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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to _____________________
Com mission file number 0-21196
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 (IRS Employer Identification No.)
incorporation or organization)
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 N/A
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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 December 11, 1998, the aggregate market value of the Registrant's
Common Stock, $.01 par value, held by nonaffiliates of the Registrant was
approximately $23,958,115.
On December 11, 1998, 3,608,747 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 22, 1999 are incorporated by reference into Part III of this
Form 10-K
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PART I
ITEM 1. Business1
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. Until September 1998, the Company also
operated in the non-maternity women's apparel market through its Episode(R)
division ("Episode"), which was acquired in June 1996, and marketed women's
bridge fashion apparel. As of September 30, 1998, the Company operated 460
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 123 leased maternity departments in stores such as Lazarus,
Rich's, and Macy's.
The Company locates its stores primarily in regional shopping malls,
factory-direct outlet centers and to a lesser extent, in central business
districts within major metropolitan areas. The Company is vertically-integrated,
performing design, manufacturing, distribution and retail sales functions
primarily in-house. The Company takes sales orders over the phone, by mail and
over the internet for a selected assortment of its maternity apparel, gifts and
other materials. In-store merchandise is further supplemented by various mail
order catalogs and brochures.
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.2 Mimi
Maternity is designed to meet the needs of fashion forward women who are willing
to spend more to make a fashion statement. Pea markets the most upscale of the
Company's maternity fashions and offers a premium 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 is the oldest chain
specialty retailer of maternity clothing in the United States and markets
moderately priced maternity clothing. Maternity Works, a chain of factory-direct
outlet stores, serves the woman who seeks apparel during her pregnancy but
cannot or will not purchase at full retail prices, and primarily serves the
moderate market with the introduction of Motherhood products during fiscal 1998.
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1 The terms "Mothers Work" and the "Company" as used in this Report
include Mothers Work, Inc. and Cave Springs, Inc., its wholly-owned subsidiary.
All references in this Report to stores or Company-owned stores include leased
departments.
2 The Company continues to operate stores under the names Maternite and
Mothers Work where bound by lease arrangements or where it would otherwise not
be economical to change the name of the store to Mimi Maternity at this time.
The Company's strategy is to:
o Respond quickly to customer fashion demand utilizing its Real
Time Retailing(R) business model.
o Secure and maintain desirable retail locations within regional
shopping malls and factory-direct outlet centers.
o Use a combination of domestic and international production to
ensure both responsiveness to market demands and cost
efficiencies.
o Expand presence in the moderate price market by identifying
key items and offering them at everyday low prices.
In May 1998, the Company announced that its Board of Directors had
instructed management to restructure the Episode non-maternity bridge women's
apparel business to eliminate the losses from that business. The Company
operated 50 stores under its Episode concept at that time the restructuring and
closure commenced. The first step of this restructuring involved closing or
converting to maternity stores 21 of the Episode stores. In September, a
decision was made to close the remainder of the Episode stores. At this time,
the Company entered into a contract with a liquidator under which the liquidator
agreed to operate the Episode stores to sell off the remaining Episode
inventory. At September 30, 1998, 30 Episode stores were being operated by the
liquidator. The Company expects the closures to be completed during the second
quarter of the 1999 fiscal year. In connection with the restructuring, the
Company also entered into an asset transfer agreement with The Wet Seal, Inc., a
Delaware corporation, by which the Company agreed to sell its leasehold rights
and interests in up to 24 of the remaining Episode stores to The Wet Seal, Inc.
The initial closing of the asset transfer occurred in early December, 1998, and
will continue through the month. In early December, the Company also assigned
its interest in its Madison Avenue store to Toppy International Limited
("Toppy"), and concurrently terminated its distribution agreements and Trademark
License Agreement related to Episode. Those stores not closed or assigned to The
Wet Seal, Inc. will cease operations by the end of the second quarter of fiscal
1999.
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.
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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. 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.
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 to the stores,
"quick-response" design, "quick-turn" domestic manufacturing and cost efficient
international production, the Company is able to provide its customers with the
merchandise that they want when they want it. 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 historical
ability to generate high sales per square foot, the fact that the Company's
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 and high end
segments of the market. Mall operators require an appropriate mix of stores for
the mall's consumer and market position. For regional malls that require one
maternity store, the Company provides several different concepts within the
moderate and high end segments of the market. In the case of multi-mall
operators, the Company has the flexibility to supply packages of stores in
multiple malls utilizing all of its concepts.
As of September 30, 1998, the Company's operations included 123 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, and Macy's and are generally staffed with
Company employees. The Company plans to terminate its lease departments in
Famous Barr stores during fiscal year 1999. The inventory of the leased
departments is merchandised and owned by the Company. Approximately 64% of the
leased departments utilize
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EDI to capture sales information, and 100% of the leased departments use Company
registers to communicate with its employees. The Company's leased department
arrangements generally have an initial term of one year.
Production - The Company's strategy is to use a combination of domestic
and international production. International sources are used for items such as
those in the moderate business where lower costs are necessary for competitive
reasons, and the fashion marketability of the item is not adversely affected by
the longer lead times which are inherent when a product is acquired from an
international vendor. The Company also uses domestic production which helps
ensure (1) in-season manufacturing capability for fast selling moderate price
product to reduce stock-outs; (2) preseason production of time-sensitive fashion
apparel; and (3) in-season production of fashion items identified during the
season. This domestic manufacturing capability allows the Company to react in
real time to changing market trends providing the Company with a competitive
advantage over other apparel retailers who source the majority of their product
overseas.
Key Items - During 1998 the Company pushed heavily into the moderate
key item market with the introduction of the $16.99 maternity jean. The
Company's strategy is to expand on the moderate item market by offering seasonal
items at everyday low prices. Typical seasonal offerings are turtlenecks,
t-shirts, leggings, and additional items identified in the market that fit the
key-item profile. The Company sources this product using a combination of
international and domestic production.
Expansion Strategy
Expansion of Apparel Business. Since the time of its initial public
offering in March 1993, the Company has increased its maternity store base by
approximately 770% (from 67 stores to 583 stores) as of September 30, 1998.
These increases include stores acquired as a result of the Company's January
1994 acquisition of Page Boy (22 stores acquired) ("Page Boy Acquisition"), its
April 1995 acquisition of A Pea in the Pod (66 stores acquired) ("Pea
Acquisition"), and its August 1995 acquisition of Motherhood (217 stores
acquired) ("Motherhood Acquisition").
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, closing certain stores, and converting others. Upon completion
of the restructuring, and other routine openings and closings, the Company
operates 115 high end stores under the Mimi Maternity and Pea concepts. This
restructuring indicates the Company's commitment to continually refine its
upscale offerings to meet customer needs.
The Company opened 80 locations in fiscal 1998, consisting of 34 leased
departments, 37 Motherhood and Maternity Works stores and 9 Episode and Episode
outlet stores, compared with 152 locations in fiscal 1997, consisting of 45
Motherhood and Maternity Works stores, 91 leased
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departments and 16 Episode and Episode outlet stores. The Company plans to add
approximately 50 maternity stores, principally Motherhood stores, in fiscal
1999.
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.
The Company is also undertaking several other maternity sales
initiatives. In fiscal 1999, the Company will enter the realm of internet
commerce. It plans to offer selected store merchandise and an expanded selection
of nursing products through its internet store and has ensured convenient, safe
shopping for its customers through a secure website. The Company also will
expand its product offering during fiscal year 1999 to include Plus size
maternity apparel and more clothing and accessories suitable for nursing
mothers. Nursing products will be initially offered through a new mail brochure
and some products will also be available in the Company's stores. The addition
of several non-mall store locations can be expected during fiscal 1999.
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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 The following table sets forth certain
information regarding the Company's store composition as of September 30, 1998,
including each store concept's target location, product description and selected
price points:
Summary of Store Concepts
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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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A Pea in the Pod High end regional Bridge, high $200-$400 2,900 Bergdorf Goodman, Neiman
malls & affluent fashion $120-$150 Marcus, Saks Fifth
residential Avenue, Gucci, Ralph
districts Lauren
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Mimi Maternity High end regional Fashion-forward, $128-$248 1,600 Neiman Marcus,
malls Contemporary $58-$108 Bloomingdales,
Nordstrom's, Saks Fifth
Avenue, Barney's, Joan &
David, Bebe, Ann Taylor,
Banana Republic
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Motherhood Moderate regional Value-oriented, $29-$98 1,200 Macy's, Sears, J.C.
malls and mostly casual $22-$38 Penney, Mervyn's, Casual
department stores basics; key Corner, Merry-Go-Round,
items jeans $16.99 Lerners, Limited,
t-shirts $11.90 Express, Eddie Bauer,
leggings $12.90 Mothertime, Dan Howard,
Target, K Mart, Kohl's
and Wal-Mart
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Maternity Works Factory direct Fashion at $78-$158 1,700 Neiman Marcus' Last
outlet malls and marked-down $48-$78 Call, Nordstrom Off the
centers prices Rack, Saks Fifth Avenue
Clearinghouse, and
outlets for Ann Taylor,
Polo, Donna Karan, Liz
Claiborne, J. Crew and
Brooks Brothers
==================================================================================================================
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, 1998, the Company had two or more maternity stores in 30 major
regional malls.
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Store Operations
The Company's centralized store 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. The visual
merchant travels among the Company's stores to enhance merchandise presentation.
Merchandising, Design and Store Inventory Planning
Merchandising. Guided by Real Time Retailing, the Company's
merchandising department combines input from Company 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 and utilizes Trend Track's open-to-buy system to plan its
domestic and international production to control inventory quantity and mix.
These fashions are generally marketed under the Company's A Pea in the Pod(R),
Mimi Maternity(R), Steena(R), and Motherhood(R) labels.
Design. The Design department produces samples and patterns for the
Company's manufactured products under the guidance of the Merchandising
department. 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 establishes target inventories
for 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. Integral to the Company's inventory management program are its
proprietary methods guided by Real Time Retailing and managed by its TrendTrack
information system.
Production and Distribution
The Company is responsible for the design and production of
approximately 75% of its merchandise including merchandise produced abroad using
the Company's designs and merchandise assembled abroad using the "807
operations" described below. 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. The Company's subcontracts its
sewing to shops in the Philadelphia metropolitan and surrounding area and works
with more than 40 subcontractors. No individual subcontractor represents a
material portion of the Company's sewing. In addition, some production is
supplied by independent foreign subcontractors, principally in Mexico and the
Far East, and the Company continues to seek additional subcontractors
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throughout the world for its sourcing needs. The Company sourcing also includes
"807 operations" in the Dominican Republic, Costa Rica, Guatemala and Honduras.
"807 operations" refers to articles assembled abroad with components produced in
the United States. The Company's 807 operations and production sourced abroad
are generally 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'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.
Finished garments from subcontractors and other manufacturers are
received at the Company's central warehouse in Philadelphia, Pennsylvania,
inspected and stored for picking. Shipments to stores 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.
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 decreased 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 or
economic 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.
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, manufacturing and financial 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. This system provides a perpetual raw material inventory, actual job
costing, scheduling and bill of materials capabilities.
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Advertising
The Company's advertising and promotion efforts focus on yellow pages
and national and local print advertising. Pea and Mimi Maternity are advertised
in magazines such as "Vogue" and "Shape Fit Pregnancy." During 1999, the Company
will increase its advertising for Motherhood which is advertised in magazines
such as "Parade", "Parent's Expecting", "Baby Talk" and "Parenting." In
addition, the Company produces maternity brochures 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. In fiscal 1999, nursing products will be initially offered
through a new mail order brochure. The Company also commenced "banner"
advertising on the Internet, and will continue to evaluate opportunities
associated therewith.
Competition
All aspects of the retail industry, including attracting customers,
securing merchandise and locating appropriate retail sites, are highly
competitive. 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. The Company faces competition in the moderate maternity market from
retailers such as Target, Kohl's, J.C. Penney, K Mart, Wal-Mart, Mervyn's, Sears
and others. Many of these competitors are larger and have significantly greater
financial resources than the Company.
Employees
At September 30, 1998, the Company had approximately 1,887 full-time
and approximately 1,425 part-time employees. None of the Company's employees are
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............ 55 Chairman of the Board and Chief Executive Officer
Rebecca C. Matthias........ 45 President, Chief Operating Officer and Director
Thomas Frank............... 42 Chief Financial Officer and Vice President - Finance
Donald W. Ochs............. 57 Senior Vice President - Operations
Lynne M. Wieder............ 38 Senior Vice President - Sales
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.
Lynne M. Wieder has been Senior Vice President - Sales since September
1995. Since joining the Company in 1991, she has also served as Director of
Stores and Vice President-Stores.
-11-
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), A Pea in the Pod(R), Maternity Redefined(R) Motherhood(R), Essentiel
Body Cream(R), Daniel & Rebecca(R) and Lauren Taylor(R). Additionally, the
Company owns the service marks Mimi Maternity(R), Real Time Retailing(R) and the
slogan What's Showing is Your Style(R). The Company owns a patent for an
adjustable waistband used in skirts, which allows the garment to be loosened
during the course of pregnancy and 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 required 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. With the cessation of the Company's Episode stores, royalties are
no longer accruing and have been settled in full. The Company is terminating
this Trademark License Agreement in connection with the termination of its
Episode division and will pay off the balance of the licensee fee. The Company
will retain, however, the right to use certain license trademarks of Episode in
conjunction with its efforts to liquidate Episode inventory.
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.
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
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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
------------------ ----------------
1999 47
2000 37
2001 41
2002 49
2003 and later 286
As of September 30, 1998, the Company's operations included 123 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, and Macy's and are generally staffed with
Company employees. The inventory of the leased departments is merchandised and
owned by the Company. Approximately 64% 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.
Item 3. Legal Proceedings
In connection with the Pea acquisition, Mothers Work (R.E.), Inc.
assumed Pea's outstanding litigation and potential claims. On February 9, 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 involved 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 believed it had very strong defenses against the
claim, it was concluded that it would undoubtedly have cost the Company more to
prevail than to settle the claim on the terms proposed. Pursuant to the
agreement, the Company, along with its Directors' and Officers Liability
Insurance Carrier ("Insurance Carrier"), agreed to pay $2,150,000. As part of
the agreement, the Company and the Insurance Carrier, on behalf of some of the
defendants, agreed to make an initial payment in October 1997 of $750,000 and
$550,000 respectively, to an escrow agent for the settlement fund. The final
$850,000 was paid by the Company during fiscal 1998.
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
-13-
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.
-14-
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 1997 High Low
----------- ---- ---
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
Fiscal 1998
-----------
First Quarter $14 3/4 $ 7
Second Quarter 10 7 1/4
Third Quarter 10 1/4 6
Fourth Quarter 11 7
As of December 11, 1998, there were 80 holders of record and 800
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.
-15-
Item 6. Selected Financial Data
The following selected consolidated financial data as of September 30,
1994, 1995, 1996, 1997 and 1998 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."
Year Ended September 30
--------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(In thousands, except per share and operating data)
INCOME STATEMENT DATA:
Net sales $58,979 $106,005 $199,180 $246,934 $298,991
Cost of goods sold 24,945 45,527 88,417 113,886 158,047
--------- --------- --------- --------- ---------
Gross profit 34,034 60,478 110,763 133,048 140,944
Selling, general and administrative
expenses 30,597 53,835 95,395 124,495 139,322
Restructuring and nonrecurring charges -- 5,427 -- 5,617 10,635
--------- --------- --------- --------- ---------
Operating income (loss) 3,437 1,216 15,368 2,936 (9,013)
Interest expense, net 347 4,484 12,636 13,252 15,181
--------- --------- --------- --------- ---------
Income (loss) before income
taxes (benefit) and
extraordinary item 3,090 (3,268) 2,732 (10,316) (24,194)
Income taxes (benefit) 1,244 (847) 1,828 (2,677) (7,477)
--------- --------- --------- --------- ---------
Income (loss) before
extraordinary item 1,846 (2,421) 904 (7,639) (16,717)
Extraordinary item, net
of income tax benefit -- (4,215) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) 1,846 (6,636) 904 (7,639) (16,717)
Preferred dividends -- 163 978 1,088 1,168
--------- --------- --------- --------- ---------
Net income (loss) applicable
to common stockholders $1,846 $(6,799) $(74) $(8,727) $(17,885)
========= ========= ========= ========= =========
Net income (loss) per common share:(1)
Before extraordinary item $.58 $(.83) $(.02) $(2.45) $(5.00)
Extraordinary item -- (1.35) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) per common share(1) $.58 $(2.18) $(.02) $(2.45) $(5.00)
========= ========= ========= ========= =========
Weighted average common shares
outstanding(1) 3,186,885 3,120,535 3,269,290 3,562,980 3,577,143
========= ========= ========= ========= =========
-16-
Year Ended September 30
--------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
OPERATING DATA:
Same-store sales increase (decrease)(2) 2.8% (0.7%) 8.0% 4.3% 13.4%
Average net sales per gross
square foot(3) $ 379 $ 360 $ 333 $ 338 $ 354
Average net sales per store(3) $439,133 $442,113 $452,446 $508,001 $464,080
At end of period:
Number of stores(4) 168 451 468 587 583
Gross square footage 218,842 643,175 719,930 819,900 737,689
September 30
--------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(In thousands)
BALANCE SHEET DATA:
Working capital $ 8,487 $ 31,611 $ 37,435 $ 32,083 $ 23,614
Total assets 40,827 148,562 164,613 171,718 172,469
Total long-term and short-term debt 10,470 95,373 103,998 108,112 119,982
Stockholders' equity 19,810 25,537 35,107 26,380 8,750
- ----------
(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 locations in operation during the entire fiscal year.
(4) September 30, 1998 excludes 30 Episode stores, which, while owned by the
Company, were being operated by a liquidator.
-17-
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
-------------------------------------------------------------
1996 1997 1998
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 44.4 46.1 52.9
----- ----- -----
Gross profit 55.6 53.9 47.1
Selling, general and
administrative expenses 47.9 50.4 46.6
Restructuring and
nonrecurring charges -- 2.3 3.5
----- ----- -----
Operating income(loss) 7.7 1.2 (3.0)
Interest expense, net 6.3 5.4 5.1
----- ----- -----
Income (loss) before income
taxes (benefit) 1.4 (4.2) (8.1)
Income taxes (benefit) 0.9 (1.1) (2.5)
----- ----- -----
Net income (loss) 0.5% (3.1%) (5.6%)
===== ===== =====
-18-
The following table sets forth certain information representing growth
in the number of stores and leased maternity departments for the periods
indicated:
Year Ended September 30
-----------------------------------------------------
1996 1997 1998
---- ---- ----
STORES:
Beginning of period 451 468 587
Opened 44 152 80
Acquired 21 --- --
Closed (48) (33) (54)
--- --- ---
End of period 468 587 613
=== === ===
Included in the 613 stores are 30 Episode stores, which, while owned by the
Company at September 30, 1998, were being operated by a liquidator.
In 1998, the Company terminated its Episode operations in two phases.
First, in May 1998, the Company closed or converted to maternity stores 21
of its Episode stores, primarily its outlets. Second, the Company ceased
operating its remaining Episode stores in September. It contracted with a
liquidator to dispose of Episode inventory and is selling or making provision to
close the remaining stores on a schedule expected to be completed in the second
quarter of fiscal 1999. The Company's results of operations for fiscal 1998
include Episode's operations through the date that the store operations were
turned over to a liquidator, and include certain inventory writedowns and
restructuring charges taken in conjunction with the cessation of Episode's
operations.
Included in the Statements of Operations for fiscal 1997 and fiscal
1998 are the following amounts for the Episode division:
Year Ended September 30
-----------------------------------
1997 1998
---- ----
Revenues $33,665,000 $45,684,000
Cost of goods sold* 18,869,000 39,275,000
Gross margin 14,796,000 6,409,000
Contribution margin (loss)* 146,000 (22,451,000)
Restructuring charges -- (10,635,000)
* Cost of goods sold for 1998 includes $10,290,000 for writedowns of
Episode inventory related to the Episode closing. Contribution
margin is comprised of gross margin less cost of store operations,
royalties and certain related expenses.
-19-
Year Ended September 30, 1998 and 1997
Net Sales. Net sales in fiscal 1998 increased by $52.1 million or
21.1%, as compared to fiscal year 1997. This increase was primarily due to a
$23.6 million or 13.4% net increase in comparable sales in its core maternity
business, a $16.6 million net increase due to maternity store opening and
closing activity, and an $11.8 million increase in the closed Episode(R) America
business. Net sales from the Company's core maternity business increased 18.8%
from $213.2 million in fiscal 1997 to $253.3 million in fiscal 1998. At
September 30, 1998, the Company operated 583 maternity stores and leased
departments: 285 operating under the Motherhood store concept, 115 under the
Pea/Mimi Maternity concept, 60 under the Maternity Works outlet concept and 123
leased maternity departments. Additionally, the Company had 30 stores in the
Episode business being operated on its behalf by a liquidator. Pursuant to an
asset transfer agreement with The Wet Seal, Inc., a Delaware corporation, the
Company agreed to sell its leasehold rights and interests in most of the
remaining Episode stores to The Wet Seal, Inc. All remaining stores are
scheduled to be sold or closed by the end of the second quarter of fiscal 1999.
At September 30, 1997, the Company operated 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.
Gross Profit. Gross profit as a percentage of net sales decreased to
47.1% in fiscal 1998, as compared to 53.9% in fiscal 1997. This decrease was
caused primarily by markdowns taken on the Episode product line and a $10.3
million charge related to the closure of the Episode business. Additionally, the
continued growth of the Motherhood sales as a percentage of total sales has
contributed to the decrease in gross profit percentage because Motherhood
operates at a lower gross profit percentage than the high end (Pea/Mimi)
maternity divisions. The Motherhood stores are experiencing substantial
increases in comparable-store sales as market share is driven through lower
price points.
Selling, General & Administrative Expenses. Selling, general and
administrative expenses increased by $14.8 million or 11.9% in fiscal 1998 as
compared to fiscal 1997; however, as a percentage of net sales decreased from
50.4% to 46.6%. The decrease in selling, general and administrative expenses as
a percentage of sales is a function of large increases in comparable store sales
combined with an effort to better control costs. 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 maternity store locations. The dollar increase in
fiscal 1998, as compared to fiscal 1997, 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, benefits and rents at the store level
resulted from the increased number of stores opened and the related staffing
costs.
-20-
Closing and Restructuring Costs. In May 1998, the Company reported that
the Board of Directors had instructed management to restructure the Episode(R)
non-maternity bridge women's apparel business to eliminate losses from that
business. The initial step of the restructuring resulted in closure or
conversion of 21 stores, principally Episode outlets. Additionally, the Company
retained an advisor to assist in establishing the extent of restructuring
necessary. Subsequently, in September, the Company's management announced that
the remaining Episode stores would be sold or closed. Costs associated with the
closing of Episode include payoff of royalties, severance, store closings,
lawyers fees, inventory and other costs incident to the closing. The aggregate
charge for closing the Episode business was $20.9 million of which $10.3 million
was included in cost of goods sold.
Operating Loss. Operating loss for fiscal 1998 was $9.0 million as
compared to operating income in fiscal 1997 of $2.9 million. Operations were
negative due to losses from the Company's Episode division and the restructuring
charges of $20.9 million in fiscal 1998. Fiscal 1997 operations were negatively
impacted by $9.6 million of restructuring charges related to the maternity
business. Exclusive of the restructuring and other unusual charges, operating
income decreased 4.8% from $12.5 million in fiscal 1997 to $11.9 million in
fiscal 1998. Operating income was positive in the core maternity business for
fiscal years 1998 and 1997.
Interest Expense, Net. Net interest expense increased by $1.9 million
in fiscal year 1998 compared to fiscal year 1997, and as a percentage of sales,
decreased from 5.4% to 5.1%. The dollar increase was primarily due to increased
short-term borrowings under the line of credit agreement.
Income Taxes. The effective income tax rate was a benefit of 30.1% in
fiscal 1998, as compared to a benefit of 25.9% in fiscal 1997. The change in the
effective income tax rate was primarily due to the relationship of
non-deductible goodwill amortization to 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
1998 and 1997.
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
-21-
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 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.
-22-
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.
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.
Liquidity and Capital Resources
The Company's cash needs have been primarily for debt service,
furniture, 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
1998, 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, 1998 the Company had
available cash and cash equivalents of $3.6 million, compared to $1.7 million at
September 30, 1997.
Net cash provided by operating activities was $0.5 million in fiscal
1998 compared with $5.2 million in fiscal 1997. The $0.5 million net cash
provided by operating activities in fiscal 1998 includes cash used by the net
loss, offset by adjustments for non-cash items of $24.3 million, less cash used
for working capital of $7.1 million. Non-cash items consisted primarily of $12.0
million in depreciation and amortization, $18.2 million of non-cash charges
related to closing the Episode business and $0.9 million provision for deferred
rent offset by $7.5 million of deferred tax benefit
-23-
which will offset future taxable income, but did not generate cash in fiscal
1998. Cash used for working capital in fiscal 1998 consisted of $4.2 million of
Episode assets held for sale, $7.5 million of prepaid expenses, inventory and
accounts receivable offset by a $2.6 million increase in accounts payable,
accrued expenses and other liabilities and a $2.6 million increase in accrued
expenses related to the Episode closure and royalties. In fiscal 1998, inventory
levels in the moderate division were increased to facilitate the increasing
sales volume.
Net cash used in investing activities decreased from $12.1 million in
fiscal 1997 to $9.6 million in fiscal 1998. The cash used in investing
activities for fiscal 1998 included $6.9 million used for capital expenditures
for new store facilities, primarily Motherhood and Episode, and improvements to
existing stores, $2.5 million for other corporate capital expenditures and $0.2
million for intangible and other assets. This compares with investing activities
for fiscal 1997 of $11.7 million used for capital expenditures for new store
facilities, and $0.5 million for intangible and other assets.
Net cash provided by financing activities increased $3.7 million, from
$7.4 million provided by financing activities in fiscal 1997 to $11.1 million in
fiscal 1997. The $11.1 million provided by financing activities in fiscal 1998
resulted primarily from $12 million in borrowings under the line of credit and
cash overdraft activity, offset by $0.9 million in repayment of long-term debt
and debt issuance costs. This compares with $7.4 million provided by financing
activities in fiscal 1997 primarily from $7.9 million in borrowings under the
line of credit and cash overdraft activity, partially offset by repayment of
$0.5 million of long-term debt and debt issuance costs.
In April 1998, the Company replaced its existing $30 million Working
Capital Facility with a new Working Capital Facility that expires in April 2001.
The new Working Capital Facility increased the Company's borrowing capacity to
$44 million, and reduced interest rates. In addition to the $44 million
available for borrowing and letters of credit, the Company also has an
additional $4 million letter of credit to collateralize an Industrial Revenue
Bond. Further, there are no financial covenant requirements unless Aggregate
Adjusted Availability, as defined in the Working Capital Facility agreement,
falls below $10 million. In the event that the Aggregate Adjusted Availability
falls below $10 million, then the Company must achieve a Minimum Cash Flow, as
defined in the agreement, of not less than zero. Consistent with the previous
working capital facility, the new Working Capital Facility is secured by
substantially all of the Company's assets. On November 20, 1998 the Company had
$20.7 million in borrowings and $7.9 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.
During 1997, the Company restructured its core maternity business by
combining the Mimi Maternity and Maternite overlapping product styles and
closing 26 stores. In fiscal 1998 this consolidation and the growth in the
Motherhood business provided net income which partially offset the net loss
produced by the Episode closing and operating losses. In its maternity
operations, the Company intends to focus primarily on growing the moderate
priced Motherhood business, subject
-24-
to capital and marketplace availability. This business represents the Company's
biggest opportunity for growth. 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.
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 1999. Based on the Company's fiscal 1999 expansion plan, the
Company expects capital expenditures to be less than 60% of the fiscal 1998
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. The Company believes that the
reserves established are sufficient; however, as certain lease terminations
remain to be negotiated, no assurance can be given that the Company will not
incur additional charges related to such termination.
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.
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 1999 and beyond to differ materially from those expressed or
implied in any such forward-looking statements: unanticipated costs associated
with the Episode closure, 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 and consequent changes in store
opening plans, continued availability of capital and financing, ability to
develop merchandise and ability to hire and train associates,
-25-
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 7A. Quantitative and Qualitative Disclosures About Market Risk
The analysis below presents the sensitivity of the market value of the
Company's financial instruments to selected changes in market rates. The range
of changes chosen reflects the Company's view of changes which are reasonably
possible over a one-year period. The Company's financial instruments consists
principally of its debt portfolio. The market value of the debt portfolio is
referred to below as the "Debt Value". The Company believes that market risk
exposure on other financial instruments is immaterial.
At September 30, 1998, the principal components of the Company's debt
portfolio are Senior Unsecured Exchange Notes (the "Notes") and a Line of Credit
(the "Line"), both denominated in US dollars. The Notes bear interest at fixed
rate of 125/8 %, and the Line of Credit bears interest at a variable rate, which
at September 30, 1998 was 8.5%. While a change in interest rates would not
affect the interest incurred or cash flows related to the fixed portion of the
debt portfolio, the Debt Value would be affected. A change in interest rates on
the variable portion of the debt portfolio impacts the interest incurred and
cash flows, but does not impact the net financial instrument position.
The sensitivity analysis as it relates to the fixed portion of the
Company's debt portfolio assumes an instantaneous 100 basis point move in
interest rates from their levels at September 30, 1998 with all other variables
held constant. A 100 basis point increase in market interest rates would result
in a decrease in the Debt Value of $0.9 at September 30, 1998. A 100 basis point
decrease in market interest rates would result in a $0.9 increase in the Debt
Value at September 30, 1998.
Based on the variable rate debt included in the Company's debt
portfolio at September 30, 1998, a 100 basis point increase in interest rates
would result in an additional $0.2 million of interest incurred per year. A 100
basis point decrease would lower interest incurred by $0.2 million.
Item 8. Financial Statements and Supplementary Data
The Company's consolidated financial statements appear at pages F-1
through F-20, as set forth in Item 14.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
-26-
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 22, 1999, 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.
-27-
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 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).
-28-
Exhibit No. Description
- ---------------- -----------------------------------------------------
*4.4 Amended and Restated Rights Agreement, dated as of
March 17, 1997, between the Company and StockTrans,
Inc. (incorporated by reference to Exhibit 4.2 to the
Company's current report on Form 8-K dated March 17,
1997).
*4.5 Amendment No. 1, dated as of June 4, 1997, to the
Amended and Restated Rights Agreement, dated as of
March 17, 1997, between the Company and StockTrans,
Inc. (Exhibit 4.3 to the Company's Quarterly Report
on Form 10-Q for the Quarter ended June 30, 1997).
*4.6 Registration Rights Agreement, dated as of June 9,
1998, by and among the Company and certain of the
Selling Stockholders (Exhibit 4.1 of the Company's
Registration Statement on Form S-3, Registration No.
333-59309, dated July 17, 1998).
*4.7 1987 Stock Option Plan (as amended and restated)
(Exhibit 4.1 of the Company's Registration Statement
on Form S-8, Registration No. 333-59529, dated July
21, 1998).
*10.1 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).
*10.2 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).
*10.3 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,
-29-
Exhibit No. Description
- ---------------- -----------------------------------------------------
Meridian Venture Partners and Apex Investment Fund,
L.P. (Exhibit 10.31 to the 1995 Registration
Statement).
*10.4 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")).
*10.5 Non-Competition and Confidentiality Agreement dated
January 28, 1993 between the Company and Lynne Wieder
(Exhibit 10.39 to the 1993 Registration Statement).
*10.6 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")).
*10.7 Employment Agreement dated as of July 14, 1994
between the Company and Rebecca C. Matthias (Exhibit
10.26 to the 1994 Form 10-K).
*10.8 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).
*10.9 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).
*10.10 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")).
-30-
Exhibit No. Description
- ---------------- -----------------------------------------------------
*10.11 Amendment to Credit Agreement dated September 1, 1995
between the Company, its subsidiaries and Meridian
Bank (Exhibit 10.28 to the 1995 Registration
Statement).
*10.12 Indenture of Trust dated September 1, 1995 between
PAID and Society National Bank (Exhibit 10.29 to the
1995 Registration Statement).
*10.13 Variable/Fixed Rate Federally Taxable Economic
Development Bond (Mothers Work, Inc.), Series of
1995, in the aggregate principal amount of $4,000,000
(Exhibit 10.30 to the 1995 Registration Statement).
*10.14 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).
*10.15 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).
*10.16 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).
*10.17 Trademark License Agreement dated May 31, 1996
between the Company and Episode USA, Inc. (Exhibit
10.1 to the June 1996 8-K).
*10.18 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).
-31-
Exhibit No. Description
- ---------------- -----------------------------------------------------
*10.19 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).
*10.20 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).
*10.21 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).
*10.22 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).
*10.23 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).
*10.24 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).
*10.25 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).
*10.26 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).
-32-
Exhibit No. Description
- ---------------- -----------------------------------------------------
*10.27 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).
*10.28 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).
*10.29 Eighth Amendment to Credit Agreement, dated September
30, 1997 between the Company, its subsidiaries and
CoreStates Bank (Exhibit 10.36 to the Company's
Annual Report on Form 10-K for the fiscal year ended
September 30, 1997.)
*10.30 Ninth Amendment to Credit Agreement dated January 30,
1998 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 30, 1997).
*10.31 Loan and Security Agreement dated as of April 24,
1998 by and among, Mothers Work, Inc., Cave Springs,
Inc. and Fleet Capital Corporation (Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the
Quarter ended March 31, 1998).
10.32 Asset Transfer Agreement dated as of August 31, 1998
by and between the Company, T3 Acquisition, Inc. and
The Wet Seal, Inc.
21 Subsidiary of the Company.
23 Consent of Arthur Andersen LLP.
27 Financial Data Schedule for the fiscal year ended
September 30, 1998.
-----------------------------
* Incorporated by reference.
-33-
(b) Reports filed on Form 8-K during the last quarter of fiscal 1998:
The Company filed three reports on Form 8-K during the last quarter of
fiscal 1998. On July 15, 1998, the Company filed a report on Form 8-K
regarding its increase in net sales for the month of June, 1998,
certain additional changes in conjunction with the previously announced
restructuring of Episode, and results of operations for the third
quarter of fiscal 1998. On September 16, 1998, the Company filed a
report on Form 8-K regarding its announcement of the August 28, 1998
appointment of William A. Schwartz, Jr. to its Board of Directors. On
September 23, 1998, the Company filed a report on Form 8-K regarding
its September 21, 1998 announcement of its plans to close the remaining
Episode division stores.
-34-
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,
1998.
By: /s/ Dan W. Matthias
---------------------------------
Dan W. Matthias, Chairman of the
Board and Chief Executive Officer
By: /s/ Thomas Frank
---------------------------------
Thomas Frank, Chief Financial
Officer, Vice President-Finance
and the principal financial
officer
-35-
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons on December 18th, 1998, 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
Thomas Frank principal 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
/s/ William A. Schwartz, Jr. Director
- ------------------------------
William A. Schwartz, Jr.
-36-
MOTHERS WORK, INC. AND SUBSIDIARY
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
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 subsidiary as of September 30, 1997 and
1998, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended September
30, 1998. 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
subsidiary as of September 30, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1998, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Philadelphia, Pa.
November 9, 1998
F-2
MOTHERS WORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30
-----------------------------
1997 1998
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,665,760 $ 3,623,003
Receivables-
Trade 2,781,803 3,422,848
Other 164,334 131,940
Inventories 63,812,590 61,678,014
Deferred income taxes 4,050,980 8,846,921
Prepaid expenses and other 2,695,218 5,992,273
------------ ------------
Total current assets 75,170,685 83,694,999
PROPERTY, PLANT AND EQUIPMENT, net 45,373,439 37,334,250
OTHER ASSETS:
Deferred income taxes 7,235,600 9,918,455
Goodwill, net of accumulated amortization of $5,641,275 and
$7,868,499 38,752,184 36,524,960
Deferred financing costs, net of accumulated amortization of
$913,748 and $1,309,971 3,339,759 3,118,042
Other intangible assets, net of accumulated amortization of
$1,452,446 and $1,721,223 1,351,221 1,154,801
Other assets 494,632 723,558
------------ ------------
Total other assets 51,173,396 51,439,816
------------ ------------
$171,717,520 $172,469,065
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 11,088,000 $ 23,095,934
Current portion of long-term debt 648,231 464,408
Accounts payable 17,264,704 14,108,610
Accrued expenses 14,087,057 22,411,762
------------ ------------
Total current liabilities 43,087,992 60,080,714
LONG-TERM DEBT 96,375,620 96,421,707
DEFERRED RENT 3,645,651 3,819,998
ACCRUED DIVIDENDS ON PREFERRED STOCK 2,228,700 3,396,916
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, 3,564,644 and
3,597,997 shares issued and outstanding 35,646 35,980
Additional paid-in capital 27,740,840 27,995,694
Accumulated deficit (12,896,929) (30,781,944)
------------ ------------
Total stockholders' equity 26,379,557 8,749,730
------------ ------------
$171,717,520 $172,469,065
============ ============
The accompanying notes are an integral part of these statements.
F-3
MOTHERS WORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended September 30
----------------------------------------------
1996 1997 1998
------------ ------------ ------------
NET SALES $199,179,984 $246,934,331 $298,990,616
COST OF GOODS SOLD 88,416,648 113,886,439 158,046,917
------------ ------------ ------------
Gross profit 110,763,336 133,047,892 140,943,699
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 95,394,902 124,494,747 139,322,385
RESTRUCTURING CHARGES -- 5,617,094 10,634,509
------------ ------------ ------------
Operating income (loss) 15,368,434 2,936,051 (9,013,195)
INTEREST INCOME 228,255 11,339 --
INTEREST EXPENSE (12,864,351) (13,263,418) (15,180,820)
------------ ------------ ------------
Income (loss) before income taxes
(benefit) 2,732,338 (10,316,028) (24,194,015)
INCOME TAXES (BENEFIT) 1,828,572 (2,676,945) (7,477,216)
------------ ------------ ------------
NET INCOME (LOSS) 903,766 (7,639,083) (16,716,799)
DIVIDENDS ON PREFERRED STOCK 977,500 1,088,284 1,168,216
------------ ------------ ------------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
$ (73,734) $ (8,727,367) $(17,885,015)
============ ============ ============
BASIC NET LOSS PER COMMON SHARE $ (.02) $ (2.45) $ (5.00)
============ ============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
3,269,290 3,562,980 3,577,143
============ ============ ============
The accompanying notes are an integral part of these statements.
F-4
MOTHERS WORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Series A Additional
Preferred Common Paid-in Accumulated
Stock Stock Capital Deficit Total
------------ ------------ ------------ ------------ ------------
BALANCE, SEPTEMBER 30, 1995 $ 11,500,000 $ 31,222 $ 18,101,425 $ (4,095,828) $ 25,536,819
Exercise of stock options -- 197 134,350 -- 134,547
Tax benefit from exercise of stock options -- -- 227,396 -- 117,485
Sales of common stock, net of expenses -- 2,000 4,394,000 -- 4,396,000
Issuance of common stock in connection with
acquisition -- 2,174 4,993,223 -- 4,995,397
Preferred stock dividends -- -- -- (977,500) (977,500)
Net income -- -- -- 903,766 903,766
------------ ------------ ------------ ------------ ------------
BALANCE SEPTEMBER 30, 1996 11,500,000 35,593 27,740,840 (4,169,562) 35,106,514
Exercise of stock options -- -- 410 -- 410
Exercise of common stock warrants -- 53 (53) -- --
Preferred stock dividends -- -- -- (1,088,284) (1,088,284)
Net loss -- -- -- (7,639,083) (7,639,083)
------------ ------------ ------------ ------------ ------------
BALANCE, SEPTEMBER 30, 1997 11,500,000 35,646 27,740,840 (12,896,929) 26,379,557
Exercise of stock options -- 66 27,458 -- 27,524
Stock issued to senior noteholders -- 268 227,396 -- 227,664
Preferred stock dividends -- -- -- (1,168,216) (1,168,216)
Net loss -- -- -- (16,716,799) (16,716,799)
------------ ------------ ------------ ------------ ------------
BALANCE, SEPTEMBER 30, 1998 $ 11,500,000 $ 35,980 $ 27,995,694 $(30,781,944) $ 8,749,730
============ ============ ============ ============ ============
The accompanying notes are an integral part of these statements.
F-5
MOTHERS WORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended September 30
------------------------------------------------------
1996 1997 1998
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 903,766 $ (7,639,083) $(16,716,799)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities-
Depreciation and amortization 10,161,531 12,169,900 11,991,958
Noncash portion of restructuring charge -- 3,731,102 7,877,310
Writedown of inventory related to
restructuring -- -- 10,289,855
Stock issuance charged to interest expense -- -- 227,664
Imputed interest on debt 103,284 117,147 131,418
Deferred tax liability (benefit) 1,444,151 (2,729,709) (7,478,796)
Amortization of deferred financing
costs 418,737 432,172 394,832
Provision for deferred rent 685,749 891,454 867,318
Changes in assets and liabilities, net of effects
from purchases of businesses-
Decrease (increase) in--
Receivables 2,986,011 (658,111) (608,651)
Inventories (15,879,647) (6,603,091) (8,155,179)
Prepaid expenses and other 64,014 (873,235) (3,525,981)
Increase (decrease) in--
Accounts payable and accrued expenses (4,283,509) 5,250,559 4,000,395
Accrued store closing (2,975,657) -- --
Other liabilities 977,500 1,088,284 1,168,216
------------ ------------ ------------
Net cash provided by (used in) operating activities (5,394,070) 5,177,389 463,560
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of business (2,442,865) -- --
Purchases of property, plant and equipment (13,445,841) (11,699,625) (9,350,300)
Increase in intangible and other assets (1,412,008) (435,866) (242,075)
------------ ------------ ------------
Net cash used in investing activities (17,300,714) (12,135,491) (9,592,375)
------------ ------------ ------------
--(continued)--
F-6
MOTHERS WORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
--(continued)--
Year Ended September 30
------------------------------------------------------
1996 1997 1998
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in line of credit and cash overdrafts, net $ 8,638,586 $ 7,928,940 $ 12,007,934
Proceeds from issuance of long-term debt 2,340,000 -- --
Repayments of long-term debt (376,464) (532,929) (776,286)
Debt issuance costs (305,930) (34,994) (173,114)
Net proceeds from sales of common stock 4,396,000 -- --
Proceeds from exercise of options and warrants 134,547 410 27,524
----------- ------------ ------------
Net cash provided by financing activities 14,826,739 7,361,427 11,086,058
----------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(7,868,045) 403,325 1,957,243
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
9,130,480 1,262,435 1,665,760
----------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,262,435 $ 1,665,760 $ 3,623,003
=========== ============ ============
The accompanying notes are an integral part of these statements.
F-7
MOTHERS WORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Nature of Business
Mothers Work, Inc. was incorporated in Delaware in 1980 and is a specialty
retailer and manufacturer of maternity clothing. The Company operates in 613
retail store locations, including 123 leased departments throughout the United
States.
Principles of Consolidation
The consolidated financial statements include the accounts of Mothers Work, Inc.
and its wholly owned subsidiary, Cave Springs, Inc (collectively, the Company),
as of September 30, 1998. 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, 1998, cash and cash equivalents include
cash on hand, cash in the bank and certificates of deposit. Cash overdrafts of
$5,479,526 and $3,716,615 are included in accounts payable at September 30, 1997
and 1998, respectively.
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 charged to expense 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 $4,448,821, $5,722,410 and $4,652,749 in fiscal 1996, 1997 and
1998, respectively.
F-8
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Additions or improvements are
capitalized, while repairs and maintenance are charged to expense as incurred.
Depreciation and amortization are 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.
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 $2,614,796,
$2,604,642 and $2,580,880 in fiscal 1996, 1997 and 1998, respectively.
Valuation of 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-lived 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 Debt Issuance Costs
Deferred debt issuance costs are amortized over the terms of the related debt
using the effective interest method. Amortization of deferred debt issuance
costs was $418,737, $432,172 and $478,998 in fiscal 1996, 1997 and 1998,
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-9
Basic Net Loss Per Common Share
The Company has presented net loss per common share for fiscal 1996, 1997 and
1998 pursuant to Statement of Financial Accounting Standards (SFAS) No. 128
"Earnings per Share".
Basic net loss per share was computed by dividing net loss applicable to common
stockholders by the weighted average number of shares of Common Stock
outstanding for each period presented. Diluted net loss per share has not been
presented, since the result is anti-dilutive due to the Company's losses.
Statement of Cash Flows
In fiscal 1996, 1997 and 1998, the Company paid $12,137,535, $12,619,836 and
$14,481,028 in interest, respectively. Income taxes refunded in fiscal 1996 were
$2,524,525. Capital lease obligations of $508,177 were incurred on equipment
leases entered into in fiscal 1998.
The following table lists noncash assets that were acquired and liabilities that
were assumed as a result of the Episode acquisition in fiscal 1996 (See Note 2)
and the finalization of estimates related to the fiscal 1995 acquisition of A
Pea in the Pod, Inc. (Pea) and Motherhood Maternity Shops, Inc. (Motherhood) in
1996 (See Note 2):
Year Ended
September 30, 1996
------------------
Noncash Assets:
Inventories $ 2,908,666
Property and equipment 4,798,207
Goodwill 2,308,912
Deferred income taxes 1,006,088
Other assets 98,940
-----------
Net noncash assets acquired 11,120,813
Less- Assumed Liabilities:
Accounts payable and accrued expenses (3,682,551)
Common stock issued to seller (4,995,397)
-----------
Net cash used in investing activities $ 2,442,865
===========
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
F-10
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 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 net 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). During 1998, the Company decided to close its Episode division (See
Note 14) and accrued all remaining costs under the licensing and distribution
agreements.
During fiscal 1996 the allocation of the purchase price to the net assets
acquired in the acquisitions of Pea and Motherhood was finalized. As a result,
approximately $2,309,000 of additional goodwill was recorded.
F-11
3. INVENTORIES:
September 30
-----------------------------
1997 1998
------------- ------------
Finished goods $ 49,937,709 $ 47,220,460
Work-in-process 4,123,387 5,329,252
Raw materials 9,751,494 9,128,302
------------- ------------
$ 63,812,590 $ 61,678,014
============= ============
4. PROPERTY, PLANT AND EQUIPMENT:
September 30
-----------------------------
1997 1998
------------- ------------
Land $ 1,400,000 $ 1,400,000
Building and improvements 8,966,636 9,263,810
Furniture and equipment 19,189,344 19,068,841
Leasehold improvements 38,201,842 34,248,218
------------- ------------
67,757,822 63,980,869
Accumulated depreciation and amortization (22,384,383) (26,646,619)
------------ ------------
$ 45,373,439 $ 37,334,250
============= ============
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
-----------------------------
1997 1998
------------- ------------
Accrued salaries, wages and employee benefits $ 4,692,365 $ 5,690,173
Accrued interest 2,157,217 2,078,157
Accrued sales tax 1,184,461 1,791,090
Accrued restructuring costs 555,065 4,761,321
Other 5,497,949 8,091,021
------------- ------------
$ 14,087,057 $ 22,411,762
============= ============
6. LINE OF CREDIT:
In April 1998, the Company replaced its previously existing $27 million working
capital facility with a new $44 million working capital facility (the Working
Capital Facility) that expires in April 2001. The new Working Capital facility
bears interest at the Base Rate, as defined, plus 25 basis points, or LIBOR plus
225 basis points. At September 30, 1998, the
F-12
interest rate was 8.5%. In addition to the $44 million available for borrowings
and letters of credit, the Company has a $4 million letter of credit that
collateralizes an Industrial Revenue Bond (see Note 7). The facility has no
financial covenants provided that the Aggregate Adjusted Availability, as
defined, does not fall below $10 million. At September 30, 1998 the Adjusted
Aggregate Availability was approximately $13,742,000 and the Company was in
compliance with all non-financial covenants. If the Aggregate Adjusted
Availability is less than $10 million, then the Company must achieve a Minimum
Cash Flow, as defined, of not less than zero. Consistent with the previous
working capital facility, the Working Capital Facility is secured by
substantially all of the Company's assets.
In fiscal 1997 and 1998, the weighted average interest rates were 9.89% and
8.75%, respectively.
7. LONG-TERM DEBT:
September 30
-----------------------------
1997 1998
------------- ------------
12-5/8% Senior Unsecured Exchange Notes, due
2005 (less unamortized discount) $ 90,336,030 $ 90,467,447
Industrial Revenue Bonds, interest is variable
(5.65% at September 30, 1998), principal due
annually through 2020 (collateralized by a
$4 million letter of credit). 3,825,000 3,730,000
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). 1,856,339 1,745,114
Interest at 2%, principal due monthly to
2011(collateralized by certain equipment at
the Company's headquarters). 273,882 256,068
Interest at 4.25%, principal due monthly to
2001 (collateralized by certain equipment at
the Company's headquarters). 209,363 152,935
Capital lease obligations 313,237 534,966
Other 210,000 --
------------ ------------
97,023,851 96,886,115
Less- Current portion (648,231) (464,408)
------------ ------------
$ 96,375,620 $ 96,421,707
============ ============
F-13
Long-term debt maturities as of September 30, 1998 are as follows:
1999 $ 464,408
2000 500,776
2001 384,745
2002 261,965
2003 275,700
2004 and thereafter 96,531,074
-----------
98,481,668
Less- Unamortized discount (1,532,553)
-----------
$96,886,115
===========
In connection with the acquisition of Motherhood on August 1, 1995, 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%. 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 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.
8. 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.
F-14
The holders of the Series A Preferred Stock are entitled to receive annual cash
dividends, which are cumulative to the extent not paid, and compound annually at
8.5%, when declared by the Company's Board of Directors, equal to 8.5% of the
stated value. 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 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, 1998, accrued dividends on the Series A Preferred
Stock were $3,396,916 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 Senior Unsecured Exchange 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).
F-15
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 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 PLANS:
The Company has two stock option plans. Under the Director Stock Option Plan,
2,000 options are granted to each director on an annual basis, and have an
exercise price equal to fair market value on the grant date, and immediately
vest. Under the 1987 Stock Option Plan, as amended and restated, officers and
certain employees may be granted options to purchase the Company's common stock
at exercise prices equal to the fair market value of the stock at the date of
grant or at other prices as determined by the Compensation Committee of the
Board of Directors. Up to a total of 1,425,000 options may be issued under the
Plans.
F-16
Options generally vest ratably over 5 years. Stock option activity for all plans
was as follows:
-----------------------------------------------------------------------------
Outstanding Weighted-Average
Options Exercise Price
-----------------------------------------------------------------------------
Balance at September 30, 1995 406,047 $11.07
Granted 222,000 13.86
Exercised (19,715) 6.82
Canceled (85,090) 14.24
-----------------------------------------------------------------------------
Balance at September 30, 1996 523,242 11.89
Granted 180,167 10.02
Exercised (40) 10.25
Canceled (33,420) 12.07
-----------------------------------------------------------------------------
Balance at September 30, 1997 669,949 11.38
Granted 183,200 8.45
Exercised (6,569) 4.81
Canceled (116,771) 10.06
-----------------------------------------------------------------------------
Balance at September 30, 1998 729,809 $10.85
-----------------------------------------------------------------------------
Options for 264,319, 348,048 and 452,613 shares were exercisable as of September
30, 1996, 1997 and 1998 respectively.
The Company has adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation," but has elected to continue to
measure compensation expense in accordance with APB Opinion No. 25, "Accounting
for Stock Issued to Employees." Accordingly, no compensation expense for stock
options has been recognized. Had compensation cost for the Company's stock-based
compensation plans been determined in accordance with SFAS No. 123, the
Company's net loss applicable to common stockholders would have been increased
to the pro forma amounts indicated below. The effect of applying SFAS No. 123 in
this pro forma disclosure is not indicative of future amounts. SFAS No. 123
does not apply to awards prior to fiscal year ended September 30, 1996.
Additional awards in future years are anticipated.
1996 1997 1998
- ---------------------------------------------------------------------------------------------------------
Net Loss Applicable to Common Stockholders:
As reported $ (73,734) $(8,727,367) $(17,885,015)
Pro forma (882,560) (9,218,623) (18,817,166)
- ---------------------------------------------------------------------------------------------------------
Basic Net Loss per Common Share:
As reported $ (0.02) $ (2.45) $ (5.00)
Pro forma (0.27) (2.59) (5.26)
- ---------------------------------------------------------------------------------------------------------
The weighted average fair value of the stock options granted during 1996, 1997
and 1998 was $9.57, $6.93 and $6.15, respectively. The fair value of each option
granted is estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:
F-17
1996 1997 1998
-------------------------------------------------------------------------------------------------
Dividend yield none none none
Expected price volatility 65.2% 65.2% 71.2%
Risk-free interest rates 6.05% 6.12% 6.11%
Expected lives 7 years 7 years 7.1 years
-------------------------------------------------------------------------------------------------
F-18
The following table summarizes information about stock options outstanding at
September 30, 1998:
Options Outstanding Options Exercisable
------------------------------------------------------- --------------------------------
Range of Number Weighted-Average Weighted Average Number Weighted Average
Exercise Prices Outstanding Remaining Life Exercise Price Exercisable Exercise Price
- --------------- ----------- -------------- -------------- ----------- --------------
$1.67 to $2.27 8,361 0.3 $1.67 8,361 $1.67
$2.28 to $4.55 9,555 3.1 $3.09 9,555 $3.09
$4.56 to $6.83 5,180 5.1 $6.45 4,380 $6.30
$6.84 to $9.10 106,650 9.1 $8.01 2,100 $7.42
$9.11 to $11.38 372,816 7.1 $10.24 253,980 $10.35
$11.39 to $13.65 190,427 6.8 $13.42 142,187 $13.39
$13.66 to $15.92 12,500 7.3 $14.50 12,200 $14.50
$15.93 to $18.20 7,500 7.3 $16.50 3,000 $16.50
$18.21 to $18.75 17,000 5.5 $18.28 16,400 $18.26
- ---------------------------------------------------------------------------------------------------------------
$1.67 to $18.75 729,809 7.1 $10.85 452,163 $11.38
- ---------------------------------------------------------------------------------------------------------------
At September 30, 1998, 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
--------------------------------------
1996 1997 1998
---------- ------------ ----------
Current provision (benefit) $ 384,421 $ -- $ --
Deferred provision (benefit) 1,444,151 (2,676,945) (7,477,216)
---------- ----------- -----------
$1,828,572 $(2,676,945) $(7,477,216)
========== =========== ===========
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,
------------------------------------
1996 1997 1998
------ ------ ------
Statutory tax rate 34.0% (34.0)% (34.0)%
State taxes, net of federal benefit 3.7 -- --
Amortization of goodwill 27.3 7.3 3.1
Other 1.9 0.8 --
----- ----- -----
66.9% (25.9)% (30.9)%
===== ===== =====
F-19
The deferred tax effects of temporary differences giving rise to the Company's
deferred income tax assets are as follows:
September 30
------------------------------
1997 1998
------------ ----------
Deferred tax assets:
Net operating loss carryforwards $ 3,400,024 $7,578,822
Depreciation of property, plant and equipment 3,660,267 6,136,967
Deferred rent 1,234,207 1,285,927
Inventory reserves 687,712 1,006,878
Employee benefit accruals 474,799 303,794
Other accruals 1,045,986 1,909,455
Alternative minimum tax credit carryforward 528,509 528,509
Other 394,591 86,095
----------- -----------
11,426,095 18,836,446
Deferred tax liabilities:
Prepaid expenses (111,075) (32,099)
Other (28,440) (38,971)
----------- -----------
$11,286,580 $18,765,376
=========== ===========
The Company has net operating loss carryforwards for tax purposes of
approximately $23,845,000 which expire in 2009 through 2013, 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 acquired net operating loss carryforwards was
recorded under the purchase method of accounting.
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 the nondeductibility of goodwill amortization and the Episode
operations, management believes it is more likely than not that the Company will
realize the net deferred tax asset at September 30, 1998. Furthermore,
management believes the existing net deductible temporary differences will
reverse during periods in which the Company generates taxable income. There can
be no assurance, however, that the Company will generate taxable earnings or any
specific level of 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.
Rent expense, including
F-20
common area maintenance, was $30,196,546, $39,022,965 and $42,738,584 in fiscal
1996, 1997 and 1998, respectively.
F-21
Future minimum lease payments, excluding those related to Episode, as of
September 30, 1998 are as follows:
Fiscal 1999 $ 24,893,680
Fiscal 2000 23,469,509
Fiscal 2001 21,628,888
Fiscal 2002 18,964,225
Fiscal 2003 15,824,882
Fiscal 2004 and thereafter 28,567,507
------------
$133,348,691
============
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.
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. Pursuant to the agreement, Mothers Work, along with its
Directors' and Officers Liability Insurance Carrier (Insurance Carrier) agreed
to pay $2,150,000. As part of the agreement, Mothers Work and the Insurance
Carrier, on behalf of some of the defendants, 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 final
$850,000 was paid by Mothers Work in January 1998.
13. SUBSIDIARY GUARANTORS:
Pursuant to the terms of the indenture relating to the 12-5/8% Senior Unsecured
Exchange Notes due 2005, Cave Springs, Inc., a direct subsidiary of Mothers
Work, Inc. has, jointly and severally, unconditionally guaranteed the
obligations of Mothers Work, Inc. with respect to the Notes. Effective April 22,
1998 the Page Boy Company, Inc. and Mothers Work (R.E.), Inc., the former
Guarantors, merged with Mothers Work, Inc. There are no restrictions on the
ability of the Guarantor to transfer funds to Mothers Work, Inc. in the form of
loans, advances or dividends, except as provided by applicable law.
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, 1997 and 1998:
F-22
September 30, September 30,
1997 1998
------------ ------------
Current assets $ 4,127,213 $ 2,865
Noncurrent assets 80,125,458 39,729,143
Current liabilities 3,064,719 --
Noncurrent liabilities 52,539,740 2,520,464
F-23
For the Year Ended
September 30,
------------------------------
1997 1998
-------------- ------------
Net sales $53,432,799 $12,997,861
Costs and expenses 39,829,468 59,410
Net income 8,978,198 8,539,372
The summarized financial information for the Guarantor and the former 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. Mothers Work, Inc pays all
expenditures on behalf of the Guarantor. 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.
14. RESTRUCTURING CHARGES:
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. Restructuring costs of
$5.6 million were recorded in fiscal 1997 and included 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. At September 30, 1997 and 1998, $0.6 million and
$0.2 million, respectively, of this restructuring charge remained in accrued
expenses. The balances were comprised principally of lease termination fees and
other miscellaneous costs.
In addition to the charges 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 closed 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 were $6,129,576 and $711,272, respectively.
F-24
In May 1998, the Company announced that, in an effort to eliminate losses from
the Episode business, approximately 21 Episode locations would be closed or
converted to maternity clothing stores. After initial attempts to eliminate
losses from that business were not successful the Company announced in
September 1998 that all remaining Episode stores would be closed or converted
into maternity clothing stores. In connection with the two announcements,
charges totaling $20,925,000 ($13,811,000 after consideration of a related tax
benefit of $7,114,000) were recorded, and are reflected in the accompanying
consolidated statement of operations as cost of goods sold ($10,290,000) and
restructuring costs ($10,635,000). The restructuring costs are comprised of $2.9
million of legal and other fees associated with the transfer of leases, $7.3
million for losses on fixed assets and leasehold improvements, $0.2 million for
severance, and the remainder for other costs). At September 30, 1998
approximately $4.6 million of the restructuring costs remains in accrued
expenses. Of the $4.6 million, approximately $2.1 million relates to losses on
purchase commitments for inventory and leasehold improvements, $2.2 million
relates to legal and other fees associated with the transfer of leases, and the
remainder is for other miscellaneous charges.
In connection with the closure of the Episode division, the Company signed a
definitive agreement to sell 24 of its 30 remaining leasehold locations to The
Wet Seal, Inc. for approximately $2.8 million. The sale, expected to close on
December 1, 1998, is subject to customary closing conditions including receipt
of required landlord consents and other third party approval. The Company will
close or sell the remaining 6 locations by March 31, 1999. At September 30,
1998, the leasehold interests held for sale to Wet Seal are included in prepaid
and other assets.
15. EMPLOYMENT AND CONSULTING AGREEMENTS:
The Company has employment agreements with its Chief Executive Officer/Chairman
of the Board (CEO), and President/Chief Operating Officer (COO). The CEO and COO
have agreements which expire on September 30, 2001. These agreements provide for
base compensation of $350,000 each for fiscal 1999, 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.
16. RELATED-PARTY ACTIVITY:
The Company paid legal fees of approximately $680,000, $470,000 and $576,000 in
fiscal 1996, 1997 and 1998, respectively, to a firm whose partner is a Director
of the Company.
17. PROFIT-SHARING PLANS:
The Company has 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 1996,
1997 or 1998.
F-25
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
1999.
F-26