SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended September 30, 1997
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to _______________
Commission file number 0-21196
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Mothers Work, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 133045573
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(State or other jurisdiction of incorporation (IRS Employer
or organization) Identification No.)
456 North Fifth Street, Philadelphia, PA 19123
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (215) 873-2200
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of class)
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 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. |_|
On November 14, 1997, the aggregate market value of the Registrant's Common
Stock, $.01 par value, held by nonaffiliates of the Registrant was approximately
$21,382,641.
On November 14, 1997, 3,564,644 shares of the Registrant's Common Stock,
$.01 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed with the
Commission in connection with the Annual Meeting of Stockholders scheduled to be
held on January 15, 1998 are incorporated by reference into Part III of this
Form 10-K.
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PART I
ITEM 1. Business(1)
General
Mothers Work, Inc., a Delaware corporation ("Mothers Work" or the
"Company"), which began operations in 1982, is the largest specialty retailer of
maternity clothing in the United States. In fiscal 1996 the Company expanded
into upscale "bridge" women's apparel (i.e., similar to designer fashions but
with a lower price point) through the acquisition of Episode USA Inc.
("Episode"). As of September 30, 1997, the Company operated 431 stores under the
Mimi Maternity(R), A Pea in the Pod(R) ("Pea"), Motherhood Maternity(R)
("Motherhood") and Maternity Works(R) concepts offering a full range of career,
casual and special occasion maternity wear. In addition, the Company operated
114 leased maternity departments in stores such as Lazarus, Rich's, Famous Barr
and Macy's. The Company also operated 42 stores under the Episode(R)(2) concept,
offering upscale bridge women's apparel. The Company locates its stores
primarily in regional shopping malls and, to a lesser extent, in central
business districts within major metropolitan areas, and in factory-direct outlet
centers. The Company is vertically-integrated, performing design, manufacturing,
distribution and retail sales functions primarily in-house.
The Company's maternity wear retail stores, although having different
merchandising and marketing strategies, are all targeted to those women seeking
to purchase moderate to upscale maternity fashions. All of the Company's
maternity store concepts sell clothing that is designed to meet an expectant
mother's entire lifestyle fashion needs including her career requirements, as
well as her casual and special occasion needs. In April 1997 the Company
restructured its core maternity business by combining the Mimi Maternity and
Maternite lines and consolidating store operations in selected markets.(3) Mimi
Maternity, which was developed in 1990, is designed to meet the needs of fashion
forward women who are willing to spend more to make a fashion statement. Pea,
which was acquired in April 1995, markets the most upscale of the Company's
maternity fashions and offers a premium or bridge merchandise selection
manufactured by the Company, including the Company's Mimi Maternity line of
clothing, and certain designer labels. Mimi Maternity and Pea collectively
constitute the Company's "high end" product line. Motherhood, the oldest
national chain specialty retailer of maternity clothing in the United States,
was acquired in August 1995 in order for the Company to enter the
moderately-priced maternity clothing market. Maternity Works,
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(1) The terms "Mothers Work" and the "Company" as used in this Report
include each of the following subsidiaries of the Company: Mothers Work (R.E.),
Inc., The Page Boy Company, Inc. ("Page Boy"), and Cave Springs, Inc. All
references in this Report to stores or Company-owned stores include leased
departments.
(2) Episode, Excursion and Excursions are registered trademarks of Episode
USA, Inc.
(3) The Company continues to operate stores under the names Maternite and
Mothers Work where bound by lease arrangements or where it would otherwise be
uneconomical to change the name of the store to Mimi Maternity at this time.
<PAGE>
a chain of factory-direct outlet stores, serves the woman who seeks upscale
apparel during her pregnancy but cannot or will not purchase at full retail
prices.
The Company also operates in the non-maternity women's apparel market
through its Episode division, which was acquired in June 1996. Episode markets
bridge women's fashion apparel heavily focused on jackets, skirts, pants and
blouses. Episode was founded by the Fang brothers of Hong Kong and their company
Toppy International Limited ("Toppy"), from whom the U.S. stores were acquired.
The Company's strategy is to:
o Respond quickly to customer fashion demand utilizing its Real Time
Retailing(R) business model which encompasses computerized point of
sale and merchandising systems, daily replenishment of inventory,
"quick-turn" manufacturing with some product being produced on a
two-week cycle domestically, and "quick-response" in-season design.
o Secure and maintain desirable retail locations within regional
shopping malls and factory-direct outlet centers.
o Capitalize on its retail, merchandising, manufacturing, design and
distribution strengths to diversify its product offering from
maternity apparel to regular sized women's apparel.
The Company is incorporated under the laws of the State of Delaware and
entered into the maternity apparel business in 1982. Its principal executive
offices and production facility are located at 456 North Fifth Street,
Philadelphia, Pennsylvania 19123 and its telephone number is (215) 873-2200.
The Maternity Apparel Market
The Company is unaware of any reliable data on the revenue size of the
maternity apparel market. The Company believes that the number of maternity
clothing wholesale vendors has decreased during the past decade as a result of
the decline in the number of large retailers and department store chains which
market maternity clothing. The Company's vertical integration reduces the need
for the Company to rely on the availability of merchandise from outside vendors,
providing a competitive advantage for the Company. Management believes that the
market is elastic due in part to customers who shop the regular market and
choose loose-fitting or larger-sized clothing as a substitute for maternity
wear. The Company considers this component of the market to be a revenue
opportunity.
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Bridge Fashion Market
The acquisition of Episode represents the Company's first entry into the
regular women's apparel market. In addition, the Company has introduced its own
non-maternity bridge line, Daniel & Rebecca(R), which is being sold through its
Episode locations. Episode markets bridge women's fashion apparel heavily
focused on jackets, skirts, pants and blouses. The women's regular-sized market
segment is extremely competitive and the Company will compete for customers with
large specialty apparel retailers, better department stores, national apparel
chains, designer boutiques and individual apparel stores.
Strategy
The key components of the Company's strategic objectives are described
below.
Real Time Retailing - Real Time Retailing is the Company's proprietary and
comprehensive capability to monitor better and respond more quickly to consumer
fashion demand, thereby reducing the fashion risk inherent in the apparel
business. Through the use of computerized point of sale and merchandising
systems, daily replenishment of inventory, "quick-turn" manufacturing and
"quick-response" design, all managed by an experienced group of employees, the
Company is able to provide its customers with the merchandise that they want
when they want it. The Company believes that this ability to react in real time
to changing consumer tastes and demand for product gives it a competitive
advantage over apparel retailers who source the majority of their product
overseas or with outside vendors which results in long lead times and an
inability to replenish merchandise quickly. The objective is to maximize the
sales potential of each store by matching the profile of the store's customers
with the proper merchandise. Real Time Retailing also assists the Company in
maximizing its in-store inventory turns and sales per square foot, reducing its
cost of goods sold and leading to higher gross profit margins.
Prime Locations and Broad Distribution - The Company's demonstrated ability
historically to generate high sales per square foot, the fact that its stores
project an image and design consistent with other quality retailers and its
multiple concept approach have enabled the Company to secure and maintain
desirable retail locations within regional shopping malls and factory-direct
outlet centers for its stores. These factors have enabled the Company not only
to locate stores at many of the most desirable shopping malls and factory-direct
outlet centers, but also to obtain desirable locations within such malls and
centers.
By operating four different store concepts, the Company is positioned to
satisfy demand for maternity clothing throughout the moderate-to-high end
segments of the market. Mall operators require an appropriate mix of stores for
the mall's perceived consumer and market position. For regional malls that
require one maternity store, the Company provides several different concepts
within the moderate to the high end segments of the market. Moreover, since
there is some overlap between store concepts (in terms of both stocked
merchandise and price points), the Company
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expects that customers will shop at more than one of its store concepts.
Accordingly, the Company is positioned to supply mall operators which require
two maternity stores. In the case of multi-mall operators, the Company has the
flexibility to supply packages of stores in multiple malls utilizing several of
its concepts.
As of September 30, 1997, the Company's operations included 114 leased
departments. Generally, start-up and operating costs for a leased department are
substantially less than for a stand-alone store. The departments are leased from
stores such as Lazarus, Rich's, Famous Barr and Macy's and are generally staffed
with Company employees. The inventory of the leased departments is merchandised
and owned by the Company. Approximately 75% of the leased departments utilize
Company point-of-sale registers to capture sales information, and 100% of the
leased departments use such registers to communicate with employees. The
Company's leased department arrangements generally have an initial term of one
year. The term is automatically renewed for up to one year or indefinitely, and
may be terminated by either party upon advance written notice of up to 90 days.
Payment terms for the leased space are based on a percentage of net sales and
generally range between 15% and 21%. In addition, expenses such as credit card
fees, miscellaneous supplies and telephone usage are paid as incurred. A
significant part of the Company's growth strategy for fiscal 1998 includes the
opening of leased departments.
Retail, Merchandising, Manufacturing, Design and Distribution Strengths -
The Company believes it can capitalize on its retail, merchandising,
manufacturing, design and distribution strengths to expand its product offering
from maternity apparel to regular sized women's apparel through its acquisition
and expansion of Episode. Through its Episode division, the Company is serving
the bridge-level customer with whom it has experience through its Pea store
concept, and most every member of the Company's design, merchandising, store
operations and manufacturing departments has some level of experience in the
regular women's apparel market. The Company is managing the merchandising,
manufacturing and design operations of the Episode division with the same
techniques and skills it has used to operate its maternity business, including
fully-staffed merchandising and design departments, computer systems as well as
quick response design and manufacturing.
Expansion Strategy
Expansion of Apparel Business. Since the time of its initial public
offering in March 1993, the Company has increased its store base by
approximately 776% (from 67 stores to 587 stores) as of September 30, 1997.
These increases include stores acquired as a result of the Company's January
1994 acquisition of Page Boy (22 stores acquired) ("Page Boy Acquisition"), a
Dallas-based maternity clothing chain, its April 1995 acquisition of Pea (66
stores acquired) ("Pea Acquisition"), also a Dallas-based maternity clothing
chain and formerly the nation's second largest maternity retailer, its August
1995 acquisition of Motherhood (217 stores acquired) ("Motherhood Acquisition"),
a California-based maternity clothing chain, and its June 1996 acquisition of
Episode (21 stores acquired) ("Episode Acquisition").
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Following the Pea Acquisition in 1995, the Company undertook an analysis of
all of its stores and entered into a store rationalization and consolidation
program to determine which acquired stores would be best operated under separate
names and which stores should be closed as redundant. In addition, in April 1997
the Company announced a plan to restructure its core maternity business by
combining the Mimi Maternity and Maternite over-lapping product styles and
closing approximately 30 retail stores, primarily high end locations, serviced
by other Company stores. In addition to the closing of the high end locations,
the Company converted 26 additional high end stores into more moderately priced
Motherhood stores. After completion of the restructuring plan, the Company
operates 120 high end stores under the Mimi Maternity and Pea concepts. The
Company believes that the high end sales from the closed and converted stores
will be effectively transferred to the remaining high end store base.
The Motherhood Acquisition provides the Company's biggest opportunity as it
gives the Company more complete mall coverage at all price points ranging from
moderate to high end and represents the Company's first significant presence
within leased departments. Motherhood, along with the leased departments
mentioned above, represents a significant part of the Company's growth strategy
for fiscal 1998, subject to capital and marketplace availability. The Episode
Acquisition, as well as the expansion of the Daniel & Rebecca(R) line, gives the
Company entry into bridge women's fashion apparel and an opportunity to grow
outside the maternity business.
The Company opened 152 locations in fiscal 1997, consisting of 91 leased
departments, 45 Motherhood and Maternity Works stores and 16 Episode and Episode
outlet stores, compared with 44 locations in fiscal 1996, consisting of 30
Motherhood, 9 high end maternity and 5 Episode and Episode outlet stores. The
Company plans to add approximately 70 maternity stores, primarily leased
departments and Motherhood stores, and approximately 9 Episode stores, primarily
Episode outlets, in fiscal 1998.
A significant portion of the Company's growth has resulted from the
addition of new stores, acquisition of existing maternity stores and the
increased sales volume from such stores. The Company's ability to open new
stores on a timely basis will depend upon the Company's success in identifying
suitable store sites, obtaining leases for those sites on acceptable terms,
constructing or refurbishing the sites where necessary, and hiring and training
skilled store managers and personnel. There can be no assurance that suitable
sites will be available for new stores or that new stores will generate sales
volumes comparable to those of the Company's existing stores, and the costs
associated with opening such stores may adversely affect the Company's
profitability. Further, from time to time, the Company also evaluates store
closing opportunities.
The Company continually identifies and evaluates real estate opportunities.
In addition to its current stores, the Company has identified additional malls
or other locations in the United States that would be well suited for maternity
stores. The Company considers markets nationwide but favors metropolitan areas
with populations greater than 500,000. The Company has also identified
additional malls and outlet centers which do not meet the Company's primary site
selection criteria, but which may nevertheless be attractive locations for one
of the Company's stores if lease terms are able to be negotiated to provide
attractive store unit economics.
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The Company believes it can further increase sales of the acquired Episode
stores through product line extensions, improved inventory management and
refined store operations. The Company plans to increase sales by augmenting the
Episode store base and merchandise selection. The Company will continue to serve
the existing Episode customer base with a full line of current product from
Toppy, which management believes will minimize risks associated with the bridge
business. In addition, the Company has continued to successfully market its own
label, Daniel & Rebecca(R), in the Episode stores. This label includes fashion
forward styles that carry an independent self-confident woman of the 90's from
the boardroom to the beach. This concept is referred to as lifestyle dressing
and is the foundation of the Daniel & Rebecca marketing position.
As part of the Episode Acquisition, the Company entered into a Trademark
License Agreement, with an initial term expiring May 31, 2000, with Toppy. The
Trademark License Agreement gives the Company the exclusive license to use the
trademark Episode(R) as a name for the Company's retail stores selling bridge
women's apparel and accessories in the United States. The Trademark License
Agreement requires the Company to pay Toppy a royalty of 5% of net sales of
products in Episode stores, with maximum royalties not to exceed $4.5 million.
See Note 12 of "Notes to Consolidated Financial Statements."
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Store Concepts
The Company operates its maternity stores under four concepts offering a
full range of career, casual and special occasion maternity wear: Pea, Mimi
Maternity, Motherhood and Maternity Works. In addition, the Company operates
high end bridge women's apparel specialty stores under the Episode(R) name. The
following table sets forth certain information regarding the Company's store
composition as of September 30, 1997, including each store concept's target
location, product description and selected price points:
Summary of Store Concepts
<TABLE>
<CAPTION>
===================================================================================================================================
Store Description of Product Price Range for Average Store Typical Anchors and
Concept Typical Location Description Dresses/Blouses Size (Sq. Ft.) Comparable Retailers
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<S> <C> <C> <C> <C> <C>
Episode High end regional Young $200-$500 3,100 Bergdorf Goodman,
malls & affluent Designer at 120-200 Neiman Marcus, Saks
residential Bridge Price Fifth Avenue, Gucci,
districts Point Ralph Lauren
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A Pea in the High end regional Bridge, high $200-$400 2,300 Bergdorf Goodman,
Pod malls & affluent fashion 120-180 Neiman Marcus, Saks
residential Fifth Avenue, Gucci,
districts Ralph Lauren
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Mimi High end regional Fashion- $78-$200 1,600 Neiman Marcus,
Maternity malls forward, 58-128 Bloomingdales,
Contemporary Nordstrom's, Saks Fifth
Avenue, Barney's, Joan
& David, Bebe, Ann
Taylor, Banana Republic
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Motherhood Moderate regional Value- $28-$88 1,200 Macy's, Sears, J.C.
malls and oriented, 28-58 Penney's, Mervyn's,
department stores mostly casual Casual Corner, Merry-
basics Go-Round, Lerners,
Limited, Express, Eddie
Bauer, Mothertime, Dan
Howard
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Maternity Factory direct Fashion at $39-$79 2,000 Neiman Marcus' Last
Works outlet malls and marked-down 29-49 Call, Nordstrom Rack,
centers prices Saks Fifth Avenue
Clearinghouse, and
outlets for Ann Taylor,
Polo, Donna Karan, Liz
Claiborne, J. Crew and
Brooks Brothers
===================================================================================================================================
</TABLE>
Most malls require only one moderate to high end maternity store; however,
major regional malls with several department stores may be able to accommodate
two. With Mimi Maternity and Pea as the Company's prestige offerings, and
Motherhood as the value oriented, mostly casual basics offering, the Company has
the potential to fill both positions at a given mall. As of September 30, 1997,
the Company had two or more maternity stores in 34 major regional malls.
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Store Operations
The Company's Senior Vice President - Stores is responsible for all
store operations. The Company's centralized operations allow store personnel to
focus on selling as well as the physical maintenance of merchandise and store
facilities. The Company employs skilled, motivated sales associates who are
trained to provide the detailed assistance and the reassurance needed by the
customer. A visual merchant coordinates with the merchandising department to
develop a space allocation plan and design store display windows and travels
among the Company's stores to enhance merchandise presentation.
Merchandising, Design and Store Inventory Planning
The Company's Vice President - Merchandising is responsible for and directs
the following departments:
Merchandising. Guided by Real Time Retailing, the Company's merchandising
department combines input from the designers, current trends seen generally in
women's clothing, outside vendor resources and store management input, with
TrendTrack computer analysis of customer preferences to provide a constant flow
of merchandise to the Company's stores. The Company strives to maintain an
appropriate balance between new merchandise and proven successful styles. These
fashions are generally marketed under the Company's A Pea in the Pod(R), Mimi
Maternity(R), Steena(R), Daniel & Rebecca(R) and Motherhood(R) labels.
TrendTrack includes a computerized open-to-buy system which projects
sales, purchases and inventory levels for each merchandise classification by
product line. This system permits the Company to plan its manufacturing and
outside purchasing weekly to control its inventory on a
classification-by-classification basis, thereby enhancing the Company's ability
to control inventory quantity and mix. By combining information from the
open-to-buy system and the TrendTrack item-tracking system, which measures
up-to-the-prior-day selling and inventory positions on every style, the
Company's merchandising department decides what items to make more of, what to
mark down or up in price, and what to close out.
All of the store concepts are on-line with TrendTrack and have integrated
merchandising operations.
Design. The Design department produces samples and patterns for the
Company's manufactured products under the guidance of the Merchandising
department. The Company's design rooms were consolidated in conjunction with the
Company's restructuring in April 1997. Prior to the restructuring, there were
six design rooms. Subsequently, the design process has been divided among three
design rooms. One for Episode and Pea, one for Mimi Maternity and one for
Motherhood. The Episode and Pea design room is staffed by a separate team of
merchandisers and designers having experience with bridge women's apparel.
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The Company divides the year into six principal seasons and 12 monthly
deliveries. Although the seasons guide general product development, color
coordinated groups are planned for monthly deliveries for each line. The design
of a product begins with a review of European and New York trends and current
retail trends through fashion reporting service slides and fabric samples. The
designers review the Company's best selling items from prior seasons and
integrate current fashion ideas from the non-maternity retail market.
Store Inventory Planning. The Company constructs profiles of each store
using its inventory planning system to enhance store merchandise coordination
and stock balance, to maintain adequate depth of merchandise by style and to
manage close-out merchandise and end-of-season consolidation of merchandise.
Each season's designs and production for each store are allocated based on prior
selling history. Stores within each chain are grouped as career oriented or
casual, more or less fashion forward, and higher or lower price point. These
factors are all considered in establishing target inventories for each store.
Stores typically maintain most styles on a one garment per color, per size, per
style basis, and inventories are replenished daily.
Integral to the Company's inventory management program are its proprietary
methods guided by Real Time Retailing and managed by its TrendTrack information
system. Each week the Company uses its TrendTrack to replenish needed items at
high-volume stores. Every week, a computer program analyzes data provided by
TrendTrack as to all slow selling and close-out items in every store to rank the
stores in order of selling rate by item. The TrendTrack system will send the
stores which are low sellers of an item a message to send the item back to the
Company's warehouse thereby creating backstock for stores where the item is
selling faster. The consolidation program reduces markdowns and increases sales
by getting product to the stores that sell it fastest.
Production and Distribution
The Company subcontracts its sewing to shops in the Philadelphia
metropolitan and surrounding area and works with approximately 25
subcontractors. In fiscal 1997 and 1996, four contractors supplied approximately
31% and 32%, respectively, of the Company's total production based on aggregate
cost. On an individual basis, the production supplied by each of these
subcontractors ranged from 7% to 9% in fiscal 1997 and from 6% to 9% in fiscal
1996. In addition, some production is supplied by independent subcontractors
located abroad, principally in Mexico and the Far East, and the Company
continues to seek additional subcontractors throughout the world for its
sourcing needs.
The Company obtains fabrics, trim and other supplies from a variety of
sources and believes that as the number of the Company's stores increases, there
will continue to be adequate sources of fabrics and other supplies to produce a
sufficient supply of quality goods in a timely manner and on satisfactory
economic terms.
In fiscal 1996 the Company expanded sourcing to include Mexico and "807
operations" in the Dominican Republic and Costa Rica. "807 operations" refers to
articles assembled abroad with
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components produced in the United States. This operation comes under Section
9802 of the Harmonized Tariff Schedule, which provides for articles exported and
returned to the United States after having been advanced in value, assembled,
further processed, or improved in condition abroad. These products are generally
cut at the Company's headquarters, supplied with trims and are then shipped out
of the country for assembly. The Company's 807 operations and production sourced
to subcontractors abroad are limited to products which are moderate in price and
are not time sensitive with respect to fashion demand (e.g. blue jeans,
leggings, T-shirts, etc.). The Company does not source any of its time-sensitive
fashion apparel or accessories overseas and, as such, is able to address quickly
changes in taste and demand for fashion products as discussed under Real Time
Retailing in the Strategy section.
The Company's production and quality assurance team monitors production at
each subcontractor's facility in the United States and abroad, to ensure quality
control, compliance with its design specifications and timely delivery of
finished goods.
That portion of the Company's merchandise imported into the United States
is subject to United States duties. The Company cannot predict whether any of
the foreign countries in which its products are currently manufactured or any of
the countries in which the Company may manufacture its products in the future
will be subject to future or increased import restrictions by the U. S.
government, including the likelihood, type or effect of any trade restrictions.
Trade restrictions, including increased tariffs or quotas, against items sold by
the Company could affect the importation of such merchandise generally and, in
that event, could increase the cost or reduce the supply of merchandise
available to the Company and adversely affect the Company's business, financial
condition, results of operations and liquidity. The Company's merchandise flow
may also be adversely affected by political instability in any of the countries
in which its goods are manufactured, if it affects the production or export of
merchandise from such countries; significant fluctuation in the value of the
U.S. dollar against foreign currencies; and restrictions on the transfer of
funds.
Finished garments from subcontractors and other manufacturers are received
at the Company's central warehouse in Philadelphia, Pennsylvania, inspected and
stored for picking. Each morning, the TrendTrack system prints replenishment
pick lists for each store. The shipments are scanned for comparison against the
bar-coded transaction number on the pick list before shipping. Shipments are
primarily made by common carrier, typically UPS, Airborne, Emery Air Freight or
a similar service providing one-or two-day delivery throughout the United
States.
The Company plans to lease and install an automated sorting and
pick-to-light system in its central warehouse during fiscal 1998.
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Management Information and Control Systems
All of the Company's stores have point-of-sale terminals that provide
information used in the Company's custom TrendTrack item and classification
tracking system. This system provides daily financial and merchandising
information integral to the Company's Real Time Retailing strategy. The
TrendTrack system has numerous features designed to integrate the Company's
retail operations with its design and manufacturing functions. These features
include custom merchandise profiles for each store, daily inventory
replenishment, item-tracking providing daily updated selling information for
every style, classification open-to-buy and inventory control, as well as daily
collection of credit card receipts.
The Company employs a comprehensive materials requirements planning system
to manage its production inventories, documentation, work orders and scheduling.
Terminals are located throughout the design, patterning and production areas.
This system provides a perpetual raw material inventory, actual job costing,
scheduling and bill of materials capabilities.
Advertising
The Company's advertising and promotion efforts focus on yellow pages and
national local print advertising. The Company will also pursue editorial
coverage in major magazines for Episode and its Daniel & Rebecca(R) lines.
Episode and the Daniel & Rebecca(R) line are advertised in magazines such as
"Vogue." Pea and Mimi Maternity are advertised in magazines such as "Vogue" and
"Shape Fit Pregnancy." Motherhood is advertised in magazines such as "Parent's
Expecting," "Baby Talk" and "Parenting." In addition, the Company produces Pea
maternity brochures annually, which are distributed to obstetricians and
customers. The customer mailing list, which by nature is constantly changing, is
regularly updated through the Company's customer response cards, which are added
to the computer database.
Competition
All aspects of the retail industry, including attracting customers,
securing merchandise and locating appropriate retail sites, are highly
competitive. The Company, with its Episode division, competes for customers with
large specialty apparel retailers, better department stores, national apparel
chains, designer boutiques and individual apparel stores. In its maternity
apparel business, the Company faces competition from various full-price
maternity clothing chains, a number of off-price specialty retailers and catalog
retailers, as well as from local, regional and national department stores and
women's and, to some extent, men's clothing stores. Many of these competitors
are larger and have significantly greater financial resources than the Company.
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Employees
At September 30, 1997, the Company had approximately 1,670 full-time and
approximately 1,490 part-time employees. None of the Company's employees is
covered by a collective bargaining agreement. The Company believes that its
relationship with its employees is good.
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Executive Officers of the Company
The executive officers of the Company are:
Name Age Position
---- --- --------
Dan W. Matthias............ 54 Chairman of the Board and
Chief Executive Officer
Rebecca C. Matthias........ 44 President, Chief Operating Officer
and Director
Thomas Frank............... 41 Chief Financial Officer and
Vice President - Finance
Donald W. Ochs............. 56 Senior Vice President - Operations
Lynne M. Wieder............ 37 Senior Vice President - Stores
Dan W. Matthias joined the Company on a full-time basis in 1982 and has
served as Chairman of the Board since its inception. From 1983 to 1993 he served
as the Company's Executive Vice President, and since January 1993, Mr. Matthias
has been the Company's Chief Executive Officer. He had previously been involved
in the computer and electronics industry, serving as a director of Zilog, Inc.
and serving as the President of a division of a subsidiary of Exxon Corporation.
Rebecca C. Matthias founded the Company in 1982 and has served as a
director of the Company and its President since its inception. Since January
1993, Ms. Matthias has served as the Company's Chief Operating Officer. Prior to
1982, she was a construction engineer for the Gilbane Building Company. In 1992,
she was chosen as "Regional Entrepreneur of the Year" by Inc. magazine and
Merrill Lynch. Ms. Matthias also serves as a member of the Board of Trustees of
Drexel University.
Thomas Frank joined the Company in 1988 and has served the Company as Vice
President - Finance since September 1989 and also as Chief Financial Officer
since September 1995. Mr. Frank was Sales Audit Manager of the Lane Bryant
Division of The Limited, Inc. from 1986 to 1988. Mr. Frank is a Certified Public
Accountant.
Donald W. Ochs joined the Company in June 1995 as Senior Vice President -
Operations with over 30 years of experience in apparel manufacturing management,
operations and worldwide sourcing of women's specialty clothing. Mr. Ochs was
Senior Vice President - Corporate Worldwide Sourcing and Manufacturing at Leslie
Fay Companies from October 1993 until joining the Company. From 1989 to 1993,
Mr. Ochs was employed by Liz Claiborne, Inc. as Senior Vice President -
Manufacturing.
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<PAGE>
Lynne M. Wieder has been Vice President - Stores since January 1993 and
Senior Vice President - Stores since September 1995. Previously, she had been
Director of Stores since joining the Company in January 1991. Ms. Wieder was
employed by Gap, Inc. as the Director of Stores for its Hemisphere division from
August 1989 to February 1990. Ms. Wieder worked at Ann Taylor from February 1981
to July 1989 and served as Regional Supervisor of Stores in various regions of
the United States.
The Company's executive officers are elected annually by the Board of
Directors and serve at the discretion of the Board.
Other than the husband and wife relationship between Dan and Rebecca
Matthias, there are no family relationships among any of the other executive
officers of the Company.
Trademarks
The Company owns such rights to the trademarks and service marks as it
believes are necessary to conduct its business as currently operated. The
Company is the owner, through its wholly-owned subsidiary, Cave Springs, Inc.,
of the registered trademarks Mothers Work(R), Maternite(R), Maternity Works(R),
Steena(R) and Daniel & Rebecca(R), and the service marks Mimi Maternity(R), Real
Time Retailing(R) and the slogan What's Showing is Your Style(R). With the
acquisition of Pea, the Company similarly became the owner of the registered
trademarks and service marks A Pea in the Pod(R) and Maternity Redefined(R).
Upon the completion of the Motherhood Acquisition, the Company likewise became
the owner of the registered trademarks Motherhood(R), Essentiel Body Cream(R)
and Lauren Taylor(R). The Company owns a patent for an adjustable waistband for
use in skirts, which allows the garment to be loosened during the course of
pregnancy and, with the acquisition of Motherhood, the Company acquired a patent
relating to the Essentiel Body Cream product. The Company is not aware of any
pending claims of infringement or other challenges to the Company's rights to
use its marks in the United States as currently used by the Company.
As part of the Episode Acquisition, the Company entered into a Trademark
License Agreement, with an initial term expiring May 31, 2000, with Toppy. The
Trademark License Agreement gives the Company the exclusive license to use the
trademark Episode(R) as a name for the Company's retail stores selling bridge
women's apparel and accessories in the United States. The Trademark License
Agreement requires the Company to pay Toppy a royalty of 5% of net sales of
products in Episode stores, with maximum royalties not to exceed $4.5 million.
See Note 12 of "Notes to Consolidated Financial Statements."
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<PAGE>
Item 2. Properties
The Company's principal executive offices, manufacturing and distribution
facilities are located at 456 North Fifth Street, Philadelphia, Pennsylvania
19123. This facility consists of approximately 318,000 square feet of which
approximately 44,000 square feet is dedicated to office space and the remaining
square footage to manufacturing and distribution. The total cost of the facility
and improvements was approximately $9.9 million. The cost was funded in part
with $6.6 million in government assisted financing, which is secured by two
separate mortgages creating an aggregate $6 million lien.
All of the Company's retail stores are leased pursuant to leases that
extend for terms averaging from seven to ten years. Certain leases allow the
Company to terminate its obligations in the event the specified store does not
achieve a specified sales volume. Certain leases include clauses that provide
for contingent payments based on sales volumes and others contain clauses for
escalations of base rent as well as increases in operating costs, marketing
costs and real estate taxes. The terms of the Company's leases, excluding leased
departments, expire as follows:
Fiscal Year
Lease Term Expires Number of Stores
------------------ ----------------
1998 48
1999 39
2000 27
2001 35
2002 54
2003 and later 270
As of September 30, 1997, the Company's operations included 114 leased
departments. Generally, start-up and operating costs for a leased department are
substantially less than for a stand-alone store. The departments are leased from
stores such as Lazarus, Rich's, Famous Barr and Macy's and are generally staffed
with Company employees. The inventory of the leased departments is merchandised
and owned by the Company. Approximately 75% of the leased departments utilize
Company point-of-sale registers to capture sales information, and 100% of the
leased departments use such registers to communicate with employees. The
Company's leased department arrangements generally have an initial term of one
year. Subsequently, the term is automatically renewed for up to one year or
indefinitely, and may be terminated by either party upon advance written notice
of up to 90 days. Payment terms for the leased space are based on a percentage
of net sales and generally range between 15% and 21%. In addition, expenses such
as credit card fees, miscellaneous supplies and telephone usage are paid as
incurred.
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<PAGE>
Item 3. Legal Proceedings
On February 9, 1994, prior to the Pea Acquisition in April 1995, a class
action complaint was filed in the United States District Court in Northern
District of Texas by plaintiff Raizy Levitin on behalf of all persons (the
"Class"), other than the defendants named therein, who purchased common stock of
Pea (the "Pea Stock") within a defined time period in connection with the
September 23, 1993 initial public offering of Pea (the "Pea IPO"). The named
defendants include Pea, its directors, those of its officers who are signatories
to the Pea IPO registration statement (the "Pea Registration Statement"),
certain Pea shareholders who sold shares in the Pea IPO and Robertson, Stephens
& Company, L.P. and Stephens, Inc. (the "Underwriter Defendants"). The
plaintiffs allege that the Pea Registration Statement was false and misleading
and failed to disclose material information concerning Pea such that the
information contained in the Pea Registration Statement was misleading and
thereby in violation of the Securities Act. The plaintiffs also allege that the
defendants are responsible as direct actors, as aiders, abettors,
co-conspirators, and as control persons. The plaintiffs are seeking an award of
damages, under a variety of theories, the largest of which would yield $9.7
million, the impression of a constructive trust upon the proceeds of the Pea IPO
(and any profits earned thereon), rescission for those members of the Class who
still hold Pea Stock or an award of damages for those members of the Class who
do not, reimbursement of litigation costs and expenses, and such other just and
proper relief. In connection with the Pea Acquisition, Mothers Work (R.E.), Inc.
assumed Pea's outstanding litigation and potential claims.
On November 7, 1996, plaintiffs Raizy Levitin and Henry Rasmussen filed an
action in the District Court of Dallas County, Texas against A Pea in the Pod,
its former officers and directors, the shareholders who sold shares in Pea's
public offering and all the underwriters in the public offering. This complaint
contains essentially the same factual allegations as the action pending in the
United States District Court for the Northern District of Texas as described
above. The complaint contains claims under the Texas Securities Act, Article
581-33A (primary securities law violation against all defendants), Article
581-33F(1) (control person liability against Pea and the individual defendants),
and Article 581-33F(2) (aiding and abetting liability against all defendants).
In addition to compensatory damages, plaintiffs seek prejudgment and
post-judgment interest and attorneys' fees pursuant to state law.
In September 1997, the parties agreed to a global settlement of this action
and the federal court action described above. The defendants agreed to pay
$2,150,000. Progressive Casualty Insurance Company ("Progressive"), the issuer
of the directors' and officers' insurance policy, has agreed to pay $550,000 to
assist in funding the settlement. Mothers Work has agreed to pay the
supplemental $1,600,000. In addition, the Underwriter Defendants have agreed to
waive their claims for indemnification against Mothers Work. The parties are in
the process of drafting a Stipulation of Settlement. Once they have reached
agreement on the terms of this document, the settlement must be submitted to
both the federal court and the state court for approval. Pursuant to the
settlement agreement, Mothers Work has placed $750,000 of the settlement amount
in an escrow account. Progressive has placed its $550,000 in the escrow account
as well. Once the parties sign the Stipulation of Settlement, the money in the
escrow account is to be transferred to an escrow account of which plaintiffs'
counsel is the escrow agent. Mothers Work has agreed to place the remaining
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<PAGE>
$850,000 in escrow on or before January 6, 1998. Should the settlement not be
approved for any reason, the probability and extent of liability that Mothers
Work (R.E.), Inc. might incur cannot be predicted with certainty but management
of the Company intends to vigorously defend against these lawsuits, believes the
plaintiffs' damages claims are grossly inflated, and believes the Company has
adequate reserves so that the ultimate outcome will not have a material impact
on its financial position.
From time to time the Company is named as a defendant in legal actions
arising from its normal business activities. Although the amount of any
liability that could arise with respect to currently pending actions of this
nature cannot be accurately predicted, in the opinion of management, no
liability for any pending action will have a material adverse effect on the
financial position of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
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<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's common stock is traded on the Nasdaq National Market under
the symbol "MWRK."
The following table sets forth, for the fiscal quarters indicated, the high
and low sales prices per share for the Company's common stock, as reported on
the Nasdaq National Market:
Fiscal 1996 High Low
----------- ---- ---
First Quarter $17 $12-1/4
Second Quarter 23-3/4 14-1/2
Third Quarter 27-3/4 20-1/2
Fourth Quarter 25-1/2 12-1/4
Fiscal 1997
-----------
First Quarter $13 $ 9-9/16
Second Quarter 10-1/4 8
Third Quarter 8-3/4 6-3/16
Fourth Quarter 13-1/4 6-3/4
As of November 7, 1997, there were 76 holders of record and 792 estimated
beneficial holders of the Company's common stock.
The Company currently intends to retain any future earnings to fund
operations and the continued development of its business and, therefore, does
not anticipate paying cash dividends on its common stock in the immediate
future. In addition, no dividends may be paid on the Company's common stock
until all cumulative and current dividends on the Company's preferred stock (the
"Preferred Stock") have been declared and paid in full. Any payment of future
dividends will be at the discretion of the Company's Board of Directors and will
be based upon certain restrictive financial covenants, earnings, capital
requirements and the operating and financial condition of the Company, among
other factors, at the time any such dividends are considered. See Note 8 of
"Notes to Consolidated Financial Statements" for further discussion on the
Preferred Stock dividends.
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<PAGE>
Item 6. Selected Financial Data
The following selected consolidated financial data as of September 30,
1993, 1994, 1995, 1996 and 1997 and for the years then ended have been derived
from the Financial Statements of the Company which have been audited by Arthur
Andersen LLP, independent public accountants. The information set forth below
should be read in conjunction with the Financial Statements and notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
Year Ended September 30
-------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(In thousands, except per share and operating data)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales $ 30,872 $ 58,979 $ 106,005 $ 199,180 $ 246,934
Cost of goods sold 13,974 24,945 45,527 88,417 113,886
----------- ----------- ----------- ----------- -----------
Gross profit 16,898 34,034 60,478 110,763 133,048
Selling, general and administrative
expenses 14,996 30,597 53,835 95,395 124,495
Restructuring and nonrecurring charges -- -- 5,427 -- 5,617
----------- ----------- ----------- ----------- -----------
Operating income 1,902 3,437 1,216 15,368 2,936
Interest expense, net 285 347 4,484 12,636 13,252
----------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes (benefit) and
extraordinary item 1,617 3,090 (3,268) 2,732 (10,316)
Income taxes (benefit) 580 1,244 (847) 1,828 (2,677)
----------- ----------- ----------- ----------- -----------
Income (loss) before
extraordinary item 1,037 1,846 (2,421) 904 (7,639)
Extraordinary item, net
of income tax benefit (126) -- (4,215) -- --
----------- ----------- ----------- ----------- -----------
Net income (loss) 911 1,846 (6,636) 904 (7,639)
Preferred dividends -- -- 163 978 1,088
----------- ----------- ----------- ----------- -----------
Net income (loss) applicable
to common stockholders $ 911 $ 1,846 $ (6,799) $ (74) $ (8,727)
=========== =========== =========== =========== ===========
Net income (loss) per common share:(1)
Before extraordinary item $ .44 $ .58 $ (.83) $ (.02) $ (2.45)
Extraordinary item (.05) -- (1.35) -- --
----------- ----------- ----------- ----------- -----------
Net income (loss) per common share(1) $ .39 $ .58 $ (2.18) $ (.02) $ (2.45)
=========== =========== =========== =========== ===========
Weighted average common shares
outstanding(1) 2,707,215 3,186,885 3,120,535 3,269,290 3,562,980
=========== =========== =========== =========== ===========
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30
-------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Same-store sales increase (decrease)(2) (1.2%) 2.8% (0.7%) 8.0% 4.3%
Average net sales per gross
square foot(3) $ 384 $ 379 $ 360 $ 333 $ 338
Average net sales per store(3) $423,998 $439,133 $442,113 $452,446 $508,001
At end of period:
Company-owned stores 97 168 451 468 587
Franchised stores 2 1 -- -- --
Gross square footage 110,356 218,842 643,175 719,930 819,900
<CAPTION>
Year Ended September 30
-------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
(In thousands)
BALANCE SHEET DATA:
Working capital $ 7,591 $ 8,487 $ 31,611 $ 37,435 $32,083
Total assets 24,469 40,827 148,562 164,613 171,718
Total long-term and short-term debt 642 10,470 95,373 103,998 108,112
Stockholders' equity 17,856 19,810 25,537 35,107 26,380
</TABLE>
(1) See Note 1 of "Notes to Consolidated Financial Statements."
(2) Based on stores opened at least 24 months in their current store format.
(3) Based on Company-owned stores in operation during the entire fiscal year.
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<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
The following tables set forth, for the periods indicated, the percentages
which the items in the Company's Statements of Operations bear to net sales:
Percentage of Net Sales
Year Ended September 30
------------------------------
1995 1996 1997
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 42.9 44.4 46.1
----- ----- -----
Gross profit 57.1 55.6 53.9
Selling, general and
administrative expenses 50.9 47.9 50.4
Restructuring and
nonrecurring charges 5.1 -- 2.3
----- ----- -----
Operating income 1.1 7.7 1.2
Interest expense, net 4.2 6.3 5.4
----- ----- -----
Income (loss) before income
taxes (benefit) and
extraordinary item (3.1) 1.4 (4.2)
Income taxes (benefit) (0.8) 0.9 (1.1)
----- ----- -----
Income (loss) before
extraordinary item (2.3) 0.5 (3.1)
Extraordinary item-debt
extinguishment costs,
net of income tax
benefit (4.0) -- --
----- ----- -----
Net income (loss) (6.3%) 0.5% (3.1%)
===== ===== =====
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<PAGE>
The following table sets forth certain information representing growth in
the number of Company-owned stores and leased maternity departments for the
periods indicated:
Year Ended September 30
--------------------------
1995 1996 1997
---- ---- ----
STORES:
Beginning of period 168 451 468
Opened 33 44 152
Acquired 283 21 --
Closed (33) (48) (33)
---- ---- ----
End of period 451 468 587
==== ==== ====
Year Ended September 30, 1997 and 1996
Net Sales. Net sales in fiscal 1997 increased by $47.8 million or
24.0%, as compared to fiscal year 1996. This increase was generated primarily by
the $26.6 million increase in Episode sales, and the $12.8 million net sales
increase derived from new, closed, and converted maternity stores. In addition,
a 4.3% increase in maternity same store sales, based on 332 stores, accounted
for $6.6 million in increased sales. At September 30, 1997, the Company had 587
stores and leased departments: 260 operating under the Motherhood store concept,
41 under the Pea concept, 79 under the Mimi Maternity concept, 51 under the
Maternity Works outlet concept, 114 leased maternity departments and 42 under
the Episode concept. At September 30, 1996, the Company had 468 stores and
leased departments: 210 operating under the Motherhood store concept, 39 under
the Pea concept, 50 under the Mimi Maternity concept, 76 under the Maternite
concept, 40 under the Maternity Works outlet concept, 26 leased maternity
departments and 27 under the Episode concept.
Gross Profit. Gross profit as a percentage of net sales decreased to 53.9%
in fiscal 1997, as compared to 55.6% in fiscal 1996. The continued growth of the
Motherhood sales as a percentage of overall sales has contributed to the
decrease in gross profit percentage because Motherhood operates with a lower
gross profit percentage from the high end maternity divisions (Pea and Mimi
Maternity). In addition, the decrease in gross profit was partially due to an
$0.8 million charge to write-down inventory related to the Company's
restructuring and consolidation of its high end maternity business and an
increase in factory overhead. Further, gross margin was impacted by a full year
of Episode sales, which have generated lower overall margins than the maternity
sales due to the high degree of competition in high end bridge women's apparel.
The Company anticipates that its gross margins may decrease further as
Motherhood and Episode become a more significant part of the overall operations.
Selling, General & Administrative Expenses. Selling, general and
administrative expenses increased by $29.1 million or 30.5% in fiscal 1997 as
compared to fiscal 1996 and, as a percentage of net sales, increased from 47.9%
to 50.4%. The increase as a percentage of sales was primarily due to higher
wages and rents necessary to operate the Episode stores, as compared to the
maternity
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<PAGE>
stores, and a $1.3 million increase in royalty expense to license the Episode
trademark. Royalty expense increased due to a full year of Episode sales in
fiscal 1997 compared with four months of sales in fiscal 1996. In addition,
during fiscal 1997 the Company recorded a charge of approximately $1.0 million
under Statement of Financial Accounting Standards No. 121 related to leasehold
improvements and furniture and equipment at 16 store locations. The dollar
increase in fiscal 1997, as compared to fiscal 1996, was primarily due to
increases in store rents, wages and benefits and operating expenses at the store
level, which accounted for $9.1 million, $7.7 million and $3.2 million of the
increase, respectively. The increases in wages and benefits and rents at the
store level resulted from the increased number of stores opened and acquired and
the related staffing costs. In addition, higher advertising, shipping,
depreciation and amortization, and corporate wages contributed $6.2 million to
the increase in selling, general, and administrative expenses. These expenses
increased due to the continued expansion of operations as a result of new store
rollouts.
Restructuring Costs. In April 1997, the Company reported that it would
combine the Mimi Maternity and Maternite over-lapping product styles and close
approximately 30 retail locations serviced by other company stores.
Restructuring costs of $5.6 million, related to the restructuring of the
Company's core high end maternity business, were charged in the second quarter
of fiscal 1997. The restructuring costs consist primarily of $2.6 million for
the write-off of furniture, fixtures and leasehold improvements, $1.7 million
for lease termination and other costs and $1.3 million for the write-off of
patterns related to over-lapping product styles that will no longer be
manufactured by the Company as a result of the Mimi Maternity and Maternite
product line consolidation, and thus have no future value.
Operating Income. Operating income in fiscal 1997 was $2.9 million, or
1.2% of sales, as compared to $15.4 million, or 7.7% of sales, in fiscal 1996.
Fiscal 1997 was impacted by pre-tax charges of $5.6 million related to
restructuring costs as described above, $2.0 million of other unusual charges
for restructuring the Company's core high end maternity business and the
operating losses incurred at the Episode division. Other unusual charges consist
of $0.8 million to write down inventory related to the Company's restructuring,
$1.0 million to write down long-lived assets at some of its continuing retail
locations and $0.2 million for certain other costs. Operating income in fiscal
1997 exclusive of restructuring and other unusual charges decreased to $10.5
million from $15.4 million in the prior year. This decrease is primarily
attributable to the operating loss in the Episode division. The Company has
taken certain initiatives that it believes will help to support the higher
selling, general, and administrative expenses of the Episode division.
Specifically, the Company continues to introduce new merchandise for the
division and provides incentives to sales associates in order to increase
Episode revenues. However, there can be no assurances that the Company's actual
performance will improve as a result of these steps.
Interest Expense, Net. Net interest expense increased by $0.6 million in
fiscal year 1997 compared to fiscal year 1996, and as a percentage of sales,
decreased from 6.3% to 5.4%. The dollar increase was primarily due to short-term
borrowings under the line of credit agreement and a reduction of interest
income.
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<PAGE>
Income Taxes. The effective income tax rate was a benefit of 25.9% in
fiscal 1997, as compared to a provision of 66.9% in fiscal 1996. The change in
the effective income tax rate was primarily due to the relationship of
non-deductible goodwill amortization to income (loss) before income taxes. See
Note 11 of "Notes to Consolidated Financial Statements" for the reconciliation
of the statutory federal income tax rate to the Company's effective tax rates in
fiscal 1997 and 1996.
Year Ended September 30, 1996 and 1995
Net Sales. Net sales in fiscal 1996 increased by $93.2 million or 87.9%, as
compared to fiscal 1995. This increase was generated primarily by a $54.7
million increase in sales from stores acquired in the Motherhood Acquisition, a
$23.3 million increase in sales from stores acquired in the Pea Acquisition and
$6.6 million in sales from stores acquired in the Episode Acquisition. In
addition, stores opened or converted during fiscal 1996 accounted for an $8.7
million increase in sales. Further, an 8.0% increase in same store sales, based
on 117 stores, and an increase in sales for stores opened during fiscal 1995
were offset by fiscal 1996 store closings. The Company had 468 Company-owned
stores (233 Motherhood stores, 78 Maternite stores, 51 Mimi Maternity stores, 40
Maternity Works outlet stores, 39 Pea stores and 27 Episode stores) at September
30, 1996 compared to 451 (214 Motherhood stores, 96 Maternite stores, 61 Mimi
Maternity stores, 43 Maternity Works outlet stores and 37 Pea stores) at
September 30, 1995.
Gross Profit. Gross profit as a percentage of net sales decreased to 55.6%
in fiscal 1996 as compared to 57.1% in fiscal 1995. This decrease was primarily
due to the full year impact of lower gross margin products sold by the
Motherhood division and lower gross margins generated by the Episode products,
which generally have a lower gross margin than the Company's maternity products.
The Company anticipates that its gross margins could decrease further due to the
integration of the operations of Episode into the Company's operations.
Selling, General & Administrative Expenses. Selling, general and
administrative expenses increased by $41.6 million or 77.2% in fiscal 1996 as
compared to fiscal 1995 and, as a percentage of net sales, decreased from 50.9%
to 47.9%. The decrease as a percentage of sales was primarily due to the
increase in sales and the economies of scale realized through the acquisitions.
The dollar increase in fiscal 1996 as compared to fiscal 1995 was primarily due
to increases in wages and benefits at the store level, and rent at the store
level, which accounted for $14.5 million and $12.0 million of the increase,
respectively. The increases in wages and benefits at the store level were a
result of the full year impact of the increased number of employees required to
staff a larger number of stores due to the acquisitions. In addition, higher
advertising, marketing, shipping, depreciation and amortization, and other store
expenses contributed $13.1 million to the increase in selling general and
administrative expenses. The Company reduced selling, general and administrative
expenses in fiscal 1996 by $0.3 million due to a prior year over accrual for
store closings.
Operating Income. Operating income in fiscal 1996 was $15.4 million or 7.7%
of net sales compared to operating income of $1.2 million or 1.1% of net sales
in fiscal 1995. Fiscal 1995
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<PAGE>
included non-recurring charges of $5.4 million. Without these nonrecurring
charges, operating income in fiscal 1995 would have been $6.6 million or 6.2% of
net sales. The dollar increase of $8.7 million, excluding nonrecurring charges,
is primarily a result of the increased sales volume and the percentage of sales
improvement is primarily due to the increase in sales and gross margin exceeding
the increase in selling, general and administrative expenses necessary to
support the acquisitions.
Interest Expense, Net. Net interest expense increased by $8.2 million in
fiscal 1996 compared with fiscal 1995. Net interest expense as a percentage of
sales increased from 4.2% to 6.3%. This increase was due to higher outstanding
borrowings resulting primarily from the Company's issuance of the 12 5/8% Senior
Unsecured Exchange Notes due 2005 (the "Notes") to fund the Motherhood
Acquisition and repay the debt incurred in the Pea Acquisition. See Note 7 of
"Notes to Consolidated Financial Statements" for further details on the Notes.
Income Taxes. The effective income tax rate was an expense of 66.9% for
fiscal 1996 as compared to a benefit of 25.9% for fiscal 1995. The increased
effective tax rate in fiscal 1996 was primarily due to a full year impact of the
non-deductible amortization of goodwill on the current year pre-tax income
compared to the prior year net loss. See Note 11 of "Notes to Consolidated
Financial Statements" for the reconciliation of the statutory federal income tax
rate to the Company's effective tax rates in fiscal 1996 and 1995.
Liquidity and Capital Resources
The Company's cash needs have been primarily for furniture and fixtures and
leasehold improvements required to increase the number of retail locations,
increased inventories to support the additional locations and building
improvements and equipment at its corporate headquarters. In fiscal 1997 the
Company's cash sources have primarily been from increases in its borrowings
under the line of credit agreement, cash overdrafts and net cash provided by
operating activities. At September 30, 1997 the Company had available cash and
cash equivalents of $1.7 million, compared to $1.3 million at September 30,
1996.
Net cash used in operating activities was $5.4 million in fiscal 1996
compared with $5.2 million provided by operating activities in fiscal 1997. The
increase in cash provided by operating activities was $10.6 million when
comparing the cash provided by operating activities in fiscal 1997 to cash used
by operating activities in fiscal 1996. The net cash provided by operating
activities in fiscal 1997 includes cash used by the net loss, offset by
adjustments for non-cash items of $7.0 million, less cash used for working
capital of $1.8 million. The cash used for working capital in fiscal 1997
consisted of $8.1 million to increase inventories (primarily for Episode),
prepaid expenses and accounts receivable offset by a $6.3 million increase in
accounts payable, accrued expenses and other liabilities. The net cash used in
operating activities in fiscal 1996 derives from cash provided by net income,
after adjustments for non-cash items, of $13.7 million, less cash used for
working capital of $19.1 million. The cash used for working capital in fiscal
1996 consisted of $15.9 million to increase inventories, a $6.3 million net
decrease in accounts payable and accrued expense, accrued store closings and
other liabilities, partially offset by a decrease in accounts
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<PAGE>
receivable, prepaid expense and other assets of $3.1 million. In fiscal 1996,
inventories increased as the Company continued to supply product to its newly
acquired Motherhood division.
Net cash used in investing activities decreased from $17.3 million in
fiscal 1996 to $12.1 million in fiscal 1997. The cash used in investing
activities for fiscal 1997 included $10.1 million used for capital expenditures
for new store facilities, primarily Motherhood and Episode, and improvements to
existing stores, $1.6 million for other corporate capital expenditures and $0.4
million for intangible and other assets. This compares with investing activities
for fiscal 1996, which included $2.4 million used in connection with the Episode
acquisition, $7.7 million used for capital expenditures for new store
facilities, $5.7 million used for furniture, equipment and improvements to the
Company headquarters, manufacturing and distribution facility (purchased in
fiscal 1995) and $1.4 million for intangible and other assets.
Net cash provided by financing activities decreased $7.4 million, from
$14.8 million provided by financing activities in fiscal 1996 to $7.4 million in
fiscal 1997. The $7.4 million provided by financing activities in fiscal 1997
resulted primarily from $7.9 million in borrowings under the line of credit and
cash overdraft activity, partially offset by $0.5 million in repayment of
long-term debt. This compares with $14.8 million provided by financing
activities in fiscal 1996 primarily from $8.6 million in borrowings under the
line of credit and cash overdraft activity, $4.4 million of net proceeds from
the sale of common stock and $2.3 million of proceeds from the issuance of
long-term debt, partially offset by repayment of long-term debt and debt
issuance costs.
In July 1997, and in order to provide the Company with additional borrowing
capacity under its working line of credit facility ("Working Capital Facility"),
the Working Capital Facility was increased from $20.0 million to $27.0 million.
The Working Capital Facility also provides for a $4.0 million letter of credit
as collateral for an Industrial Revenue Bond. In April 1997, in connection with
the restructuring, the Company obtained revisions to certain financial covenants
pertaining to the Working Capital Facility. The Working Capital Facility has
been extended through July 31, 1999. Financial covenant requirements were
changed and a monthly rolling twelve-month operating cash flow covenant was
added. In addition, the interest coverage ratio was replaced with a fixed charge
coverage ratio. On November 18, 1997 the Company had $14.9 million in borrowings
and $10.0 million in additional letters of credit issued under the Working
Capital Facility, including the $4.0 million letter of credit collateralizing
the Industrial Revenue Bond.
In its maternity operations, the Company intends to focus primarily on
growing the moderate priced Motherhood and leased department businesses, subject
to capital and marketplace availability. These businesses represent the
Company's biggest opportunity for growth In comparison to the maternity business
as a whole, the Company does not anticipate the leased departments to have
materially different gross profit and selling, general and administrative
expenses as a percentage of sales. However, gross margin from Motherhood is
typically lower than the remainder of the maternity business and growth in the
Motherhood business could result in lower gross margins.
-26-
<PAGE>
The near-term strategy for the Episode division is to broaden the product
line through the growth of the Daniel & Rebecca(R) product and to add several
stores in major metropolitan areas, subject to capital and marketplace
availability. The Episode division has operated at a loss since the acquisition
on June 1, 1996, and the decrease in operating income for fiscal 1997, exclusive
of restructuring and other unusual charges, is primarily attributable to Episode
operations. Although sales levels improved in the fiscal 1997 third and fourth
quarter, Episode revenues remain below management's initial estimates and are
currently at levels which would not support profitable operations of the Episode
division. Based on the existing operations at Episode the Company needs to
increase comparable store revenues in order to be profitable at that division.
The Company's management has limited experience in the bridge women's regular
apparel business and the integration of Episode into the rest of the Company's
operations has required substantial management time and other resources. In
addition, the operations of a bridge women's fashion business are subject to
numerous risks, unanticipated operating problems, and greater competition and
fashion risk than the Company's maternity business. Based on the foregoing
factors, there can be no assurance that the Company's Episode operations will
become profitable. Further, the Episode acquisition could result in additional
indebtedness, which in turn could result in an increase in the degree of
financial leverage of the Company and a decrease in the Company's financial
flexibility. At September 30, 1997 the Episode assets consist primarily of
inventory and furniture, equipment and leasehold improvements of approximately
$11.9 million and $8.3 million, respectively. The Company also has lease
commitments on Episode stores approximating $35.9 million payable through 2011.
The Company believes that its current cash and working capital positions,
available borrowing capacity through the Working Capital Facility and net cash
expected to be generated from operations will be sufficient to fund the
Company's working capital requirements and required principal and interest
payments for fiscal 1998. Based on the Company's fiscal 1998 expansion plan, the
Company expects capital expenditures to be approximately one-half of the fiscal
1997 amount. There are currently no restrictions on the ability of the
Guarantors to transfer funds to the Company in the form of cash dividends, loans
or advances other than restrictions imposed by applicable law.
Seasonality
The Company's operations are slightly seasonal with the Company's net sales
historically being the lowest in the second fiscal quarter.
Inflation
The Company does not believe the relatively moderate levels of inflation
which have been experienced in the United States in recent years have had a
significant effect on its net sales or profitability. However, there can be no
assurance that the Company's business will not be affected by inflation in the
future.
-27-
<PAGE>
Safe Harbor Statement Under the Private Securities Litigation
Reform Act of 1995
The Company cautions that any forward-looking statements (as such term is
defined in the Private Securities Litigation Reform Act of 1995) contained in
Item 1, Business and Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Report or made from time to time by
management of the Company involve risks and uncertainties, and are subject to
change based on various important factors. The following factors, among others,
in some cases have affected and in the future could affect the Company's
financial performance and actual results and could cause actual results for
fiscal 1997 and beyond to differ materially from those expressed or implied in
any such forward-looking statements: changes in consumer spending patterns, raw
material price increases, consumer preferences and overall economic conditions,
the impact of competition and pricing, changes in weather patterns, availability
of suitable store locations at appropriate terms, continued availability of
capital and financing, ability to develop merchandise and ability to hire and
train associates, changes in fertility and birth rates, political stability,
currency and exchange risks and changes in existing or potential duties, tariffs
or quotas, postal rate increases and charges, paper and printing costs, and
other factors affecting the Company's business beyond the Company's control.
Item 8. Financial Statements and Supplementary Data
The Company's consolidated financial statements appear at pages F-1 through
F-26, as set forth in Item 14.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
-28-
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning directors, appearing under the caption "Election of
Directors" in the Company's Proxy Statement (the "Proxy Statement") to be filed
with the Securities and Exchange Commission in connection with the Annual
Meeting of Stockholders scheduled to be held on January 15, 1998, and
information concerning executive officers, appearing under the caption "Item 1.
Business - Executive Officers of the Company" in Part I of this Form 10-K, are
incorporated herein by reference in response to this Item 10.
Item 11. Executive Compensation
The information contained in the section titled "Executive Compensation" in
the Proxy Statement, with respect to executive compensation, and the information
contained in the section entitled "Compensation of Directors" with respect to
director compensation, are incorporated herein by reference in response to this
Item 11.
Item 12. Security Ownership of Certain Beneficial Owners and Management
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
The information contained in the section titled "Certain Transactions" of
the Proxy Statement, with respect to certain relationships and related
transactions, is incorporated herein by reference in response to this Item 13.
-29-
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this
Form 10-K, commencing on page F-1.
(2) Schedules
None.
(3) Exhibits
Exhibit No. Description
----------- -----------
*3.1 Amended and Restated Certificate of Incorporation of
the Company (effective March 10, 1993) (Exhibit 3.3
to the Company's Registration Statement on Form S-1,
Registration No. 33-57912, dated February 4, 1993
(the "1993 Registration Statement")).
*3.2 By-Laws of the Company (Exhibit 3.5 to the Company's
Annual Report on Form 10-K for the year ended
September 30, 1993 (the "1993 Form 10-K")).
*4.1 Certificate of Designations for the Series A
Cumulative Convertible Preferred Stock of the Company
(Exhibit 3.1 to the Company's Quarterly Report on
Form 10-Q for the Quarter ended June 30, 1995 (the
"June 1995 10-Q")).
*4.2 Indenture dated as of August 1, 1995 from the Company
to Society National Bank, as Trustee (Exhibit 4.1 to
the June 1995 10-Q).
*4.3 Rights Agreement dated as of October 9, 1995 between
the Company and StockTrans, Inc. (Exhibit 4.1 to the
Company's Current Report on Form 8-K, dated October
5, 1995 ("October 1995 8-K")).
*4.4 Specimen certificate representing shares of the
Company's common stock with legend regarding
Preferred Stock Purchase Rights. (Exhibit 4.2 to the
October 1995 8-K).
*4.5 Amended and Restated Rights Agreement, dated as of March
17, 1997, between the Company and StockTrans, Inc.
(incorporated by reference to
-30-
<PAGE>
Exhibit No. Description
----------- -----------
Exhibit 4.2 to the Company's current report on Form
8-K dated March 17, 1997).
*4.6 Amendment No. 1, dated as of June 4, 1997, to the Amended
and Restated Rights Agreement, dated as of March 17, 1997,
between the Company and StockTrans, Inc. (Exhibit 4.3 to the
Company's Quarterly Report on Form 10-Q for the Quarter
ended June 30, 1997).
*10.1 Agreement of Lease dated September 22, 1986 between
the Company and Broad and Noble Associates, Inc., and
amendments thereto (Exhibit 10.1 to the 1993
Registration Statement).
*10.2 Registration Rights and Right of Co-Sale Agreement dated as
of May 4, 1992 among the Company, Dan W. Matthias, Rebecca
C. Matthias, Meridian Venture Partners, Penn Janney Fund,
Inc., Apex Investment Fund, L.P., Meridian Capital Corp.,
Butcher & Singer/Keystone Venture II, L.P., G-2 Family
Partnership, PIISC - Penn Venture Fund, John L. Plummer,
Gail G. Davis, Milton S. Stearns Jr., Trustee U/D/T dated
12/20/88, Stevan Simich, Growth Investors, George P. Keeley,
Robert E. Brown Jr., Bruce II. Hooper, John J. Serrell,
Charles G. Schiess, Terence Kavanagh and Michael B. Staebler
(Exhibit 10.8 to the 1993 Registration Statement).
*10.3 Voting Agreement dated as of March 12, 1993 among Rebecca
C. Matthias, Dan W. Matthias, Elam M. Hitchner III, Keystone
Venture II, L.P., G-2 Family Partnership, Penn Janney Fund,
Inc., Apex Investment Fund, L.P. and Meridian Venture
Partners (Exhibit 10.10 to the 1993 Registration Statement).
*10.4 Termination of Voting Agreement dated September 28, 1995
among Rebecca C. Matthias, Dan W. Matthias, Keystone Venture
II, L.P., Penn Janney Fund, Inc., G-2 Family Partnership,
Hitchner & Associates Profit Sharing Plan, Meridian Venture
Partners and Apex Investment Fund, L.P. (Exhibit 10.31 to
the 1995 Registration Statement).
*10.5 Stock Subscription Warrant of the Company (No. Penn-Janney:
1992-1) issued to Penn Janney Fund, Inc. dated January 24,
1992 (Exhibit 10.29 to the 1993 Registration Statement).
*10.6 1987 Stock Option Plan.
-31-
<PAGE>
Exhibit No. Description
----------- -----------
*10.7 1994 Director Stock Option Plan (Exhibit 10.12 to the
Company's Annual Report on Form 10-K for the year ended
September 30, 1994 (the "1994 Form 10-K")).
*10.8 Non-Competition and Confidentiality Agreement dated January
28, 1993 between the Company and Lynne Wieder (Exhibit 10.39
to the 1993 Registration Statement).
*10.9 Employment Agreement dated as of July 14, 1994 between the
Company and Dan W. Matthias (Exhibit 10.25 to the Company's
Current Report on Form 8-K dated January 31, 1994 (the "1994
Form 8-K")).
*10.10 Employment Agreement dated as of July 14, 1994 between the
Company and Rebecca C. Matthias (Exhibit 10.26 to the 1994
Form 10-K).
*10.11 Employment Agreement dated as of June 19, 1995 between the
Company and Donald W. Ochs (Exhibit 10.3 to the June 1995
10-Q).
*10.12 Registration Rights Agreement dated as of August 1, 1995
among the Company and Morgan Stanley & Co. Incorporated,
Wheat, First Securities, Inc. and Janney Montgomery Scott
Inc. (Exhibit 10.2 to the June 1995 10-Q).
*10.13 Credit Agreement dated as of August 1, 1995 between
the Company, its subsidiaries and Meridian Bank
(Exhibit 10.1 to the June 1995 10-Q).
*10.14 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")).
*10.15 Amendment to Credit Agreement dated September 1, 1995
between the Company, its subsidiaries and Meridian Bank
(Exhibit 10.28 to the 1995 Registration Statement).
*10.16 Indenture of Trust dated September 1, 1995 between PAID
and Society National Bank (Exhibit 10.29 to the 1995
Registration Statement).
*10.17 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).
-32-
<PAGE>
Exhibit No. Description
----------- -----------
*10.18 Agreement and Plan of Merger dated as of July 3, 1995 by
and among the Company, Motherhood Maternity Shops, Inc., The
Shansby Group, TSG International and Motherhood Acquisition
Corp. (Exhibit 2.1 to the June 1995 10-Q).
*10.19 Agreement and Plan of Merger dated as of March 5, 1995 by
and among the Company, A Pea in the Pod, Inc., and MW
Acquisition Corporation (Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the Quarter ended March
31, 1995).
*10.20 Second Amendment to Credit Agreement dated January 25,
1996 between the Company, its subsidiaries and Meridian Bank
(Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the Quarter ended March 31, 1996).
*10.21 Third Amendment to Credit Agreement dated May 31, 1996
between the Company, its subsidiaries and Meridian Bank
(Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the Quarter ended June 30, 1996).
*10.22 Asset Purchase Agreement dated April 25, 1996 among the
Company, T3 Acquisition, Inc. and Episode USA, Inc. (Exhibit
2.1 of the Company's Current Report on Form 8-K, dated June
17, 1996 (the "June 1996 8-K).
*10.23 Trademark License Agreement dated May 31, 1996 between the
Company and Episode USA, Inc. (Exhibit 10.1 to the June 1996
8-K).
*10.24 Distribution Agreement dated April 25, 1996 among Toppy
International Limited, T3 Acquisition, Inc. and the Company
(Exhibit 10.2 to the June 1996 8-K).
*10.25 Fourth Amendment to Credit Agreement dated September 30,
1996 between the Company, its subsidiaries and Meridian Bank
(Exhibit 10.25 to the Company's Annual Report on Form 10-K
for the fiscal year ended September 30, 1996).
*10.26 Consulting Agreement dated September 11, 1996 between the
Company and Marvin Traub Associates, Inc (Exhibit 10.26 to
the Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1996).
-33-
<PAGE>
Exhibit No. Description
----------- -----------
*10.27 Residential Lease dated June 28, 1996 between the Company
and Daniel & Rebecca Matthias (Exhibit 10.27 to the
Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1996).
*10.28 First Amendment to Asset Purchase Agreement dated May 31,
1996 by and among the Company, T3 Acquisition, Inc. and
Episode USA, Inc. (Exhibit 10.28 to the Company's Annual
Report on Form 10-K for the fiscal year ended September 30,
1996).
*10.29 Note dated February 14, 1996 from the Company to PIDC
Local Development Corporation (Exhibit 10.29 to the
Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1996).
*10.30 Installment Sale Agreement dated April 4, 1996 by and
between PIDC Financing Corporation and the Company (Exhibit
10.30 to the Company's Annual Report on Form 10-K for the
fiscal year ended September 30, 1996).
*10.31 Open-End Mortgage dated April 4, 1996 between PIDC
Financing Corporation and the Pennsylvania Industrial
Development Authority ("PIDA") (Exhibit 10.31 to the
Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1996).
*10.32 Loan Agreement dated April 4, 1996 by and between PIDC
Financing Corporation and PIDA (Exhibit 10.32 to the
Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1996).
*10.33 Fifth Amendment to Credit Agreement, dated January 31,
1997 between the Company, its subsidiaries and CoreStates
Bank (Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the Quarter ended December 31, 1996).
*10.34 Sixth Amendment to Credit Agreement, dated April 16, 1997
between the Company, its subsidiaries and CoreStates Bank
(Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the Quarter ended March 31, 1997).
-34-
<PAGE>
Exhibit No. Description
----------- -----------
*10.35 Seventh Amendment to Credit Agreement, dated July 31, 1997
between the Company, its subsidiaries and CoreStates Bank
(Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the Quarter ended June 30, 1997).
10.36 Eighth Amendment to Credit Agreement, dated September 30,
1997 between the Company, its subsidiaries and CoreStates
Bank.
*10.37 Amendment No. 1 to Stock Subscription Warrant of the
Company (No. Penn-Janney: 1992-1) issued to Penn Janney
Fund, Inc. dated January 14, 1997 (Exhibit 10.9 to the
Company's Quarterly Report on Form 10-Q for the Quarter
ended March 31, 1997).
11 Statement Regarding Computation of Per Share Earnings.
21 Subsidiaries of the Company.
23 Consent of Arthur Andersen LLP.
27 Financial Data Schedule for the fiscal year ended September
30, 1997.
- ---------------
* Incorporated by reference.
(b) Reports filed on Form 8-K during the last quarter of fiscal 1997:
None
-35-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Philadelphia, Commonwealth of Pennsylvania, on the 18th day of December,
1997.
By: /s/ Dan W. Matthias
-----------------------------------------------
Dan W. Matthias, Chairman of the Board and Chief
Executive Officer, the principal executive officer
By: /s/ Thomas Frank
-----------------------------------------------
Thomas Frank, Chief Financial Officer, Vice
President-Finance and the principal financial
officer
-36-
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on December 18th, 1997, in the
capacities indicated:
/s/ Dan W. Matthias Chairman of the Board, Chief Executive Officer
- --------------------------- and Director, the principal executive officer
Dan W. Matthias
/s/ Rebecca C. Matthias President, Chief Operating Officer and Director
- ---------------------------
Rebecca C. Matthias
/s/ Thomas Frank Chief Financial Officer, Vice President - Finance
- --------------------------- and Chief Accounting Officer, the principal
Thomas Frank financial officer and principal accounting
officer
/s/ Verna K. Gibson Director
- ---------------------------
Verna K. Gibson
/s/ Joseph A. Goldblum Director
- ---------------------------
Joseph A. Goldblum
/s/ Elam M. Hitchner, III Director
- ---------------------------
Elam M. Hitchner, III
/s/ Walter F. Loeb Director
- ---------------------------
Walter F. Loeb
/s/ William L. Rulon-Miller Director
- ---------------------------
William L. Rulon-Miller
-37-
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants...................... F-2
Consolidated Balance Sheets................................... F-3
Consolidated Statements of Operations......................... F-4
Consolidated Statements of Stockholders' Equity............... F-5
Consolidated Statements of Cash Flows......................... F-6 to F-7
Notes to Consolidated Financial Statements.................... F-8 to F-26
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Mothers Work, Inc.:
We have audited the accompanying consolidated balance sheets of Mothers Work,
Inc. (a Delaware corporation) and subsidiaries as of September 30, 1996 and
1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended September
30, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 financial statements referred to above present fairly, in
all material respects, the financial position of Mothers Work, Inc. and
subsidiaries as of September 30, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Philadelphia, Pa.
November 14, 1997
F-2
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30
-------------------------------
1996 1997
-------------- --------------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,262,435 $ 1,665,760
Receivables--
Trade 2,141,102 2,781,803
Other 146,924 164,334
Inventories 57,209,499 63,812,590
Deferred income taxes 3,815,002 4,050,980
Prepaid expenses and other 1,791,070 2,695,218
-------------- --------------
Total current assets 66,366,032 75,170,685
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT, net 45,451,114 45,373,439
-------------- --------------
OTHER ASSETS:
Deferred income taxes 4,741,869 7,235,600
Goodwill, net of accumulated amortization of $3,403,751 and $5,641,275 40,989,708 38,752,184
Other intangible assets, net of accumulated amortization of $1,244,180
and $1,452,446 1,310,900 1,351,221
Deferred financing costs, net of accumulated amortization of $481,576 and
$913,748 3,736,937 3,339,759
Other assets 2,016,178 494,632
-------------- --------------
Total other assets 52,795,592 51,173,396
-------------- --------------
$ 164,612,738 $ 171,717,520
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 6,558,193 $ 11,088,000
Current portion of long-term debt 758,911 648,231
Accounts payable 9,102,185 17,264,704
Accrued expenses 12,511,600 14,087,057
-------------- --------------
Total current liabilities 28,930,889 43,087,992
-------------- --------------
LONG-TERM DEBT 96,680,722 96,375,620
-------------- --------------
DEFERRED RENT 2,754,197 3,645,651
-------------- --------------
ACCRUED DIVIDENDS ON PREFERRED STOCK 1,140,416 2,228,700
-------------- --------------
COMMITMENTS AND CONTINGENCIES (Note 12)
STOCKHOLDERS' EQUITY:
Series A Cumulative convertible preferred stock, $.01 par value, $280.4878
stated value, 2,000,000 shares authorized, 41,000 shares
issued and outstanding (liquidation value of $11,500,000) 11,500,000 11,500,000
Series B Junior participating preferred stock, $.01 par value,
10,000 shares authorized, none outstanding -- --
Common stock, $.01 par value, 10,000,000 shares authorized, 3,559,277 and
3,564,644 shares issued and outstanding 35,593 35,646
Additional paid-in capital 27,740,483 27,740,840
Accumulated deficit (4,169,562) (12,896,929)
-------------- --------------
Total stockholders' equity 35,106,514 26,379,557
-------------- --------------
$ 164,612,738 $ 171,717,520
============== ==============
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended September 30
-----------------------------------------------------
1995 1996 1997
---------------- ---------------- ---------------
<S> <C> <C> <C>
NET SALES $ 106,005,028 $ 199,179,984 $ 246,934,331
COST OF GOODS SOLD 45,527,498 88,416,648 113,886,439
---------------- ---------------- ---------------
Gross profit 60,477,530 110,763,336 133,047,892
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 53,834,596 95,394,902 124,494,747
RESTRUCTURING AND NONRECURRING CHARGES 5,426,779 -- 5,617,094
---------------- ---------------- ---------------
Operating income 1,216,155 15,368,434 2,936,051
INTEREST INCOME 21,278 228,255 11,339
INTEREST EXPENSE (4,505,436) (12,864,351) (13,263,418)
---------------- ---------------- ---------------
Income (loss) before income taxes (benefit)
and extraordinary item (3,268,003) 2,732,338 (10,316,028)
INCOME TAXES (BENEFIT) (847,287) 1,828,572 (2,676,945)
---------------- ---------------- ---------------
Income (loss) before extraordinary item (2,420,716) 903,766 (7,639,083)
EXTRAORDINARY ITEM--EARLY EXTINGUISHMENT OF DEBT, net
of income tax benefit of $2,171,435 (4,215,138) -- --
---------------- ---------------- ---------------
NET INCOME (LOSS) (6,635,854) 903,766 (7,639,083)
DIVIDENDS ON PREFERRED STOCK 162,916 977,500 1,088,284
---------------- ---------------- ---------------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS $ (6,798,770) $ (73,734) $ (8,727,367)
================ ================ ===============
NET LOSS PER COMMON SHARE:
Before extraordinary item $ (.83) $ (.02) $ (2.45)
Extraordinary item (1.35) -- --
---------------- ---------------- ---------------
NET LOSS PER COMMON SHARE $ (2.18) $ (.02) $ (2.45)
================ ================ ===============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 3,120,535 3,269,290 3,562,980
================ ================ ===============
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A Additional Retained
Preferred Common Paid-in Earnings Deferred
Stock Stock Capital (Deficit) Compensation
------------ --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE, SEPTEMBER 30, 1994 $ -- $ 31,198 $17,088,307 $ 2,702,942 $ (12,823)
Issuance of preferred stock in connection with
acquisition 11,500,000 -- -- -- --
Issuance of common stock warrants -- -- 1,000,000 -- --
Exercise of 2,394 stock options -- 24 13,118 -- --
Amortization of deferred compensation -- -- -- -- 12,823
Preferred stock dividends -- -- -- (162,916) --
Net loss -- -- -- (6,635,854) --
------------ --------- ----------- ----------- ---------
BALANCE, SEPTEMBER 30, 1995 11,500,000 31,222 18,101,425 (4,095,828) --
Exercise of 19,715 stock options -- 197 134,350 -- --
Tax benefit from exercise of stock options -- -- 117,485 -- --
Sale of 200,000 shares of common stock, net of
expenses -- 2,000 4,394,000 -- --
Issuance of 217,365 shares of common stock in
connection with acquisition -- 2,174 4,993,223 -- --
Preferred stock dividends -- -- -- (977,500) --
Net income -- -- -- 903,766 --
------------ --------- ----------- ----------- ---------
BALANCE, SEPTEMBER 30, 1996 11,500,000 35,593 27,740,483 (4,169,562) --
Exercise of 40 stock options -- -- 410 -- --
Exercise of common stock warrants -- 53 (53) -- --
Preferred stock dividends -- -- -- (1,088,284) --
Net loss -- -- -- (7,639,083) --
------------ --------- ----------- ----------- ---------
BALANCE, SEPTEMBER 30, 1997 $11,500,000 $ 35,646 $27,740,840 $(12,896,929) $ --
============ ========= =========== =========== =========
</TABLE>
Total
-----------
BALANCE, SEPTEMBER 30, 1994 $19,809,624
Issuance of preferred stock in connection with
acquisition 11,500,000
Issuance of common stock warrants 1,000,000
Exercise of 2,394 stock options 13,142
Amortization of deferred compensation 12,823
Preferred stock dividends (162,916)
Net loss (6,635,854)
-----------
BALANCE, SEPTEMBER 30, 1995 25,536,819
Exercise of 19,715 stock options 134,547
Tax benefit from exercise of stock options 117,485
Sale of 200,000 shares of common stock, net of
expenses 4,396,000
Issuance of 217,365 shares of common stock in
connection with acquisition 4,995,397
Preferred stock dividends (977,500)
Net income 903,766
-----------
BALANCE, SEPTEMBER 30, 1996 35,106,514
Exercise of 40 stock options 410
Exercise of common stock warrants --
Preferred stock dividends (1,088,284)
Net loss (7,639,083)
-----------
BALANCE, SEPTEMBER 30, 1997 $26,379,557
===========
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended September 30
---------------------------------------------
1995 1996 1997
------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ (6,635,854) $ 903,766 $ (7,639,083)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities--
Extraordinary item, before income tax benefit 6,386,573 -- --
Depreciation and amortization 5,814,529 10,161,531 12,169,900
Noncash portion of restructuring and nonrecurring charges 2,107,773 -- 3,731,102
Imputed interest on debt 21,202 103,284 117,147
Deferred tax liability (benefit) (814,125) 1,444,151 (2,729,709)
Amortization of deferred financing costs 260,305 418,737 432,172
Provision for deferred rent 805,526 685,749 891,454
Changes in assets and liabilities, net of effects from
purchases of businesses--
Decrease (increase) in--
Receivables (2,452,597) 2,986,011 (658,111)
Inventories (6,470,888) (15,879,647) (6,603,091)
Prepaid expenses and other 1,440,952 64,014 (873,235)
Increase (decrease) in--
Accounts payable and accrued expenses (7,717,337) (4,283,509) 5,250,559
Accrued store closing 1,196,719 (2,975,657) --
Accrued income taxes (545,645) -- --
Other liabilities 162,916 977,500 1,088,284
------------- ------------ ------------
Net cash provided by (used in) operating activities (6,439,951) (5,394,070) 5,177,389
------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of businesses, net of cash acquired (47,972,035) (2,442,865) --
Purchases of property, plant and equipment (10,943,951) (13,445,841) (11,699,625)
Increase in intangible and other assets (1,196,250) (1,412,008) (435,866)
------------- ------------ ------------
Net cash used in investing activities (60,112,236) (17,300,714) (12,135,491)
------------- ------------ ------------
</TABLE>
--(continued)--
F-6
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--(continued)--
<TABLE>
<CAPTION>
Year Ended September 30
-------------------------------------------
1995 1996 1997
------------ ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in line of credit and cash overdrafts, net $ -- $ 8,638,586 $ 7,928,940
Proceeds from issuance of long-term debt 143,418,430 2,340,000 --
Repayments of long-term debt (58,536,641) (376,464) (532,929)
Debt issuance costs (5,840,059) (305,930) (34,994)
Payments upon early extinguishment of debt (4,656,562) -- --
Net proceeds from sales of common stock -- 4,396,000 --
Issuance of warrants 1,000,000 -- --
Proceeds from exercise of options and warrants 13,142 134,547 410
------------ ----------- -----------
Net cash provided by financing activities 75,398,310 14,826,739 7,361,427
------------ ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,846,123 (7,868,045) 403,325
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 284,357 9,130,480 1,262,435
------------ ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 9,130,480 $ 1,262,435 $ 1,665,760
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
MOTHERS WORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business
Mothers Work, Inc. was incorporated in Delaware in 1980 and is a specialty
retailer and manufacturer of maternity clothing and non-maternity upscale
women's apparel and accessories, similar to designer fashions but with a lower
price point (commonly referred to as "bridge" fashion). The Company operates in
587 retail store locations, including 42 Episode non-maternity high end "bridge"
women's specialty stores and 545 maternity clothing locations (including 114
leased departments) throughout the United States.
Principles of Consolidation
The consolidated financial statements include the accounts of Mothers Work, Inc.
and its wholly owned subsidiaries, Cave Springs, Inc., Mothers Work (R.E.), Inc.
and The Page Boy Company, Inc. (collectively, the Company) as of September 30,
1997. All significant intercompany transactions and accounts have been
eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires 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 the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents for the purpose of
determining cash flows. At September 30, 1997, cash and cash equivalents include
cash on hand, cash in the bank and certificates of deposit. Cash overdrafts of
$5,479,526 and $2,080,393 are included in accounts payable at September 30, 1997
and 1996, respectively.
Statement of Cash Flows Information
In fiscal 1995, 1996 and 1997, the Company paid $2,833,214, $12,137,535 and
$12,619,836 in interest, respectively. Income taxes paid in fiscal 1995 were
$340,949, and income taxes refunded in fiscal 1996 were $2,524,525. Capital
lease obligations of $124,594 were incurred on equipment leases entered into in
fiscal 1995.
F-8
<PAGE>
The following table lists noncash assets that were acquired and liabilities that
were assumed as a result of the acquisitions discussed in Note 2:
Year Ended September 30
----------------------------
1995 1996
------------ ------------
Noncash Assets:
Accounts receivable $ 2,156,704 $ --
Inventories 13,423,409 2,908,666
Prepaid expenses 1,811,739 --
Property and equipment 17,063,218 4,798,207
Goodwill 39,994,807 2,308,912
Other intangible assets 487,560 --
Deferred income taxes 7,467,707 1,006,088
Other assets 392,693 98,940
------------ ------------
Net noncash assets acquired 82,797,837 11,120,813
Less-- Assumed Liabilities:
Accounts payable and accrued expenses (19,000,333) (3,682,551)
Accrued store closings (4,325,469) --
Common stock issued to seller -- (4,995,397)
Preferred stock issued to seller (11,500,000) --
------------ ------------
Net cash used in investing activities $ 47,972,035 $ 2,442,865
============ ============
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market.
Inventories manufactured by the Company include the cost of materials, freight,
direct labor, manufacturing and distribution overhead.
Prepaid Expenses and Other
Advertising costs are expensed as incurred or the first time the advertising
takes place. Catalog costs are deferred and amortized over the period in which
the related catalogs are distributed. Advertising and catalog expenses were
$2,503,732, $4,448,821 and $5,722,410 in fiscal 1995, 1996 and 1997,
respectively.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Additions or improvements
are capitalized, while repairs and maintenance are charged to expense.
Depreciation is provided over the estimated useful lives of the assets using the
straight-line method. The estimated useful lives are forty years for the
building, five to ten years for furniture and equipment and the shorter of the
estimated useful life or lease term for leasehold improvements.
F-9
<PAGE>
Intangible Assets
Goodwill, leasehold interests and other intangible assets are amortized over
twenty years, the lease term and five to ten years, respectively. Amortization
of goodwill, leasehold interests and other intangible assets was $1,094,733,
$2,614,796 and $2,604,642 in fiscal 1995, 1996 and 1997, respectively.
Long-Lived Assets
The Company has adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and For Long-Lived Assets to be Disposed Of," at the beginning of Fiscal 1997.
SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that full recoverability is questionable. Management
evaluates the recoverability of goodwill and other long-live assets and several
factors are used in the valuation including, but not limited to, management's
future operating plans, recent operating results and projected cash flows. An
impairment is recognized when future net cash flows for each store are expected
to be less than the carrying amount of the assets. The fair value of each store
asset is determined based on a forecast of expected cash flows.
Deferred Financing Costs
Deferred financing costs are amortized over the terms of the related debt using
the effective interest method. Amortization of deferred financing costs was
$260,305, $418,737 and $432,172 in fiscal 1995, 1996 and 1997, respectively.
Deferred Rent
Rent expense on leases is recorded on a straight-line basis over the lease
period. The excess of rent expense over the actual cash paid has been recorded
as deferred rent.
Stock-Based Compensation
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method and provides pro forma
disclosure of net income and earnings per share as if the fair value-based
method had been applied in measuring compensation expense (see Note 10).
F-10
<PAGE>
Net Income (Loss) Per Common Share
Net income (loss) per common share is calculated utilizing the modified treasury
stock method because the Company's outstanding options and warrants exceed 20%
of the number of common shares outstanding at the end of the period. Presently,
per-share computations under the modified treasury stock method are the same as
the treasury stock method. All per-share amounts are based upon the weighted
average common shares and dilutive common share equivalents outstanding during
the period, except where antidilutive.
Primary and fully diluted net income (loss) per common share for fiscal 1995,
1996 and 1997 have been computed after deducting dividends accrued on the
preferred stock.
In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 128, "Earnings per share", which the Company is required to adopt for both
interim and annual periods ending after December 15, 1997. SFAS No. 128
simplifies the EPS calculation by replacing primary EPS with basic EPS. Basic
EPS is computed by dividing reported earnings available to common stockholders
by weighted average shares outstanding. Fully diluted EPS, now called diluted
EPS, is still required. Early application is prohibited, although footnote
disclosure of pro forma EPS amounts computed is required. Under SFAS No. 128,
pro forma basic and diluted EPS for the years ended September 30, 1995, 1996 and
1997, would have been the same as reported.
Adoption of New Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income",
which requires that an enterprise report, by major components and as a single
total, the change in its net assets during the period from non-owner sources;
and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information", which establishes annual and interim reporting standards for an
enterprise's operating segments and related disclosures about its products,
services, geographic areas and major customers. Adoption of these standards will
not impact the Company's consolidated financial position, results of operations
or cash flows, and any effect will be limited to the form and content of its
financial statements and disclosures. Both statements are effective for fiscal
years beginning after December 15, 1997, with earlier application permitted.
2. ACQUISITIONS:
On April 5, 1995, the Company acquired A Pea in the Pod, Inc. (Pea) for
$25,487,000, in cash, including transaction costs, and the assumption of
$2,459,000 in funded debt. The purchase price and the repayment of the funded
debt was financed with borrowings from a bank and an insurance company. The
purchase price was allocated to the fair value of the net assets acquired, with
$21,524,000 allocated to goodwill under the purchase method of accounting.
During fiscal 1996, the goodwill was adjusted to $22,530,000 to reflect
refinements of estimates for certain accrued expenses (see Note 12).
F-11
<PAGE>
On August 1, 1995, the Company acquired Motherhood Maternity Shops, Inc.
(Motherhood) for $33,985,000, including transaction costs, and the assumption of
$20 million in funded debt and accrued interest. Approximately $22,485,000 was
paid in cash and $11.5 million was paid with newly issued preferred stock (see
Note 8). The purchase price was allocated to the fair value of the net assets
acquired with $18,471,000 allocated to goodwill under the purchase method of
accounting. During fiscal 1996, the goodwill was adjusted to $19,774,000 to
reflect refinements of estimates for certain accrued expenses. The cash portion
of the purchase price and the repayment of the funded debt and accrued interest
were financed with the sale of Senior Unsecured Notes (see Note 7). Of the
41,000 shares of preferred stock issued to the owners of Motherhood, 21,392
shares, representing $6 million in value, were placed in escrow. Such shares,
plus accrued and unpaid dividends, are subject to set-off against any
indemnification payments that may become due. The preferred stock will be
released from escrow, net of any claims, over a three-year period ending August
1, 1998.
On June 1, 1996, the Company assumed leases, acquired associated assets and
inventory of 21 stores of Episode USA Inc. (Episode) for $7.4 million, including
transaction costs. Approximately $2.4 million was paid in cash and $5 million
was paid through the issuance of 217,365 shares of Mothers Work common stock.
The purchase price was allocated to the fair value of the assets acquired under
the purchase method of accounting. No goodwill was recorded in this transaction.
In connection with the acquisition, the Company entered into a licensing and
distribution agreement with the seller, Toppy International, Inc. (Toppy) (see
Note 12). Costs associated with these agreements will be expensed as incurred.
If the Pea, Motherhood and Episode acquisitions would have occurred on October
1, 1994, unaudited pro forma net sales would have been approximately
$184,201,000, unaudited pro forma net loss before extraordinary item would have
been approximately $10,049,000, and unaudited pro forma net loss per share would
have been approximately $3.16 for the year ended September 30, 1995.
If the Episode acquisition would have occurred on October 1, 1995, unaudited pro
forma net sales would have been approximately $209,648,000, unaudited pro forma
net loss would have been approximately $2,407,000, and unaudited pro forma net
loss per share would have been approximately $0.68 for the year ended September
30, 1996.
3. INVENTORIES:
September 30
---------------------------
1996 1997
----------- -----------
Finished goods $45,496,732 $49,937,709
Work-in-process 2,107,453 4,123,387
Raw materials 9,605,314 9,751,494
----------- -----------
$57,209,499 $63,812,590
=========== ===========
F-12
<PAGE>
4. PROPERTY, PLANT AND EQUIPMENT:
September 30
----------------------------
1996 1997
------------ ------------
Land $ 1,400,000 $ 1,400,000
Building and improvements 8,488,598 8,966,636
Furniture and equipment 14,869,223 19,189,344
Leasehold improvements 33,889,168 38,201,842
------------ ------------
58,646,989 67,757,822
Accumulated depreciation and amortization (13,195,875) (22,384,383)
------------ ------------
$ 45,451,114 $ 45,373,439
============ ============
During fiscal 1997, the Company recorded charges under SFAS No. 121 of
approximately $952,000, related to the impairment of leasehold improvements and
furniture and equipment at 16 store locations.
5. ACCRUED EXPENSES:
September 30
-------------------------
1996 1997
----------- -----------
Accrued salaries, wages and employee benefits $ 3,587,135 $ 4,692,365
Accrued interest 2,121,414 2,157,217
Accrued sales tax 1,166,897 1,184,461
Other 5,636,154 6,053,014
----------- -----------
$12,511,600 $14,087,057
=========== ===========
6. LINE OF CREDIT:
In August 1995, the Company entered into a three-year, $15 million working
capital and letter of credit facility (the Working Capital Facility). The
Working Capital Facility is secured by substantially all of the assets of the
Company, excluding raw materials inventory. On May 31, 1996, concurrent with the
Episode acquisition (see Note 2), and in order to provide the Company with
additional borrowing capacity, the revolving credit portion of the Working
Capital Facility was increased from $15 million to $20 million. In April 1997,
the Working Capital Facility was increased from $20 million to $27 million, was
extended for one year to July 31, 1999 and certain financial covenants were
revised. The Company had $11.1 million in borrowings and $8.1 million in letters
of credit issued under the Working Capital Facility at September 30, 1997. In
addition to the $27 million available for borrowings and letters of credit, the
Company also has an additional $4 million letter of credit to collateralize an
Industrial Revenue Bond. All of the subsidiaries of Mothers Work, Inc. are
jointly and severally liable for obligations under the Working Capital Facility.
F-13
<PAGE>
The interest rate on borrowings under the Working Capital Facility can be
selected by the Company from one of the following two alternatives: (i) the
Alternate Base Rate (8.50% at September 30, 1997) plus 1.5%, or (ii) the
Adjusted LIBOR Rate (5.66% at September 30, 1997) plus 3%. The Alternate Base
Rate is defined as a fluctuating rate of interest equal to the greater of the
Bank's National Commercial Rate, or (b) the Federal Funds Effective Rate, as
defined, plus one-half of 1%. Adjusted LIBOR means the London Interbank Offered
Rate, adjusted at all times for statutory reserves. Overdue amounts under the
Working Capital Facility bear interest at 2% above the interest rate then in
effect. Interest on Alternate Base Rate loans is payable monthly and interest on
Adjusted LIBOR Rate loans is payable at the end of the relevant interest period
(and quarterly in the case of interest periods in excess of three months).
The Working Capital Facility includes various restrictive covenants prohibiting
Mothers Work, Inc. and its subsidiaries, with certain limited exceptions, from,
among other things, incurring additional indebtedness and making dividend,
redemption and certain other payments. The Working Capital Facility also
contains financial covenants including current ratio, total senior funded debt
to operating cash flow, a fixed charge coverage ratio with a monthly rolling
twelve-month operating cash flow requirement and a net income covenant which is
suspended until the first quarter of fiscal 1998. Violation of the monthly
rolling twelve-month operating cash flow requirement will grant additional
collateral under the Working Capital Facility in the form of the raw materials
inventory.
In fiscal 1996 and 1997, the highest outstanding line of credit balances were
$9,241,193 and $12,716,000, the average outstanding balances were $6,050,510 and
$4,850,505, and the weighted average interest rates were 9.75% and 9.89%,
respectively.
F-14
<PAGE>
7. LONG-TERM DEBT:
<TABLE>
<CAPTION>
September 30
----------------------------
1996 1997
------------ ------------
<S> <C> <C>
12-5/8% Senior Unsecured Exchange Notes, due 2005 $ 90,218,882 $ 90,336,030
Industrial Revenue Bonds, interest is variable (5.75% at September 30, 1997),
principal due annually through 2025 (collateralized by a $4 million letter of
credit) 3,915,000 3,825,000
Mortgage notes:
Interest at 3%, principal due monthly to 2011 (collateralized by a $1
million letter of credit and a second mortgage on certain property and equipment
at the Company's headquarters) 1,964,621 1,856,339
Interest at 2%, principal due monthly to 2011(collateralized by certain
equipment at the Company's headquarters) 291,382 273,882
Interest at 4.25%, principal due monthly to 2001 (collateralized by
certain equipment at the Company's headquarters) 263,689 209,363
Capital lease obligations 576,059 313,237
Other 210,000 210,000
------------ ------------
97,439,633 97,023,851
Less-- Current portion (758,911) (648,231)
------------ ------------
$ 96,680,722 $ 96,375,620
============ ============
</TABLE>
Long-term debt maturities as of September 30, 1997 are as follows:
1998 $ 648,231
1999 376,009
2000 366,168
2001 277,869
2002 255,119
2003 and thereafter 96,764,426
------------
98,687,822
Less-- Unamortized discount (1,663,971)
------------
$ 97,023,851
============
In connection with the Motherhood acquisition, the Company sold 12-5/8% Senior
Unsecured Notes due 2005 (the Notes) with a face amount of $92 million. The
Notes were issued at 97.934% of their face amount, resulting in an annual
effective interest rate of 13%.
F-15
<PAGE>
Interest on the Notes is payable semiannually in cash on February 1 and August
1. The Notes were issued by Mothers Work, Inc. and are unconditionally
guaranteed on a senior basis by each subsidiary (see Note 13). The Notes are
redeemable at the option of the Company, in whole or in part, at any time on or
after August 1, 2000, at 106.250% of their face amount, plus accrued interest,
declining ratably to 100% of their face amount on and after August 1, 2002, plus
accrued interest. In addition, at the option of the Company at any time prior to
August 1, 1998, up to 35% of the aggregate face amount of the Notes may be
redeemed from the proceeds of one or more public stock offerings (as defined) at
110% of their face amount, plus accrued interest, provided that $58.5 million of
Notes remain outstanding immediately after such redemption. In November 1995,
the Company completed an exchange offer whereby the Notes were exchanged for
12-5/8% Senior Unsecured Exchange Notes due 2005 which have been registered
under the Securities Act of 1933.
The proceeds from the sale of the Notes were used to acquire Motherhood and
repay the debt incurred in the Pea acquisition. The early extinguishment of the
Pea debt resulted in an extraordinary charge of $6,387,000 before the related
income tax benefit. The charge was comprised of a prepayment penalty of
$3,550,000, the write-off of deferred financing costs of $1,730,000 and
unamortized original issue discount of $976,000, and fees and expenses of
$131,000. In connection with the debt issued in the Pea acquisition, warrants
were issued to purchase 140,123 shares of the Company's common stock at $.01 per
share. The warrants were valued at $1 million and remain outstanding (see Note
10).
COMMON AND PREFERRED STOCK:
Private Placement
On May 31, 1996, the Company completed a private placement of 200,000 shares of
its common stock to a number of institutional investors at $22.25 per share. The
Company used the proceeds to pay the cash portion of the purchase price for the
Episode assets (see Note 2), to finance the opening of additional stores and for
general working capital purposes.
Preferred Stock
In connection with the Motherhood acquisition, the Company issued 41,000 shares
of Series A Cumulative Convertible Preferred Stock (the Series A Preferred
Stock) with a stated value of $11.5 million. The Series A Preferred Stock has a
preference in liquidation equal to the stated value, plus accrued but unpaid
dividends. The Company may redeem (but is under no obligation to do so) the
Series A Preferred Stock at any time at a price equal to liquidation preference,
subject to certain limitations imposed by the Working Capital Facility and the
holders of the Notes.
The holders of the Series A Preferred Stock are entitled to receive annual cash
dividends, when declared by the Company's Board of Directors, equal to 8.5% of
the stated value ($977,500 per year). Dividends are cumulative to the extent not
paid and compound annually at 8.5%. No dividends may be paid on common stock or
any other shares of capital stock of the Company ranking junior to the Series A
Preferred Stock (other than
F-16
<PAGE>
dividends payable in shares of common stock), until all cumulative and current
dividends on Series A Preferred Stock have been declared and paid in full. As of
September 30, 1997, accrued dividends on the Series A Preferred Stock were
$2,228,700 and are classified as long-term liabilities.
The Series A Preferred Stock is convertible into shares of common stock (i)
between August 1, 2000 and November 1, 2006, at an initial conversion rate
(subject to adjustments for stock splits, stock dividends, recapitalizations and
similar events) equal to ten shares of common stock for each share of Series A
Preferred Stock, or (ii) after November 1, 2006, at an initial conversion rate
determined by dividing the aggregate stated value of all shares of Series A
Preferred Stock to be converted by 90% of the then-market price of the common
stock, as defined. After a holder's exercise of the conversion right under (i)
above, the Company may only redeem the Series A Preferred Stock from the
proceeds of an equity offering. The limitation on this redemption right may only
be modified with the consent of the holders of a majority of the outstanding
principal amount of the Notes. Upon any conversion, the holder of the Series A
Preferred Stock to be converted is entitled to receive payment of all accrued
and unpaid dividends in cash unless the Company is prohibited by limitations
contained in the Notes. In the case of a conversion under (i) above, if
dividends are not paid in cash, the Company will issue a note with interest at
the prime rate, payable beginning one year after the date of conversion. The
note will be subordinated to the Notes and will be payable only to the extent
permitted under the restrictions contained in the Notes. If the note is not paid
by August 1, 2003, then all principal and accrued interest may be converted into
that number of shares of common stock determined by dividing the amount due by
the then-market price, as defined. In the case of a conversion under (ii) above,
if accrued dividends are not paid in cash, then such dividends are convertible
into common stock on the same basis as the shares of Series A Preferred Stock.
In connection with the Rights Agreement (see Note 9), the Company authorized
10,000 shares of Series B Junior Participating Preferred Stock (the Series B
Preferred Stock). The Series B Preferred Stock can be purchased in units equal
to one one-thousandth of a share (the Series B Units) under the terms of the
Rights Agreement (see Note 9). The holders of the Series B Units are entitled to
receive dividends when and if declared on Common Stock. Series B Units are
junior to the Common Stock and Series A Preferred Stock for both dividends and
liquidations. Each Series B Unit votes as one share of Common Stock.
9. RIGHTS AGREEMENT:
Under the Rights Agreement, the Company has one Right outstanding for each share
of Mothers Work common stock now or hereafter outstanding. Under certain limited
conditions as defined in the Rights Agreement, each Right entitles the
registered holder to purchase from the Company one Series B Unit at $85 per
share subject to adjustment. The rights expire on October 9, 2005 (the Final
Expiration Date).
On March 17, 1997 the Company entered into an amendment to its Rights Agreement,
to provide the independent directors of the Company with some discretion in
determining when the Distribution Date (as defined in the Rights Agreement)
shall occur and the date until which the Rights may be redeemed. In addition,
the Amended and Restated Rights Agreement exempts from its operation any person
that acquires, obtains the right to
F-17
<PAGE>
acquire, or otherwise obtains beneficial ownership of 10% or more of the then
outstanding shares of Company Common Stock without any intention of changing or
influencing control of the Company provided that such person, as promptly as
practicable, divests himself or itself of a sufficient number of shares of
Common Stock so that such person would no longer be an Acquiring Person.
The Rights are not exercisable until the Distribution Date which will occur upon
the earlier of (i) ten business days following a public announcement that an
Acquiring Person has acquired beneficial ownership of 10% or more of Mothers
Work's outstanding common stock, and ten business days following the
commencement of a tender offer or exchange offer that would result in a person
or group owning 10% or more of Mothers Work's outstanding common stock, or (ii)
such later date as may be determined by action of a majority of the independent
directors.
The Rights have certain anti-takeover effects. The Rights will cause substantial
dilution to a person or group that attempts to acquire the Company without
conditioning the offer on the redemption of the Rights. The rights can be
mandatorily redeemed by action of a majority of the independent directors at any
time prior to the earlier of the Final Expiration Date and the Distribution Date
for $.01 per right.
Upon exercise and the occurrence of certain events as defined in the Rights
Agreement, each holder of a Right, except the Acquiring Person, will have the
right to receive Mothers Work common stock or common stock of the acquiring
company having a value equal to two times the exercise price of the Right.
10. STOCK OPTION PLAN:
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options. Under APB 25, because the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
The Company has a stock option plan (the 1987 Stock Option Plan), which provides
for the grant of common stock options to eligible employees and others. Options
granted may be at the fair market value of the stock or at a price determined by
a committee of the Board. The stock options vest over varying periods up to five
years and are exercisable over a period determined by the committee, but not
longer than ten years.
In fiscal 1996, the 1987 Stock Option Plan was amended to provide for the grant
of up to 725,000 shares of common stock. In fiscal 1995, the Company granted
137,506 options at exercise prices ranging from $10.25 to $16.50 per share to
certain officers, including 81,810 options at an exercise price of $11.25 per
share to officers who are also Board members. In fiscal 1996, the Company
granted 90,000 options at an exercise price of $13.50 per share to certain
officers, including 60,000 options to officers who are also Board members.
In fiscal 1997, the Company granted 28,000 options at an exercise price of
$10.00 per share to certain officers, excluding the Chairman and the President.
F-18
<PAGE>
In fiscal 1994, the shareholders approved the Director Stock Option Plan
(Director Plan), which provides for the grant of 2,000 options to each director
on an annual basis. Options granted under the Director Plan are nonqualified,
have an exercise price equal to fair market value, a ten-year term and fully
vest on the grant date. A total of 200,000 shares of common stock were reserved
for issuance under the Director Plan, with 14,000 options granted at an exercise
price of $9.50 per share in fiscal 1995, 12,000 options granted at an exercise
price of $14.50 per share in fiscal 1996 and 12,000 options granted at an
exercise price of $9.50 per share in fiscal 1997.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee and director stock options under the fair value method of SFAS No. 123.
The fair value for these options was estimated at the date of grant using the
Black-Scholes option-pricing model with the weighted average assumptions used
for all fixed option grants in fiscal 1996 and 1997, respectively: no dividend
yields, expected volatility of 65.2%, risk-free interest rates of 6.05% and
6.12%, and expected lives of 7.0 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Pro forma information regarding net income and earnings per share follows:
1996 1997
------------ --------------
Net Loss Applicable to Common Stockholders:
As reported $ (73,734) $ (8,727,367)
Pro forma (882,560) (9,218,623)
Net Loss Per Common Share:
As reported $ (0.02) $ (2.45)
Pro forma (0.27) (2.59)
F-19
<PAGE>
A summary of the Company's stock option activity including the 1987 Stock Option
Plan, the Director Plan and the options granted to an individual outside the
plans (see Note 15), and related information for the years ended September 30
follows:
<TABLE>
<CAPTION>
1995 1996 1997
Weighted Weighted Weighted
Average Average Average
1995 Exercise 1996 Exercise 1997 Exercise
Options Price Options Price Options Price
------- ---------- ------- --------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding beginning of year 192,049 $ 11.34 406,047 $ 11.07 523,242 $ 11.89
Granted 286,059 11.36 222,000 13.86 180,167 10.02
Exercised (2,394) 5.49 (19,715) 6.82 (40) 10.25
Canceled (69,667) 13.80 (85,090) 14.24 (33,420) 12.07
------- ---------- ------- --------- ------- ----------
Outstanding end of year 406,047 11.07 523,242 11.89 669,949 11.38
======= ======= =======
Options exercisable at year-end 163,978 264,319 348,048
======= ======= =======
Weighted-average fair value of
options granted during the year $ 9.57 $ 6.93
========= ==========
</TABLE>
The following table summarizes information about stock options outstanding at
September 30, 1997:
<TABLE>
<CAPTION>
Weighted
Weighted Average Weighted
Range of Average Remaining Average
Exercise Number Exercise Contractual Options Exercise
Prices Outstanding Price Life (Years) Exercisable Price
- -------------- ----------- -------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C>
$1.67 - $ 8.75 50,262 5.13 6.1 27,945 3.31
$9.00 - $11.25 366,820 10.43 7.7 174,923 10.73
$13.00- $18.75 252,867 14.00 7.8 145,180 14.18
</TABLE>
During fiscal 1997, warrants to purchase 7,465 shares of common stock at a price
of $2.72 per share were exercised. At September 30, 1997, warrants are
outstanding to purchase 140,123 shares of common stock at an exercise price of
$0.01, these warrants expire on April 5, 2002.
11. INCOME TAXES:
Income taxes (benefit) are comprised of the following:
Year Ended September 30
-------------------------------------------
1995 1996 1997
---------- ----------- ------------
Current provision (benefit) $ (893,214) $ 384,421 $ --
Deferred provision (benefit) 45,927 1,444,151 (2,676,945)
---------- ----------- ------------
$ (847,287) $ 1,828,572 $ (2,676,945)
========== =========== ============
F-20
<PAGE>
The extraordinary item generated an additional income tax benefit of $2,171,435
in fiscal 1995, of which $1,311,383 was a current tax benefit and $860,052 was a
deferred tax benefit.
The reconciliation of the statutory federal rate to the Company's effective
income tax rate on the income (loss) before extraordinary item is as follows:
Year Ended September 30
----------------------------------
1995 1996 1997
----- ---- -----
Statutory tax rate (34.0)% 34.0% (34.0)%
State taxes, net of federal benefit -- 3.7 --
Amortization of goodwill 8.0 27.3 7.3
Other .1 1.9 0.8
----- ---- -----
(25.9)% 66.9% (25.9)%
===== ==== =====
The deferred tax effects of temporary differences giving rise to the Company's
deferred income tax assets are as follows:
September 30
----------------------------
1996 1997
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 2,765,391 $ 3,400,024
Depreciation of property, plant and equipment 2,076,929 3,660,267
Deferred rent 826,557 1,234,207
Inventory reserves 995,124 687,712
Employee benefit accruals 381,941 474,799
Other accruals 1,262,806 1,045,986
Alternative minimum tax credit carryforward 528,509 528,509
Other 261,327 394,591
------------ ------------
9,098,584 11,426,095
Deferred tax liabilities:
Prepaid expenses (175,665) (111,075)
Other (366,048) (28,440)
------------ ------------
$ 8,556,871 $ 11,286,580
============ ============
The Company has net operating loss carryforwards for tax purposes of
approximately $10,000,000 which expire in 2009 through 2012, of which $4,309,000
were acquired in the acquisitions of Pea and Motherhood. The Company also has
alternative minimum tax credits of approximately $529,000 which can be utilized
against regular income taxes in the future. While the acquired net operating
loss carryforwards are subject to certain annual limitations due to the change
in ownership, the Company does not expect the limitations to reduce its ability
to ultimately use such carryforwards. The entire tax benefit of the net
operating loss carryforwards has been recorded as a deferred income tax asset,
as it is more likely than not that it will be realized during the carryforward
period. The tax benefit of the
F-21
<PAGE>
acquired net operating loss carryforwards was recorded under the purchase method
of accounting, while the remainder of the benefit was recorded as an income tax
benefit in the accompanying statement of operations.
No valuation allowance has been provided for the net deferred tax assets. Based
on the Company's historical levels of taxable income, as adjusted for the
restructuring and nonrecurring charges and the nondeductibility of goodwill
amortization, management believes it is more likely than not that the Company
will realize the benefit of the net deferred tax assets existing at September
30, 1997. Furthermore, management believes the existing net deductible temporary
differences will reverse during periods in which the Company generates net
taxable income. There can be no assurance, however, that the Company will
generate taxable earnings or any specific level of continuing earnings in the
future.
12. COMMITMENTS AND CONTINGENCIES:
The Company leases its retail facilities and certain equipment under various
noncancelable operating leases. Certain of these leases have renewal options.
Future minimum lease payments as of September 30, 1997 are as follows:
1998 $ 27,993,759
1999 26,036,048
2000 24,729,735
2001 23,005,318
2002 20,054,481
2003 and thereafter 56,050,139
------------
$ 177,869,480
=============
Rent expense, including common area maintenance, was $18,081,333, $30,196,546
and $39,022,965 in fiscal 1995, 1996 and 1997, respectively.
In connection with the Episode acquisition, the Company entered into a licensing
agreement and distribution agreement to operate the Episode stores in their
current format and under their current name. The Company licensed the Episode
trademark and is required to pay through a royalty of 5% of sales, with the
royalty payment not to exceed $4.5 million. The distribution agreement provides
for Toppy to sell inventory to the Company with certain Toppy trademarks. The
distribution agreement also permits the Company to manufacture articles with
such trademarks in consideration of the payment by the Company to Toppy of a 2%
royalty on all sales of such manufactured articles by the Company. Additionally,
Mothers Work is required to have items purchased from Toppy represent 50% of the
inventory value at each Episode store.
From time to time, the Company is named as a defendant in legal actions arising
from its normal business activities. Although the amount of any liability that
could arise with respect to currently pending actions cannot be accurately
predicted, in the opinion of the Company, any such liability will not have a
material adverse effect on the financial position or operating results of the
Company.
F-22
<PAGE>
In connection with the Pea acquisition, Mothers Work (R.E.), Inc. assumed Pea's
outstanding litigation and potential claims. On February 7, 1994, a civil
complaint was filed in a United States District Court against Pea and its
then-officers and Board of Directors, and its former preferred shareholders.
In October 1997, an agreement in principle to settle the litigation in its
entirety was reached. The settlement also involves a waiver by Pea's
underwriters of a claim of counsel fees under the Company's indemnification
undertakings to the underwriters contained in the underwriting agreement for the
Pea public offering. Although the Company believes it has very strong defenses
against this claim, it has concluded that it would undoubtedly cost the Company
more to prevail than it would to settle on the terms proposed. The principles
are in the process of negotiating a Stipulation of Settlement to document the
terms of the agreement. Pursuant to the agreement, Mothers Work, along with its
Directors' and Officers Liability Insurance Carrier (Insurance Carrier) has
agreed to pay $2,150,000. As part of the agreement, Mothers Work and Insurance
Carrier, on behalf of some of the defendants, have agreed to make an initial
payment in October 1997 of $750,000 and $550,000, respectively, to an escrow
agent for the settlement fund once the Stipulation of Settlement is executed.
The additional $850,000 is to be paid by Mothers Work on January 6, 1998 or the
date on which the settlement is finally approved, whichever occurs earlier.
Should the settlement not be approved for any reason, the probability and extent
of liability that the Company might incur cannot be predicted with certainty but
management of the Company intends to vigorously defend against these lawsuits,
and believes the Company has adequate reserves so that the ultimate outcome will
not have a material impact on its financial position.
13. SUBSIDIARY GUARANTORS:
Pursuant to the terms of the indenture relating to the 12-5/8% Senior Unsecured
Exchange Notes due 2005, the direct subsidiaries of Mothers Work,
Inc.--consisting of Cave Springs, Inc., The Page Boy Company, Inc., Mothers Work
(R.E.), Inc. (d/b/a/A Pea in the Pod, Inc.), and Motherhood Maternity Shops,
Inc. (collectively, the Guarantors)--have, jointly and severally,
unconditionally guaranteed the obligations of Mothers Work, Inc. with respect to
these notes. The operations of Motherhood Maternity Shops, Inc. were merged into
the operations of Mothers Work, Inc. as of September 30, 1996. The only
subsidiary of the Company that is not a Guarantor is Motherhood International,
Inc. (International). International, an indirect wholly owned subsidiary of the
Company which is inconsequential to the assets and operations of the Company and
to the Guarantors in that it has no assets or operations, was dissolved as of
November 28, 1996. There are no restrictions on the ability of any of the
Guarantors to transfer funds to Mothers Work, Inc. in the form of loans,
advances or dividends, except as provided by applicable law.
F-23
<PAGE>
Accordingly, set forth below is certain summarized financial information (within
the meaning of Section 1-02[bb] of Regulation S-X) for the Guarantors, as of and
for the year ended September 30, 1996 and 1997:
September 30, September 30,
1996 1997
------------- -------------
Current assets $ 5,601,825 $ 4,127,213
Noncurrent assets 20,963,279 80,125,458
Current liabilities 3,059,322 3,064,719
Noncurrent liabilities 3,835,768 52,539,740
For the Year Ended
September 30,
----------------------------
1996 1997
----------- -----------
Net sales $51,284,307 $53,432,799
Costs and expenses 40,273,798 39,829,468
Net income 7,158,349 8,978,198
The summarized financial information for the Guarantors has been prepared from
the books and records maintained by the Guarantors and the Company. The
summarized financial information may not necessarily be indicative of the
results of operations or financial position had the Guarantors operated as
independent entities. Certain intercompany sales included in the subsidiary
records are eliminated in consolidation. The Guarantors receive all inventory
from and transfer all cash to Mothers Work, Inc., who, in turn, pays all
expenditures on behalf of the Guarantors. An amount due to/due from parent will
exist at any time as a result of this activity. The summarized financial
information includes the allocation of material amounts of expenses such as
corporate services, administration and taxes on income. The allocations are
generally based on proportional amounts of sales or assets, and taxes on income
are allocated consistent with the asset and liability approach used for
consolidated financial statement purposes. Management believes these allocation
methods are reasonable. The financial information of Motherhood Maternity Shops,
Inc. has been excluded from the table above due to the merger on September 30,
1996.
14. RESTRUCTURING AND NONRECURRING CHARGES:
Nonrecurring charges for the year ended September 30, 1995, include $900,000
accrued for the relocation to a new headquarters, manufacturing and distribution
facility and $4,527,000 for planned closings of Mothers Work stores. On March
31, 1995, the Company implemented a one-year plan, due to excess capacity in
certain markets, to close 38 Mothers Work stores and, in conjunction with the
Pea acquisition, to close 15 Pea stores. The net sales and store operating
income before corporate overhead allocations for the stores closed in fiscal
1996 that are included in the accompanying statement of operations for the year
ended September 30, 1996, are $3,538,804 and $206,858, respectively.
F-24
<PAGE>
In April 1997, the Company announced a plan to restructure its core maternity
business by combining the Mimi Maternity and Maternite overlapping product
styles and closing approximately 30 retail locations serviced by other Company
stores. Restructuring costs of $5.6 million were recorded in fiscal 1997 and
includes approximately $2.6 for the write-off of furniture, fixtures and
leasehold improvements, $1.7 million for lease termination and other costs and
$1.3 million for the write-off of patterns related to over-lapping product
styles that will no longer be manufactured by the Company as a result of the
Mimi Maternity and Maternite product line consolidation, and thus have no future
value.
In addition to the charge discussed above, in March 1997, the Company also
recorded a $0.8 million inventory reserve in cost of goods sold for the
overlapping product lines, a $0.7 million asset impairment in selling, general
and administrative expense for 14 additional facilities and approximately $0.5
million in selling, general and administrative expense for other occupancy
related items.
During fiscal 1997, the Company closed 26 stores in connection with the April
1997 restructuring plan. The Company plans to close one additional store in
fiscal 1998 under this restructuring plan. The net sales and operating income
before corporate overhead allocations for the stores closed in fiscal 1997 that
are included in the accompanying statement of operations for the year ended
September 30, 1997 are $6,129,576 and $711,272, respectively.
15. EMPLOYMENT AND CONSULTING AGREEMENTS:
The Company has employment agreements with its Chief Executive Officer/Chairman
of the Board (CEO), its President/Chief Operating Officer (COO), its Senior Vice
President-Operations and its Head Pattern Maker. The CEO and COO have agreements
which expire on September 30, 1999. These agreements provide for base
compensation of $275,000 for fiscal 1997, increasing annually thereafter. On
October 1, of each year the term of each agreement automatically extends for
successive one year periods extending the expiration date into the third year
after the extension. Additionally, the CEO and COO are entitled to an annual
cash bonus and stock options based on performance, as defined.
The agreement with the Senior Vice President--Operations is through June 19,
1997, and provides for an initial base salary of $250,000 per year, incentive
bonuses based upon specified goals and a one-time grant of 20,000 stock options.
The agreement with the Head Pattern Maker is through July 17, 1997, and provides
for an initial base salary of $100,000 per year, an annual bonus and a one-time
grant of 3,000 stock options.
On October 1, 1996, the Company entered into a one-year agreement with an
individual. The agreement requires the individual to perform consulting and
advisory services for the Company in connection with the growth and strategic
development of the maternity and Episode businesses. The agreement provides for
payment of $200,000, payable in equal monthly installments, a grant of 16,667
fully vested stock options, and an obligation to serve as a Director of the
Company, if elected. The stock options are exercisable up to one year after the
individual ceases to be a Director of the Company.
F-25
<PAGE>
16. RELATED-PARTY ACTIVITY:
The Company paid legal fees of approximately $1.1 million, $680,000 and $470,000
in fiscal 1995, 1996 and 1997, respectively, to a firm whose partner is a
Director of the Company.
PROFIT-SHARING PLANS:
Effective January 1, 1993, the Company established a 401(k) savings plan for
full-time employees who have at least one year of service and are 21 years of
age. Employees can contribute up to 15% of their annual salary. The Company may
make contributions to the plan, which vest over a five-year period. No Company
contributions were made in fiscal 1995, 1996 or 1997.
In conjunction with the acquisition of Pea, the Company assumed responsibility
for Pea's 401(k) Employees' Savings Plan. Employees who have at least one year
of service may participate in the plan, and the Company may make contributions
to the plan that vest over a four-year period. No Company contributions were
made in fiscal 1995 or 1996. The Company terminated this plan in fiscal 1996 by
merging the plan into the Mothers Work 401(k) Savings Plan. In conjunction with
the acquisition of Motherhood, the Company assumed responsibility for the final
distribution and termination of the Motherhood Retirement Savings Plan. The
Company expects that final distributions of this plan will be made in fiscal
1998.
F-26
<PAGE>
EIGHTH AMENDMENT TO CREDIT AGREEMENT dated as of September 30, 1997 by and
among Mothers Work, Inc., a Delaware corporation, on its own behalf and as
successor, by merger, to Motherhood Maternity Shops, Inc., a Delaware
corporation ("MWI"), Cave Springs, Inc., a Delaware corporation ("Cave"), The
Page Boy Company, Inc., a Delaware corporation ("Page Boy"), Mothers Work
(R.E.), Inc., a Pennsylvania corporation ("MW-RE"), (each, a "Borrower", and
collectively, jointly and severally, the "Borrowers"), and CoreStates Bank,
N.A., successor to Meridian Bank ("Bank").
BACKGROUND
The Borrowers and the Bank are parties to a Credit Agreement dated as of
August 1, 1995, as first amended September 1, 1995, as second amended January
25, 1996, as third amended. May 31, 1996, as fourth amended September 30, 1996,
as fifth amended January 31, 1997, as sixth amended April 16, 1997 and as
seventh amended July 31, 1997 (the "Credit Agreement") pursuant to which the
Bank established, in favor of the Borrowers, a credit facility in an aggregate
principal amount of $31,094,684.93, subject to the terms and conditions set
forth therein. Borrowers have requested the Bank to modify certain terms of the
Credit Agreement, including certain of the financial covenants set forth in the
Credit Agreement, which Bank is willing to do, all on the terms and conditions
set forth herein. Capitalized terms used herein, and not otherwise defined,
shall have the meanings ascribed to them in the Credit Agreement.
AGREEMENTS
The parties hereto, intending to be legally bound, hereby agree:
1. Section 7.07 of the Credit Agreement shall be amended by deleting
the language found therein in its entirety, and by substituting therefor the
following:
"SECTION 7.07. Total Senior Funded Debt to Operating Cash Flow Ratio.
Permit, at any time, the ratio of (x) Total Senior Funded Debt of MWI
and its Subsidiaries on a Consolidated basis, to (y) Operating Cash
Flow of MWI and its Subsidiaries on a Consolidated basis for the four
most recent consecutive fiscal quarters ending on or immediately
preceding such date of determination to be greater than the respective
amounts set forth below for the periods indicated:
Period Ratio
------ -----
During the Fiscal Quarter
ending September 30, 1997 5.60:1.00
During the Fiscal Quarter
ending December 31, 1997 5.20:1.00
<PAGE>
During the Fiscal Quarter
ending March 31, 1998 4.85:1.00
During the Fiscal Quarter
ending June 30, 1998 4.85:1.00
During the Fiscal Quarter
ending September 30, 1998 4.60:1.00
During the Fiscal Quarter
ending December 31, 1998 4.50:1.00
During the Fiscal Quarter
ending March 31, 1999,
and thereafter 4.50:1.00
provided, however, that for purposes of these calculations, any charges incurred
in any fiscal period resulting from the application of FASB 121 (Accounting for
the Impairment of Long-Lived Assets, and Long-Lived Assets to be Disposed Of)
shall not be included for purposes of determining Net Income for that period.
2. Section 7.08 of the Credit Agreement shall be amended by deleting
the language found therein in its entirety, and by substituting therefor the
following:
SECTION 7.08. Ratio of Operating Cash Flow to Interest Expense, Current
Portion of Long-Term Debt and Capital Expenditures. Permit, at any
time, the ratio of Operating Cash Flow of MWI and its Subsidiaries on a
Consolidated basis for the four most recent consecutive fiscal quarters
ending on or immediately preceding such date of determination to the
aggregate of (x) the Interest Expense plus (y) the Capital Expenditures
incurred-during the same four most recent fiscal quarters, plus (z) the
Current Portion of Long-Term Debt, calculated as of the date of such
determination, to be less than the respective amounts set forth below
for the periods indicated:
Period Ratio
------ -----
During the Fiscal Quarter
ending September 30, 1997 0.80:1.00
During the Fiscal Quarter
ending December 31, 1997; 0.80:1.00
-2-
<PAGE>
During the Fiscal Quarter
ending March 31, 1998 0.95:1.00
During the Fiscal Quarter
ending June 30, 1998 1.00:1.00
During the Fiscal Quarter
ending September 30, 1998 1.10:1.00
During the Fiscal Quarter
ending December 31, 1998 1.20:1.00
During the Fiscal Quarter
ending March 31, 1999,
and thereafter 1.30:1.00
provided, however, that for purposes of these calculations, any charges incurred
in any fiscal period resulting from the application of FASB 121 (Accounting for
the Impairment of Long-Lived Assets, and Long-Lived Assets to be Disposed Of)
shall not be included for purposes of determining Net Income for that period.
3. Section 7.09 of the Credit Agreement shall be amended by deleting
the language found therein in its entirety, and by substituting therefor the
following:
"SECTION 7.09. Current Ratio. Permit the ratio of the Current Assets to
the Current Liabilities to, at any time, be less than the respective
amounts set forth below for the periods indicated:
Period Ratio
------ -----
During the Fiscal Quarter
ending September 30, 1997 1.65:1.00
During the Fiscal Quarter
ending December 31, 1997 1.75:1.00
During the Fiscal Quarter
ending March 31, 1998 1.90:1.00
During the Fiscal Quarter
ending June 30, 1998 2.00:1.00
-3-
<PAGE>
During the Fiscal Quarter
ending September 30, 1998,
and thereafter 2:25:1.00
4. The Bank shall, promptly after the end of January, 1998, calculate
the average daily amount of Revolving Credit Loans outstanding to the Borrowers
during the month of January, 1998 and shall deliver such calculation to the
Borrowers. If the average daily amount of Revolving Credit Loans in January,
1998 (which excludes the aggregate undrawn amounts of all outstanding Letters of
Credit) exceeds the sum of $5,000,000, the Borrower shall pay to the Bank,
immediately upon demand, an amount equal to, one-eighth of one percent of the
amount of the Revolving Credit Commitment, which amount shall be paid in
immediately available funds.
5. As a condition to the execution and delivery of this Eighth
Amendment to Credit Agreement, the Borrowers shall deliver to the Bank, in form
and content satisfactory to the Bank and its counsel, the following documents,
instruments or payments:
a. A certified copy of resolutions adopted by the Board of
Directors of each of the Borrowers authorizing the execution, delivery and
performance of this Eighth Amendment, and all of the documents and instruments
required by the Bank for the implementation of this Eighth Amendment;
b. The favorable written opinion of Pepper Hamilton Scheetz,
counsel for the Borrowers, substantially in the form of Exhibit "A" hereto,
dated the date of this Eighth Amendment, addressed to the Bank and satisfactory
to it;
c. An Amendment fee in the amount of $2,500; and
d. the inventory location report, as described in Section 6.05(k)
of the Credit Agreement.
6. The Borrowers hereby:
a. acknowledge and agree that all of their representations,
warranties and covenants contained in the Credit Agreement and/or in the Loan
Documents, as amended hereby, are true, accurate and correct on and as of the
date hereof as if made on and as of the date hereof, except as set forth on
Schedule 6(a) attached to this Eighth Amendment; provided, however, that with
respect to the dates set forth in certain representations, such dates shall be
updated as follows:
(i) in Section 4.05, the referenced date shall be
September 30, 1996;
-4-
<PAGE>
(ii) in Section 4.07(a), the referenced date for consolidated
balance sheet shall be September 30, 1996;
(iii) in Section 4.07(b), the referenced date shall be 1997;
and
(iv) in Section 4.07(c), the referenced 1995 Fiscal Year and
1996 Fiscal Year shall be changed to 1996 Fiscal Year and 1997 Fiscal Year,
respectively.
b. acknowledge and agree that they have no defense, set-off,
counterclaim or challenge against the payment of any sums owing under the Credit
Agreement or the Loan Documents or the Obligations, or the enforcement of any of
the terms of the Credit Agreement or the Loan Documents, as amended hereby; and
c. represent and warrant that no Event of Default, as defined in
the Credit Agreement, exists or will exist upon the delivery of notice, passage
of time or both.
7. The Borrowers will pay all of Bank's out-of-pocket costs and
expenses incurred in connection with the review, preparation, negotiation,
documentation and closing of this Eighth Amendment and the consummation of the
transactions contemplated herein, including, without limitation, fees, expenses
and disbursements of counsel retained by Bank and all fees related to filings,
recording of documents and searches, appraisal costs, whether or not the
transactions contemplated hereunder are consummated.
8. All other terms and conditions of the Credit Agreement and of the
Loan Documents, not inconsistent with the terms hereof, shall remain in full
force and effect and are hereby ratified and confirmed by the Borrowers.
-5-
<PAGE>
IN WITNESS WHEREOF, the Borrowers and the Bank have caused this Eighth
Amendment to Credit Agreement to be executed by their respective authorized
officers as of the day and year first above written.
MOTHERS WORK, INC.
By: /s/ Thomas Frank
-------------------------------
Name: Thomas Frank
Title: Vice President
CAVE SPRINGS, INC.
By: /s/ Thomas Frank
-------------------------------
Name: Thomas Frank
Title: Vice President
THE PAGE BOY COMPANY, INC.
By: /s/ Thomas Frank
-------------------------------
Name: Thomas Frank
Title: Vice President
MOTHERS WORK (R.E.), INC.
By: /s/ Thomas Frank
-------------------------------
Name: Thomas Frank
Title: Vice President
CORESTATES BANK, N.A.
By: /s/ Randal D. Southern
-------------------------------
Name: Randal D. Southern
Title: Vice President
-6-
<PAGE>
EXHIBIT 11
MOTHERS WORK, INC. AND SUBSIDIARIES
COMPUTATION OF PRIMARY EARNINGS (LOSS) PER COMMON SHARE
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------
1995 1996 1997
----------- ---------- ----------
<S> <C> <C> <C>
Average shares outstanding 3,120,535 3,269,290 3,562,980
Net effect of dilutive stock options and
warrants -- -- --
----------- ---------- ----------
3,120,535 3,269,290 3,562,980
=========== ========== ===========
Net income (loss) $(6,635,854) $ 903,766 $(7,639,083)
Preferred stock dividends (162,916) (977,500) (1,088,284)
----------- ----------- -----------
Net loss applicable to common stockholders $(6,798,770) $ (73,734) $(8,727,367)
=========== ========== ===========
Per common share amount:
Before extraordinary item $ 0.83 $ (0.02) $ (2.45)
After extraordinary item 1.35
----------- ----------- -----------
Net loss per common share $ 2.18 $ (0.02) $ (2.45)
=========== ========== ===========
</TABLE>
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
Name Under
Name of Jurisdiction of Which Subsidiary
Subsidiary Incorporation Does Business
- ---------- --------------- ----------------
Cave Springs, Inc. Delaware Cave Springs
Mothers Work (R.E.), Inc. Pennsylvania A Pea in the Pod
The Page Boy Company, Inc. Delaware Maternite
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed
Registration Statements File Nos. 33-64580, 333-2404, 333-3480, 333-12321 and
333-27611.
Arthur Andersen LLP
Philadelphia, PA
December 18, 1997
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S 1997 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> SEP-30-1997
<CASH> 1,665,760
<SECURITIES> 0
<RECEIVABLES> 2,946,137
<ALLOWANCES> 0
<INVENTORY> 63,812,590
<CURRENT-ASSETS> 75,170,685
<PP&E> 67,757,822
<DEPRECIATION> (22,384,383)
<TOTAL-ASSETS> 171,717,520
<CURRENT-LIABILITIES> 43,087,992
<BONDS> 96,375,620
0
11,500,000
<COMMON> 35,646
<OTHER-SE> 14,843,911
<TOTAL-LIABILITY-AND-EQUITY> 171,717,520
<SALES> 246,934,331
<TOTAL-REVENUES> 246,934,331
<CGS> 113,886,439
<TOTAL-COSTS> 113,886,439
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13,263,418
<INCOME-PRETAX> (10,316,028)
<INCOME-TAX> (2,676,945)
<INCOME-CONTINUING> (7,639,083)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,639,083)
<EPS-PRIMARY> (2.45)
<EPS-DILUTED> (2.45)
</TABLE>
