Overview

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

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

In assessing the performance of our business, we consider a variety of operational and financial measures. The key measures for determining how our business is performing are net income determined in accordance with generally accepted accounting principles ("GAAP net income") and the corresponding net income (or earnings) per share (diluted), net income before stock-based compensation expense, restructuring and other charges, and loss on extinguishment of debt ("Non-GAAP adjusted net income") and the corresponding earnings per share (diluted), Adjusted EBITDA, net sales, and comparable sales (which consists of comparable store sales and Internet sales). Adjusted EBITDA represents operating income before deduction for the following non-cash charges:
(i) depreciation and amortization expense; (ii) loss on impairment of tangible and intangible assets; (iii) loss on disposal of assets; and (iv) stock-based compensation expense.

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

Fiscal 2012 Financial Results

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

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

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

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

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

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

                                                                                         % Period to Period
                                             % of Net Sales (1)                        Favorable (Unfavorable)
                                          Year Ended September 30,                    Year Ended September 30,
                                                                                                           2011 vs.
                                     2012           2011           2010           2012 vs. 2011              2010
Net sales                             100.0 %        100.0 %        100.0 %                 (0.7 )%              2.7 %
Cost of goods sold (2)                 46.3           45.6           45.2                   (0.9 )              (3.5 )

Gross profit                           53.7           54.4           54.8                   (2.1 )               2.0
Selling, general and
administrative expenses (3)            47.2           47.2           47.4                    0.7                (2.3 )
Store closing, asset impairment
and asset disposal expenses             0.4            0.2            0.4                  (90.9 )              54.5
Restructuring and other charges           -            0.0            1.1                  100.0                96.6

Operating income                        6.1            7.0            5.9                  (13.4 )              21.7
Interest expense, net                   0.2            0.4            0.6                   45.6                32.3
Loss on extinguishment of debt          0.0            0.0            0.0                   40.5                27.5

Income before income taxes              5.9            6.6            5.3                  (11.4 )              28.1
Income tax provision                    2.3            2.4            2.1                    3.8               (15.4 )

Net income                              3.6 %          4.2 %          3.2 %                (15.7 )%             36.6 %

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

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

(3) The "selling, general and administrative expenses" line item includes:
advertising and marketing expenses, corporate administrative expenses, store expenses (including store payroll and store occupancy expenses), and store opening expenses.

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

                                                                                   Year Ended September 30,
                                           2012                                              2011                                              2010
                                                           Total                                             Total                                             Total
                                        Leased            Retail                          Leased            Retail                          Leased            Retail
Retail Locations (1)    Stores        Departments        Locations        Stores        Departments        Locations        Stores        Departments        Locations
Beginning of period         658              1,694            2,352           698              1,027            1,725           724                360            1,084
Opened                        8                 13               21            12                694              706            11                680              691
Closed                      (41 )             (324 )           (365 )         (52 )              (27 )            (79 )         (37 )              (13 )            (50 )

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

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

--------------------------------------------------------------------------------
                                                                                      Year Ended September 30,
                                            2012                                                 2011                                               2010
                                                            Total                                               Total                                              Total
                                                        International                                       International                                      International
International                       Shop-in-Shop         Franchised                     Shop-in-Shop         Franchised                     Shop-in-Shop        Franchised
Franchised Locations   Stores         Locations           Locations         Stores        Locations           Locations         Stores        Locations          Locations
Beginning of period         15                 51                   66            8                23                   31            1                 7                   8
Opened                       2                 54                   56            7                29                   36            7                16                  23
Closed                      (1 )               (2 )                 (3 )          -                (1 )                 (1 )          -                 -                   -

End of period               16                103                  119           15                51                   66            8                23                  31

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

                                                    Year Ended                              Year Ended
                                                September 30, 2012                      September 30, 2011
                                          Net        Diluted       Diluted        Net        Diluted       Diluted
                                         Income       Shares         EPS         Income       Shares         EPS
As reported                             $ 19,372       13,267     $    1.46     $ 22,988       13,120     $    1.75
Add: stock-based compensation
expense, net of tax                        1,472            -                      1,467            -
Add: restructuring and other charges,
net of tax                                     -            -                        120            -
Add: loss on extinguishment of debt,
net of tax                                    14            -                         23            -

As adjusted before stock-based
compensation expense, restructuring
and other charges, and loss on
extinguishment of debt                  $ 20,858       13,267     $    1.57     $ 24,598       13,120     $    1.87

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

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

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

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

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

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

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

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

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

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

Income Taxes. For fiscal 2011, our effective tax rate was 36.1% compared to 40.1% for fiscal 2010. Our effective tax rate for fiscal 2011 was slightly higher than the statutory federal tax rate of 35% primarily due to the effect of state income taxes, net of federal benefit, on our pretax income for fiscal 2011, partially offset by reductions of state income tax expense, net of federal . . .