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DEST > SEC Filings for DEST > Form 10-K on 13-Dec-2013All Recent SEC Filings

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Form 10-K for DESTINATION MATERNITY CORP


13-Dec-2013

Annual Report


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

Overview

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

We are the leading designer and retailer of maternity apparel in the United States with 1,907 retail locations, including 596 stores in all 50 states, Puerto Rico and Canada, and 1,311 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 1,158 stores throughout the United States and offers maternity apparel in a significant number of its stores. 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 locations. We also sell merchandise on the Internet, primarily through DestinationMaternity.com and our various brand-specific websites. We have store franchise and product supply relationships in the Middle East, South Korea and Mexico. In November 2013, we announced our expansion into Mexico through a franchise agreement with the largest department store company in Mexico. Also in November 2013, we announced that we were unable to reach mutual agreement on acceptable renewal terms with our franchisee for India and, thus, this franchise relationship, which began in April 2009, will end in March 2014. We do not expect that the discontinuation of our India franchise relationship will have a significant impact on our financial results. As of September 30, 2013, we have 143 international franchised locations, comprised of 20 stand-alone stores in the Middle East, South Korea and India operated under one of our retail nameplates, and 123 shop-in-shop locations in India and South Korea in which we have a Company branded department operated by our franchise partners within other retail stores. As of September 30, 2013, the international franchised locations include one stand-alone store and 110 shop-in-shop locations operated by our India franchisee that are expected to close in March 2014. 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 certain charges or credits, when applicable, such as restructuring and other charges, loss on extinguishment of debt and certain infrequent income tax adjustments ("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: (1) depreciation and amortization expense, (2) loss on impairment of tangible and intangible assets,
(3) loss on disposal of assets, and (4) stock-based compensation expense.

Following is a summary of our fiscal 2013 results with regard to each of the key measures noted above:

Fiscal 2013 Financial Results

- GAAP net income for fiscal 2013 was $23.9 million, a 24% increase compared to GAAP net income of $19.4 million for fiscal 2012. GAAP diluted earnings per share for fiscal 2013 was $1.78, a 22% increase compared to GAAP diluted earnings per share of $1.46 for fiscal 2012.

- Non-GAAP adjusted net income for fiscal 2013 was $22.7 million, a 17% increase compared to comparably adjusted Non-GAAP net income of $19.4 million for fiscal 2012. Non-GAAP diluted earnings per share for fiscal 2013 was $1.69, a 16% increase compared to Non-GAAP diluted earnings per share of $1.46 for fiscal 2012.

ˇ GAAP net income for fiscal 2013 includes a reduction of state income tax expense, net of federal expense, of $1.2 million, or $0.09 per share (diluted), recognized in the fourth quarter, resulting from state income tax regulation changes.

- Adjusted EBITDA was $54.0 million for fiscal 2013, an 8.2% increase compared to $49.9 million of Adjusted EBITDA for fiscal 2012.

- Net sales for fiscal 2013 decreased 0.2% to $540.3 million from $541.5 million for fiscal 2012.

- Comparable sales (which include Internet sales) for fiscal 2013 increased 2.6% versus a comparable sales decrease of 0.3% for fiscal 2012. Adjusting for the calendar timing shift, as described in Item 6 in this report, our calendar-adjusted comparable sales increased 3.2% for fiscal 2013 and decreased 0.8% for fiscal 2012. Internet sales increased 13% for fiscal 2013, on top of a 26% increase for fiscal 2012.


Results of Operations

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

                                                                                             % Period to Period
                                           % of Net Sales (1)                              Favorable (Unfavorable)
                                        Year Ended September 30,                          Year Ended September 30,
                                 2013             2012             2011            2013 vs. 2012             2012 vs. 2011

Net sales                          100.0 %          100.0 %          100.0 %                  (0.2 )%                  (0.7 )%
Cost of goods sold (2)              46.1             46.3             45.6                     0.6                     (0.9 )
Gross profit                        53.9             53.7             54.4                     0.1                     (2.1 )
Selling, general and
administrative expenses (3)         46.6             47.2             47.2                     1.4                      0.7
Store closing, asset
impairment and asset disposal
expenses                             0.3              0.4              0.2                    27.3                    (90.9 )
Other charges                         -                -               0.0                      -                     100.0
Operating income                     6.9              6.1              7.0                    13.3                    (13.4 )
Interest expense, net                0.1              0.2              0.4                    56.2                     45.6
Loss on extinguishment of debt       0.0              0.0              0.0                    59.1                     40.5
Income before income taxes           6.8              5.9              6.6                    16.0                    (11.4 )
Income tax provision                 2.4              2.3              2.4                    (4.1 )                    3.8
Net income                           4.4 %            3.6 %            4.2 %                  23.6 %                  (15.7 )%

(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 (1) locations where Kohl's sells our products under an exclusive product and license agreement, and (2) international franchised locations.

                                                                                                             Year Ended September 30,
                                                                2013                                                   2012                                                   2011
                                                                                  Total                                                  Total                                                  Total
                                                              Leased             Retail                              Leased             Retail                              Leased             Retail
Retail Locations (1)                        Stores          Departments         Locations          Stores          Departments         Locations          Stores          Departments         Locations

Beginning of period                              625               1,383             2,008              658               1,694             2,352              698               1,027             1,725
Opened                                            15                  74                89                8                  13                21               12                 694               706
Closed                                           (44 )              (146 )            (190 )            (41 )              (324 )            (365 )            (52 )               (27 )             (79 )
End of period                                    596               1,311             1,907              625               1,383             2,008              658               1,694             2,352

(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,
                                                                    2013                                                        2012                                                         2011
                                                                                      Total                                                       Total                                                        Total
                                                               Shop-in-           International                            Shop-in-           International                            Shop-in-            International
International                                                    Shop              Franchised                                Shop              Franchised                                Shop                Franchised
Franchised Locations (1)                      Stores          Locations             Locations             Stores          Locations             Locations             Stores           Locations             Locations

Beginning of period                                 16                103                     119               15                 51                      66                8                  23                       31
Opened                                               5                 30                      35                2                 54                      56                7                  29                       36
Closed                                              (1 )              (10 )                   (11 )             (1 )               (2 )                    (3 )             -                   (1 )                     (1 )
End of period (1)                                   20                123                     143               16                103                     119               15                  51                       66

(1) As of September 30, 2013, includes one store and 110 shop-in-shop locations operated by our India franchisee that are expected to close in March 2014.

In fiscal 2012 we also operated leased departments in Babies"R"Us stores. However, in connection with our broad-based partnership with Bed Bath & Beyond Inc. and its subsidiary, Buy Buy Baby, Inc., we discontinued operation of our 124 remaining leased departments in Babies"R"Us in late October 2012 and began to open leased departments in select buybuy BABY stores. According to Bed Bath & Beyond Inc.'s latest public disclosure, as of October 9, 2013 there are 86 buybuy BABY stores. As of September 30, 2013 we operate leased departments in 59 buybuy BABY stores. We expect to continue to increase the number of buybuy BABY stores in which we have a maternity apparel leased department. The decrease in leased department locations at the end of September 2013 compared to September 2012 predominantly reflects this change of partners in October 2012.

Year Ended September 30, 2013 Compared to Year Ended September 30, 2012

Net Sales. Our net sales for fiscal 2013 decreased by 0.2% or $1.2 million, to $540.3 million from $541.5 million for fiscal 2012. Comparable sales increased 2.6% during fiscal 2013 versus a comparable sales decrease of 0.3% during fiscal 2012. Adjusting for the calendar timing shift, as described in Item 6 in this report, our calendar-adjusted comparable sales increased 3.2% for fiscal 2013 and decreased 0.8% for fiscal 2012. Our Internet sales, which are included in comparable sales, increased 13.3% for fiscal 2013, on top of a 26.2% increase for fiscal 2012. The decrease in total reported sales for fiscal 2013 compared to fiscal 2012 resulted primarily from decreased sales related to our continued efforts to close underperforming stores and decreased sales due to the closure of all of our remaining leased departments within Babies"R"Us stores during the month of October 2012, substantially offset by the increase in comparable sales and increased sales from our licensed brand relationship.

As of September 30, 2013, we operated a total of 596 stores and 1,907 total retail locations: 476 Motherhood Maternity stores (including 86 Motherhood Maternity Outlet stores), 31 A Pea in the Pod stores, 89 Destination Maternity stores, and 1,311 leased maternity apparel departments, of which 502 were in Sears stores under the Two Hearts Maternity brand and the balance were in other department stores and baby specialty stores. In addition, our Oh Baby by Motherhood collection is available at Kohl's stores throughout the United States. In comparison, 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. As of September 30, 2013, our store total included 89 multi-brand Destination Maternity nameplate stores, including 56 Destination Maternity combo stores and 33 Destination Maternity superstores. In comparison, as of September 30, 2012, we operated 82 multi-brand Destination Maternity nameplate stores, including 50 Destination Maternity combo stores and 32 Destination Maternity superstores. During fiscal 2013, we opened 15 stores, including nine Destination Maternity nameplate stores, and closed 44 stores, with 14 of these store closings related to Destination Maternity nameplate store openings. In addition, during fiscal 2013, we opened 74 leased department locations and closed 146 leased department locations.

Gross Profit. Our gross profit for fiscal 2013 increased by 0.1%, or $0.3 million, to $291.0 million compared to $290.7 million for fiscal 2012, and our gross profit as a percentage of net sales (gross margin) for fiscal 2013 was 53.9% compared to 53.7% for fiscal 2012. The increase in gross profit for fiscal 2013 compared to fiscal 2012 was due to our higher gross margin. The increase in gross margin for fiscal 2013 compared to fiscal 2012 was primarily due to lower product costs.

Selling, General and Administrative Expenses. Our selling, general and administrative expenses for fiscal 2013 decreased by 1.4%, or $3.6 million, to $252.0 million from $255.6 million for fiscal 2012. As a percentage of net sales, selling, general and administrative expenses decreased to 46.6% for fiscal 2013 compared to 47.2% for fiscal 2012. This decrease in expense and expense percentage for fiscal 2013 compared to fiscal 2012 resulted primarily from lower expenses (primarily payroll and occupancy costs) related to our continued closure of underperforming stores and the closure of all of our remaining leased departments within Babies"R"Us stores during October 2012, and continued tight expense controls, partially offset by higher expenses for variable incentive compensation, advertising and marketing, and corporate payroll to drive increased sales. We also recognized a non-recurring


reduction to selling, general and administrative expenses of $0.9 million during the fourth quarter of fiscal 2013, for the sale of our rights to a portion of a VisaŽ/MasterCardŽ class action settlement fund.

Store Closing, Asset Impairment and Asset Disposal Expenses. Our store closing, asset impairment and asset disposal expenses for fiscal 2013 decreased by approximately $0.6 million, to $1.4 million from $2.0 million for fiscal 2012, reflecting lower impairment charges for write-downs of long-lived assets.

Operating Income. Our operating income for fiscal 2013 increased by 13.3%, or $4.4 million, to $37.5 million from $33.1 million for fiscal 2012. Operating income as a percentage of net sales for fiscal 2013 increased to 6.9% from 6.1% for fiscal 2012. The increase in operating income and operating income percentage was primarily due to our lower selling, general and administrative expenses.

Interest Expense, Net. Our net interest expense for fiscal 2013 decreased by 56.2%, or $0.7 million, to $0.5 million from $1.2 million in fiscal 2012. This decrease was due to our lower debt level, primarily as a result of the $15.3 million of debt repayments we made in fiscal 2013.

Loss on Extinguishment of Debt. In November 2012, we prepaid the remaining $13.4 million of our outstanding Term Loan. The $13.4 million Term Loan prepayment resulted in a pretax charge of $9,000 in fiscal 2013, representing the write-off of unamortized deferred financing costs. 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.

Income Taxes. Income tax expense for fiscal 2013 includes a reduction of state income tax expense, net of federal expense, of $1.2 million, or $0.09 per diluted share, for the estimated carryforward tax benefit of certain state net operating losses based upon recently enacted changes in applicable state income tax regulations, which was recognized in the fourth quarter of fiscal 2013. For fiscal 2013, our effective tax rate was 35.2% compared to 39.2% for fiscal 2012. Our effective tax rate for fiscal 2013 was slightly 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, largely offset by the recognition of the estimated tax benefit of the state net operating loss carryforwards. 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. See Note 14 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 2013 increased by 23.6%, to $23.9 million from $19.4 million for fiscal 2012. Net income per share (diluted) for fiscal 2013 increased by 21.9%, to $1.78 per share from $1.46 per share in fiscal 2012. Net income for fiscal 2013 includes (net of tax) loss on extinguishment of debt of $6,000 and $1.2 million of state income tax benefits resulting from regulation changes. Net income for fiscal 2012 includes (net of tax) loss on extinguishment of debt of $14,000. Before these charges or credits, our fiscal 2013 adjusted net income was $22.7 million or $1.69 per share (diluted) compared to $19.4 million or $1.46 per share (diluted) for fiscal 2012.

Our average diluted shares outstanding of 13.4 million for fiscal 2013 was 1.3% higher than the 13.3 million average diluted shares outstanding for fiscal 2012. The increase in average shares outstanding reflects the higher shares outstanding in fiscal 2013 compared to fiscal 2012, primarily as a result of the exercise of stock options and vesting of restricted stock.

Following is a reconciliation of net income and net income per share (diluted) ("Diluted EPS") to adjusted net income and adjusted Diluted EPS for the years ended September 30, 2013 and 2012 (in thousands, except per share amounts):

                                                            Year Ended                                            Year Ended
                                                        September 30, 2013                                    September 30, 2012
                                              Net             Diluted           Diluted             Net             Diluted           Diluted
                                            Income            Shares              EPS             Income            Shares              EPS

As reported                                $  23,943            13,439         $    1.78         $  19,372            13,267         $    1.46
Add: loss on extinguishment of debt, net
of tax                                             6                -                                   14                -
Less: recognition of state income tax
benefits resulting from regulation changes    (1,216 )              -                                   -                 -
As adjusted                                $  22,733            13,439         $    1.69         $  19,386            13,267         $    1.46


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. Adjusting for the calendar timing shift, as described in Item 6 in this report, our calendar-adjusted comparable sales decreased 0.8% for fiscal 2012 and increased 0.1% for fiscal 2011. Our Internet sales, which are included in comparable sales, increased 26.2% for fiscal 2012, on top of a 28.3% increase for 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 brand 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 multi-brand Destination Maternity nameplate stores, including 50 Destination Maternity combo stores and 32 Destination Maternity superstores. In comparison, as of September 30, 2011, we operated 80 Destination Maternity nameplate stores, including 52 Destination Maternity combo stores and 28 Destination Maternity superstores. During fiscal 2012, we opened eight stores, including six Destination Maternity nameplate stores, and closed 41 stores, with 12 of these store closings related to Destination Maternity nameplate 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 merchandise margin driven by higher product costs and somewhat higher levels of promotional activity and markdowns.

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

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

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