operating results and projected cash flows. If the associated undiscounted cash flows are insufficient to support the recorded asset, an impairment loss is recognized to reduce the carrying value of the asset. The amount of the impairment loss is determined by comparing the fair value of the asset with the carrying value.

During fiscal 2012, 2011 and 2010, the Company recorded impairment write-downs of property, plant and equipment totaling $1,875,000, $759,000 and $1,863,000, respectively, on a pretax basis.

g. Intangible Assets

Intangible assets with definite useful lives consist primarily of patent and lease acquisition costs. The Company capitalizes legal costs incurred to defend its patents when a successful outcome is deemed probable and to the extent of an evident increase in the value of the patents. Intangible assets are amortized over the shorter of their useful life or, if applicable, the lease term. Management reviews the carrying amount of these intangible assets as impairment indicators arise, to assess the continued recoverability based on future undiscounted cash flows and operating results from the related asset, future asset utilization and changes in market conditions. During fiscal 2012, 2011 and 2010, the Company recorded write-downs of intangible assets totaling $1,000, $9,000 and $2,000, respectively, on a pretax basis. The Company has not identified any indefinite-lived intangible assets. Aggregate amortization expense of intangible assets in fiscal 2012, 2011 and 2010 was $142,000, $135,000 and $119,000, respectively.

Estimated amortization expense of the Company’s intangible assets as of September 30, 2012, for the next five fiscal years, is as follows (in thousands):

 

Fiscal Year

      

2013

   $ 151   

2014

     134   

2015

     117   

2016

     112   

2017

     105   

h. Interest Rate Derivatives

The Company mitigated a portion of its floating rate interest risk on variable rate long-term debt through an interest rate swap agreement that expired on April 18, 2012. In accordance with applicable accounting standards for derivative instruments, the Company recognized the derivative on the balance sheet at fair value. On the date the derivative instrument was entered into, the Company designated it as a hedge of the variability of cash flows

 

F-9


DESTINATION MATERNITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

to be received or paid related to a recognized asset or liability (“cash flow hedge”). Changes in the fair value of a derivative that is designated as, and meets all the criteria for, a cash flow hedge are recorded in accumulated other comprehensive loss and reclassified into earnings as the underlying hedged item affects earnings. When applicable, the Company formally documents the relationship between hedging instruments and hedged items. Also when applicable, the Company formally assesses at the inception of the hedge and on a quarterly basis, whether the derivative is highly effective in offsetting changes in cash flows of the hedged item. Any portion of the change in fair value of the derivative associated with hedge ineffectiveness is included in current earnings. For fiscal 2012, 2011 and 2010, the Company’s interest rate swap was determined to have no ineffectiveness.

i. Deferred Financing Costs

Deferred financing costs are amortized to interest expense over the term of the related debt agreement. Amortization expense of deferred financing costs in fiscal 2012, 2011 and 2010 was $105,000, $170,000 and $196,000, respectively. In connection with debt extinguishments, in fiscal 2012, 2011 and 2010 the Company wrote off $22,000, $37,000 and $51,000, respectively, of unamortized deferred financing costs (see Note 10). In connection with its new credit facility entered into on November 1, 2012, the Company incurred approximately $825,000 in deferred financing costs, of which $61,000 was paid in fiscal 2012 (see Note 9).

Estimated amortization expense of the Company’s deferred financing costs as of September 30, 2012 plus those incurred in November 2012, for the next five fiscal years, is as follows (in thousands):

 

Fiscal Year

      

2013

   $ 173   

2014

     165   

2015

     165   

2016