DEBS Deb Shops (MM)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a)
of the Securities Exchange Act of 1934 (Amendment No.     )

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DEB SHOPS, INC.

(Name of Registrant as Specified in Its Charter)

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9401 Blue Grass Road

Philadelphia, PA 19114

(215) 676-6000

 

September 24, 2007

 

To our Shareholders:

 

You are cordially invited to attend a special meeting of the shareholders of Deb Shops, Inc. (the “Company”), at the Company’s offices located at 9401 Blue Grass Road, Philadelphia, PA 19114 on Tuesday, October 16, 2007, beginning at 10 a.m. local time.

 

At the special meeting, you will be asked to consider and vote upon a proposal to adopt the Agreement and Plan of Merger, dated as of July 26, 2007 among the Company, DSI Holdings, LLC (“Parent”) and DSI Acquisition, Inc. (“Merger Sub”), a wholly-owned subsidiary of Parent, and approve the merger.

 

The merger agreement provides for, among other things, the merger of Merger Sub with and into the Company, with the Company as the surviving corporation in the merger. As a result of the merger, the Company will become a wholly-owned subsidiary of Parent. If the merger is completed, you will be entitled to receive $27.25 in cash, without interest, for each share of our common stock you own.

 

Our Board of Directors has unanimously approved the merger agreement and the transactions contemplated by the merger agreement, including the merger, and has determined that the transactions contemplated by the merger agreement are fair to, and in the best interests of, the Company’s shareholders. Accordingly, our Board of Directors recommends that you vote “FOR” the adoption of the merger agreement and the approval of the merger.

 

The proxy statement attached to this letter provides you with information about the proposed merger and the special meeting. We encourage you to read the entire proxy statement carefully because it explains the proposed merger and related matters, including the conditions to the completion of the merger. You may also obtain more information about the Company from documents we have filed with the Securities and Exchange Commission.

 

The merger cannot be completed unless the merger agreement is adopted and the merger is approved by the affirmative vote of a majority of the votes cast by the holders of the outstanding shares of our common stock that are entitled to vote at the special meeting and by a majority of the votes cast by the holders of the outstanding shares of our preferred stock that are entitled to vote at the special meeting, voting as a separate class. Certain of our directors and officers, and their affiliates, who beneficially own approximately 64% of the outstanding shares of our common stock and 100% of the outstanding shares of our preferred stock, have entered into a voting agreement with Parent, under which they have agreed to vote all of their shares in favor of the approval of the merger and adoption of the merger agreement. Accordingly, the merger and the merger agreement will be approved and adopted at the special meeting.

 

Whether or not you plan to attend the special meeting, it is important that your shares be represented. Accordingly, we urge you to vote, by completing, signing, dating and promptly returning the enclosed proxy card in the envelope provided, which requires no postage if mailed in the United States. Alternatively, you may vote through the Internet or by telephone as directed on the enclosed proxy card. If you receive more than one proxy card because you own shares that are registered differently, please vote all of your shares shown on all of your proxy cards.

 

Voting by proxy will not prevent you from voting your shares in person if you subsequently choose to attend the special meeting.

 

We look forward to seeing you at the special meeting.

 

Sincerely,

 

Marvin Rounick

President and Chief Executive Officer

 

9401 Blue Grass Road

Philadelphia, PA 19114

 

TABLE OF CONTENTS

 

 

SUMMARY

 

The following summary highlights selected information from this proxy statement and may not contain all of the information that is important to you. Accordingly, we encourage you to read carefully this entire proxy statement, its annexes and the documents referred to in this proxy statement. Each item in this summary includes a page reference directing you to a more complete description of that item in this document.

 

Unless we otherwise indicate or unless the context requires otherwise: all references in this document to “Company,” “Deb,” “we,” “our,” and “us” refer to Deb Shops, Inc. and its subsidiaries; all references to “Parent” refer to DSI Holdings, LLC.; all references to “Merger Sub” refer to DSI Acquisition, Inc.; all references to “Merger Agreement” refer to the Agreement and Plan of Merger, dated as of July 26, 2007, among the Company, Parent and Merger Sub, as it may be amended from time to time, a copy of which is attached as Annex A to this document; all references to the “Merger” refer to the merger contemplated by the Merger Agreement; all references to “Merger Consideration” refer to the per share merger consideration of $27.25 in cash contemplated to be received by the holders of our common stock pursuant to the Merger Agreement.

 

Parties to the Merger (page 11)

 

Deb Shops, Inc.   Deb Shops, Inc., together with its wholly-owned subsidiaries, operates 337 women’s and men’s specialty apparel retail stores in regional malls and strip shopping centers principally located in the East and Midwest regions of the United States. We operate 331 stores under the name “DEB” which offer moderately priced, fashionable, coordinated women’s tops, bottoms, dresses, coats, lingerie, accessories, shoes and novelty items for junior and plus-sizes. DEB merchandise consists of clothing and accessories designed to appeal primarily to fashion-conscious junior and plus-sized female consumers between the ages of 13 and 25. One hundred eighty-eight of the DEB stores contain plus-size departments. In addition, we operate two outlet stores under the name “CSO.” The outlet stores offer the same merchandise as DEB at reduced prices and serve as clearance stores for slow-moving inventory. We also operate four apparel retail stores under the name “Tops ‘N Bottoms.” The Tops ‘N Bottoms stores sell moderately priced men’s and women’s apparel. Thirteen of the DEB stores contain Tops ‘N Bottoms departments. Store information is as of July 31, 2007 unless otherwise indicated.

 

DSI Holdings, LLC.   DSI Holdings, LLC, or Parent, is a Delaware limited liability company organized for the purpose of effecting the Merger. Parent has not engaged in any business except activities incidental to its formation and in connection with the transactions contemplated by the Merger Agreement. Upon the closing of the Merger it will be controlled by private equity funds sponsored by Lee Equity Partners, LLC (“Lee Equity”).

 

Lee Equity.   Lee Equity is a private equity investment firm based in New York, New York founded by Thomas H. Lee. Over the past 33 years, Mr. Lee, who is president of Lee Equity, has been responsible for investing in excess of $10 billion in more than 100 transactions. The members of management of Lee Equity have expertise in the retail and consumer products sectors and have, on a combined basis, completed over 30 investments.

 

DSI Acquisition, Inc.   DSI Acquisition, Inc., which we refer to as Merger Sub, is a Pennsylvania corporation formed for the sole purpose of completing the Merger with the Company. Merger Sub is a wholly-owned subsidiary of Parent.

 

The Merger (page 14)

 

On July 26, 2007, the Company entered into the Merger Agreement. Upon the terms and subject to the conditions of the Merger Agreement, Merger Sub will merge with and into the Company, with the Company as the surviving corporation. We will become a wholly-owned subsidiary of Parent. You will have no equity interest in the Company or Parent after the effective time of the Merger. At the effective time of the Merger:

 

 

 

Quarterly Dividend (page 41)

 

On July 2, 2007, we declared our regular quarterly dividend of $30 per share on the outstanding Preferred Stock and $0.125 per share on the outstanding Common Stock, which was paid on August 21, 2007. Pursuant to the terms of the Merger Agreement, no other dividends will be paid.

 

Certain Effects of the Merger (page 37)

 

If the Merger is completed, and you hold shares of Common Stock at the effective time of the Merger, you will be entitled to receive $27.25 in cash without interest, for each share of Common Stock owned by you. As a result of the Merger, the Company will cease to be an independent, publicly traded company. You will not own any shares of the surviving corporation.

 

The Special Meeting (page 12)

 

The special meeting will be held on October 16, 2007 starting at 10 a.m. local time at the Company’s offices located at 9401 Blue Grass Road, Philadelphia, Pennsylvania 19114.

 

Record Date, Quorum and Voting Power (page 12)

 

Shareholders of record at the close of business on September 18, 2007 are entitled to notice of, and to vote at, the special meeting. The presence at the meeting, in person or by proxy, of the holders of a majority of the outstanding shares of Preferred Stock and the holders of a majority of the outstanding shares of Common Stock entitled to be cast as of the close of business on the record date will constitute a quorum.

 

Vote Required for Approval (page 12)

 

The adoption of the Merger Agreement and approval of the Merger requires the affirmative vote of majority of the votes cast by the holders of the outstanding shares of our Common Stock that are entitled to vote at the special meeting and by a majority of the votes cast by the holders of the outstanding shares of our Preferred Stock entitled to vote at the special meeting, voting as a separate class.

 

Voting by Directors and Executive Officers (page 13)

 

As of September 18, 2007, the record date for the special meeting, certain of our directors and officers beneficially owned, in the aggregate, 9,200,702 shares of Common Stock and 460 shares of Preferred Stock representing approximately 64% of our outstanding Common Stock and 100% of our outstanding Preferred Stock. Such directors and executive officers, and their affiliates, are parties to a voting agreement with Parent, pursuant to which they have agreed to vote all of their Common Stock and Preferred Stock “FOR” the adoption of the Merger Agreement and approval of the Merger, which assures that the Merger and the Merger Agreement will be approved and adopted at the special meeting.

 

Recommendation of Our Board of Directors (page 20)

 

Our Board of Directors has unanimously (i) approved, adopted and declared advisable the Merger Agreement and the Merger, (ii) determined that the Merger Agreement, the Merger and the transactions contemplated by the Merger Agreement are fair to, and in the best interests of the Company’s shareholders, and (iii) recommended that our shareholders vote “FOR” adoption of the Merger Agreement and approval of the Merger.

For a discussion of the material factors considered by the Board of Directors in reaching their conclusions, see “The Merger — Reasons for the Merger; Recommendation of Our Board of Directors” beginning on page 20.

 

Opinion of the Company’s Financial Advisor (page 22 and Annex B)

 

In connection with the Merger, Lehman Brothers Inc. (“Lehman Brothers”), our financial advisor, delivered to our Board of Directors a written opinion, dated July 26, 2007, as to the fairness, from a financial point of view and as of July 26, 2007, of the $27.25 per share cash merger consideration to be offered to the holders of our Common Stock in the proposed Merger. The full text of Lehman Brothers’ written opinion, dated July 26, 2007, which sets forth the assumptions made, the matters considered and qualifications to and limitations of the review undertaken in connection with the opinion, is attached as Annex B to this proxy statement and is incorporated by reference in its entirety into this proxy statement. You are encouraged to read the opinion in its entirety. Lehman Brothers provided its opinion for the benefit and use of our Board of Directors in connection with its evaluation of the transaction. Lehman Brothers’ opinion does not constitute a recommendation to any shareholder as to how to vote in connection with the Merger or otherwise. Lehman Brothers’ opinion does not address our underlying business decision to pursue the transactions contemplated by the Merger Agreement, the relative merits of the transactions as compared to any alternative business strategies or transactions that might exist for us or the effects or implications of any other transaction proposed to us or in which we might engage.

 

Parent’s Financing (page 45)

 

The total amount of funds required to complete the Merger and the related transactions, including payment of fees and expenses in connection with the Merger, is anticipated to be approximately $410 million. Lee Equity has advised us that this amount is expected to be provided through a combination of (i) equity contributions from Lee Equity and its affiliates totaling approximately $122.5 million, (ii) debt financing totaling approximately $175 million, referred to as the “bank financing” and (iii) cash and cash equivalents held by Deb and its subsidiaries. The closing of the Merger is not conditioned on the receipt of the bank financing.

 

Treatment of Stock Options (page 38)

 

In connection with the Merger, each option to purchase our Common Stock outstanding immediately prior to the effective time of the Merger will become fully-vested and exercisable and each holder of an option will be entitled to receive a cash payment with respect to each option held by the holder equal to the product of the number of shares subject to such option multiplied by the excess of (a) $27.25 per share less (b) the exercise price of such option, without interest.

 

Restrictions on Solicitations (page 42)

 

In the Merger Agreement, we have agreed that we will not:

 

 

Notwithstanding these restrictions, the Merger Agreement provides that if we receive an unsolicited Competing Proposal from a third party before the shareholder vote, that is, or could reasonably be expected to result in, a “Superior Proposal” (as such term is defined in the Merger Agreement), the Company may engage in discussions with the third party and provide non-public information to the third party in regard to the Competing Proposal,

provided that we enter into a confidentiality agreement with such third party meeting certain requirements and that we provide advance notice to Parent in accordance with the requirements of the Merger Agreement.

 

If we receive a Superior Proposal, we may terminate the Merger Agreement and enter into a definitive agreement and/or effect a Change of Recommendation (as defined in the Merger Agreement) with respect to the Superior Proposal, provided that our Board of Directors concludes in good faith it is a Superior Proposal and as long as we have given four days prior written notice to Parent and Merger Sub, which includes specific information, and a copy of the proposed transaction agreement (and a new notice if there are any material changes to such Superior Proposal). If the Merger Agreement is terminated upon the receipt of such Superior Proposal or a Change of Recommendation is effected we would be required to pay Parent a termination fee of $15 million.

 

Conditions to the Merger (page 44)

 

Conditions to Each Party’s Obligations.

 

Each party’s obligation to complete the Merger is subject to the satisfaction or waiver of the following conditions:

 

 

Conditions to Parent and Merger Sub’s Obligations.

 

The obligation of Parent and Merger Sub to complete the Merger is subject to the satisfaction or waiver of the following conditions:

 

 

The Company’s EBITDA, calculated in accordance with the terms of the Merger Agreement, for the twelve months ending July 31, 2007 was $33.6 million. There is no financing condition to Parent’s and Merger Sub’s obligations to complete the Merger. However, the parties are not required to complete the Merger until the end of a period of 21 consecutive days after the later of (i) September 4, 2007, and (ii) the second business day following the mailing by the Company of this proxy statement, which period is referred to in this proxy statement as the “Marketing Period.” Parent and Merger Sub are obligated to consummate the transactions contemplated by the debt financing commitments no later than the last day of the Marketing Period.

 

Conditions to the Company’s Obligations.

 

Our obligation to complete the Merger is subject to the satisfaction or waiver of the following additional conditions: Parent and Merger Sub have performed in all material respects its obligations required to be performed by them at or prior to the effective time of the Merger; the representations and warranties of Parent and Merger Sub

must be true and correct in all material respects as of the effective time of the Merger; and the Company has received a certificate signed by the chief executive officer or another senior officer of Parent to the foregoing effect.

 

Termination of the Merger Agreement (page 46)

 

The Company and Parent may mutually agree to terminate the Merger Agreement at any time upon the mutual written consent of the parties. Other circumstances under which the Company or Parent may terminate the Merger Agreement are described under “Terms of the Merger Agreement — Termination of the Merger Agreement” beginning on page 46. Under certain circumstances resulting in the termination of the Merger Agreement, we will be required to pay a termination fee of $15 million to Parent. In addition, under certain circumstances resulting in the termination of the Merger Agreement, we will be entitled to receive a termination fee of $15 million from Parent. The specific circumstances in which we are required to pay or entitled to receive a termination fee are described under “Terms of the Merger Agreement — Fees and Expenses” beginning on page 47.

 

Regulatory and Other Governmental Approvals (page 35)

 

The Merger is subject to review by the Antitrust Division of the Department of Justice (the “Antitrust Division”) and the Federal Trade Commission (“FTC”) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”). The HSR Act provides that transactions such as the Merger may not be completed until certain information and documents have been submitted to the FTC and the Antitrust Division and certain waiting period requirements have been observed. On August 14, 2007, the Company and Parent, an affiliate of Lee Equity, each filed a Notification and Report Form with the Antitrust Division and the FTC and requested early termination of the waiting period. On August 27, 2007, the Company and Parent were notified that early termination of the waiting period under the HSR Act had been granted.

 

Except as noted above with respect to the required filings under the HSR Act, at or before the effective time of the Merger, we are unaware of any material federal, state or foreign regulatory requirements or approvals required for the execution of the Merger Agreement or completion of the Merger.

 

Material U.S. Federal Income Tax Consequences of the Merger to Our Shareholders (page 34)

 

Generally, the Merger will be taxable to our shareholders who are U.S. holders for U.S. federal income tax purposes. A U.S. holder of Deb Common Stock and Preferred Stock receiving cash in the Merger generally will recognize gain or loss for U.S. federal income tax purposes in an amount equal to the difference between the amount of cash received and the holder’s adjusted tax basis in our Common Stock or Preferred Stock surrendered. You should consult your own tax advisor for a full understanding of how the Merger will affect your particular tax circumstances.

 

Interests of Deb’s Directors and Officers in the Merger (page 32)

 

In considering the recommendation of our Board of Directors with respect to the Merger, you should be aware that certain of our directors and officers have interests in the Merger that are different from, or in addition to, your interests as a shareholder and that may present actual or potential conflicts of interest. Our Board of Directors was aware of these interests and considered that the interests may be different from or in addition to the interests of our shareholders generally, among other matters, in approving the Merger Agreement and the transactions contemplated thereby, including the Merger, and in determining to recommend that our shareholders vote for adoption of the Merger Agreement and approval of the Merger. You should consider these and other interests of our directors and executive officers that are described in this proxy statement.

 

Procedure for Receiving Merger Consideration (page 38)

 

As soon as reasonably practicable after the effective time of the Merger, American Stock Transfer & Trust Company, the paying agent, will mail a letter of transmittal and instructions to all Company shareholders. The letter of transmittal and instructions will tell you how to surrender your stock certificates or book-entry shares in exchange for the Merger Consideration, without interest. You should not return any share certificates you hold with the enclosed proxy card, and you should not forward your share certificates to the paying agent without a letter of transmittal.

 

Market Price of Common Stock (page 52)

 

Our Common Stock is listed on The NASDAQ Stock Market under the trading symbol “DEBS.” The closing sale price of Common Stock on July 26, 2007, which was the last trading day before the announcement of the execution of the Merger Agreement, was $26.68 per share. On September 18, 2007, the closing sale price of our Common Stock was $27.15 per share.

 

Absence of Dissenters’ Rights of Appraisal (page 53)

 

Under the PBCL, holders of shares of the Company’s Common Stock and Preferred Stock are not entitled to dissenters rights in connection with the proposed Merger.

 

QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING AND THE MERGER

 

The following questions and answers are intended to briefly address some commonly asked questions regarding the Merger, the Merger Agreement and the special meeting. These questions and answers may not address all questions that may be important to you as a Deb shareholder. Please refer to the “Summary” and the more detailed information contained elsewhere in this proxy statement, the annexes to this proxy statement and the documents referred to or incorporated by reference in this proxy statement, which you should read carefully. See “Where Shareholders Can Find Additional Information” beginning on page 56.

 

 

 

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION

 

This proxy statement contains statements that are not historical facts and that are considered “forward-looking” within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these statements by the fact that they do not relate strictly to historical or current facts. We have based these forward-looking statements on our current expectations about future events. Statements that include words such as “may,” “will,” “project,” “might,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” “continue” or “pursue,” or the negative or other words or expressions of similar meaning, may identify forward-looking statements. These forward-looking statements, include without limitation, those relating to future actions, strategies, future performance and future financial results. Although we believe that the expectations underlying these forward looking statements are reasonable, there are a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward-looking statements should, therefore, be considered in light of various important factors set forth from time to time in our filings with the Securities and Exchange Commission, which we refer to as the “SEC.” In addition to other factors and matters contained or incorporated in this document, these statements are subject to risks, uncertainties and other factors, including, among others:

 

 

The foregoing sets forth some, but not all, of the factors that could impact our ability to achieve results described in any forward-looking statements. A more complete description of the risks applicable to us is provided in our filings with the SEC available at the SEC’s web site at http://www.sec.gov, including our most recent filings on Forms 10-Q and 10-K. Investors are cautioned not to place undue reliance on these forward-looking statements. Investors also should understand that is not possible to predict or identify all risk factors and that neither this list nor the factors identified in our SEC filings should be considered a complete statement of all potential risks and uncertainties. We have no obligation to publicly update or release any revisions to these forward-looking statements to reflect events or circumstances after the date of this proxy statement.

 

THE PARTIES TO THE MERGER

 

Deb Shops, Inc.

 

Deb Shops, Inc.

9401 Blue Grass Road

Philadelphia, Pennsylvania 19114

 

Deb Shops, Inc., together with its wholly-owned subsidiaries, operates 337 women’s and men’s specialty apparel retail stores in regional malls and strip shopping centers principally located in the East and Midwest regions of the United States. We operate 331 stores under the name “DEB” which offer moderately priced, fashionable, coordinated women’s tops, bottoms, dresses, coats, lingerie, accessories, shoes and novelty items for junior and plus-sizes. DEB merchandise consists of clothing and accessories designed to appeal to fashion-conscious junior and plus-sized female consumers between the ages of 13 and 25. One hundred eighty-eight of the DEB stores contain plus-size departments. In addition, we operate two outlet stores under the name “CSO.” The outlet stores offer the same merchandise as DEB at reduced prices and serve as clearance stores for slow-moving inventory. We also operate four apparel retail stores under the name “Tops ’N Bottoms.” The Tops ’N Bottoms stores sell moderately priced men’s and women’s apparel. Thirteen of the DEB stores contain Tops ’N Bottoms departments. Store information is as of July 31, 2007, unless otherwise indicated.

 

Detailed descriptions about the Company’s business and financial results are contained in our Annual Report on Form 10-K for the fiscal year ended January 31, 2007, which is incorporated in this proxy statement by reference. See “Where Shareholders Can Find More Information” beginning on page 56 of this proxy statement.

 

Parent and Merger Sub

 

DSI Holdings, LLC

DSI Acquisition, Inc.

c/o Lee Equity Partners, LLC

767 Fifth Avenue

17th Floor

New York, New York 10153

 

DSI Holdings, LLC, or Parent, is a Delaware limited liability company organized for the purpose of effecting the Merger. Parent has not engaged in any business except activities incidental to its formation and in connection with the transactions contemplated by the Merger Agreement. Upon the closing of the Merger it will be controlled by private equity funds sponsored by Lee Equity.

 

Lee Equity is a private equity investment firm based in New York, New York founded by Thomas H. Lee. Over the past 33 years, Mr. Lee, who is president of Lee Equity, has been responsible for investing in excess of $10 billion in more than 100 transactions. The members of management of Lee Equity have expertise in the retail and consumer products sectors and have, on a combined basis, completed over 30 investments.

 

DSI Acquisition, Inc., which we refer to as Merger Sub, is a Pennsylvania corporation and a wholly-owned subsidiary of Parent, formed for the sole purpose of completing the Merger with the Company. Merger Sub has not conducted any business operations except for activities incidental to its formation and as contemplated by the Merger. Upon consummation of the proposed Merger, Merger Sub will cease to exist and the Company will continue as the surviving corporation, under the name “Deb Shops, Inc.”

 

THE SPECIAL MEETING

 

Time, Place and Purpose of the Special Meeting

 

The enclosed proxy is solicited on behalf of our Board of Directors for use at a special meeting of shareholders to be held on Tuesday, October 16, 2007, at 10 a.m. local time, or at any adjournments or postponements of the special meeting. The special meeting will be held at the Company’s offices located at 9401 Blue Grass Road, Philadelphia, Pennsylvania 19114. The Company intends to mail this proxy statement and the accompanying proxy card on or about September 24, 2007 to all shareholders entitled to vote at the special meeting.

 

At the special meeting, shareholders will be asked to consider and vote upon a proposal to adopt the Merger Agreement among the Company, Parent, and Merger Sub and approve the merger of Merger Sub, with and into the Company, with the Company continuing as the surviving corporation. As a result of the Merger, among other things, each share of Common Stock of the Company outstanding immediately prior to the effective time of the Merger (other than shares held by the Company, Parent, Merger Sub or their subsidiaries) will be converted into the right to receive $27.25 in cash, without interest.

 

The Company does not expect a vote to be taken on any other matters at the special meeting. If any other matters are properly presented at the special meeting, however, the holders of the proxies, if properly authorized, will have the authority to vote on these matters in their discretion.

 

Record Date, Quorum and Voting Power

 

Shareholders of record at the close of business on September 18, 2007 are entitled to notice of, and to vote at, the special meeting. On September 18, 2007, the outstanding voting securities consisted of 14,330,808 shares of Common Stock and 460 shares of Preferred Stock. Each share of Common Stock and Preferred Stock entitles its holder to one vote on all matters properly coming before the special meeting.

 

A quorum of holders of the Common Stock and Preferred Stock must be present for the special meeting to be held. The presence at the meeting, in person or by proxy, of the holders of a majority of the outstanding shares of Preferred Stock and the holders of a majority of the outstanding shares of Common Stock issued and outstanding and entitled to be cast as of the close of business on the record date will constitute a quorum for the purpose of considering the proposal regarding adoption of the Merger Agreement and approval of the Merger.

 

Vote Required for Approval

 

For us to complete the Merger, we need the affirmative vote of a majority of the votes cast by the holders of the outstanding shares of our Common Stock that are entitled to vote at the special meeting and by a majority of the votes cast by the holders of the outstanding shares of our Preferred Stock that are entitled to vote at the special meeting, voting as a separate class.

 

In order for your Common Stock to be included in the vote, if you are a registered shareholder (that is, if you hold your Common Stock in certificated form), you must submit your proxy and vote your shares by returning the enclosed proxy, marked, signed and dated, in the postage prepaid envelope provided, or by telephone or through the Internet, as indicated on the proxy card, or you may vote in person at the special meeting.

 

Abstentions and broker non-votes, if any, will be treated as shares that are present and entitled to vote at the special meeting for purposes of determining whether a quorum exists. A broker non-vote occurs when, as is the case with respect to the adoption of the Merger Agreement and approval of the Merger, brokers are prohibited from exercising discretionary authority in voting for beneficial owners who have not provided voting instructions. Because adoption of the Merger Agreement and approval of the Merger requires the affirmative vote of a majority of votes cast by the holders of the Company’s Common Stock outstanding on the record date, under the PBCL, failures to vote, abstentions and broker non-votes, if any, are not considered votes “cast” and therefore will have no effect on the vote and will not be considered in determining whether the proposals have received the requisite shareholder vote.

 

Voting by Directors and Executive Officers

 

As of September 18, 2007, the record date for the special meeting, certain of our directors and officers, and their affiliates, beneficially owned, in the aggregate, 9,200,702 shares of Common Stock and 460 shares of Preferred Stock, representing approximately 64% of our outstanding Common Stock and 100% of our outstanding Preferred Stock. Such directors and executive officers, and their affiliates, are parties to a voting agreement with Parent, pursuant to which they have agreed to vote all of their Common Stock and Preferred Stock “FOR” the adoption of the Merger Agreement and approval of the Merger, which assures that the Merger and the Merger Agreement will be approved and adopted at the special meeting.

 

Proxies; Revocation

 

If you vote your shares of Common Stock by returning a signed proxy card by mail, or through the Internet or by telephone as indicated on the proxy card, your shares will be voted at the special meeting in accordance with the instructions given. If no instructions are indicated on your signed proxy card, your shares will be voted “FOR” the adoption of the Merger Agreement and in the discretion of the persons appointed as proxies on any other matters properly brought before the special meeting for a vote.

 

If you wish to change your vote and your shares are held in street name, you should follow the instructions of your broker, bank or other nominee regarding revocation or change of votes. If your broker, bank or other nominee allows you to submit a vote by telephone or through the Internet, you may be able to change your vote by submitting new voting instructions by telephone or through the Internet.

 

You may revoke or change your proxy at any time before the vote is taken at the special meeting, except as otherwise described below. If you have not voted through your broker, bank or other nominee because you are the registered shareholder, you may revoke or change your proxy before it is voted by:

 

 

The Company does not expect that any matter other than the proposal to adopt the Merger Agreement and approve the Merger will be brought before the special meeting. If, however, such a matter is properly presented at the special meeting or any adjournment or postponement of the special meeting, the persons appointed as proxies will have discretionary authority to vote the shares represented by duly executed proxies in accordance with their discretion and judgment.

 

Please do NOT send in your share certificates with your proxy card.   If the Merger is completed, shareholders will be mailed a transmittal form following the completion of the Merger with instructions for use in effecting the surrender of certificates in exchange for the Merger Consideration.

 

Questions and Additional Information

 

If you have more questions about the Merger or how to submit your proxy, or if you need additional copies of this proxy statement or the enclosed proxy card or voting instructions, please call the Company’s Investor Relations:

 

Deb Shops, Inc.
9401 Blue Grass Road
Philadelphia, Pennsylvania 19114

 

Telephone: (215) 676-6000

 

THE MERGER

 

Background of the Merger

 

As part of its long-term planning, the Company’s Board of Directors (the “Board”) has from time to time evaluated strategic alternatives available to the Company and ways in which shareholder value can be enhanced, including strategic acquisitions, dividend declaration, stock splits and the possible sale of the Company.

 

In the summer of 2005, the Company had discussions with and engaged a financial advisor to explore the possible sale of the Company. The financial advisor contacted and had exploratory discussions with eight potential strategic buyers and one private equity sponsor to gauge their interest in acquiring the Company. Based on the lack of interest expressed by these parties, the Board determined in the early fall of 2005 to discontinue any further exploratory discussions by the financial advisor and to terminate the engagement of the Company’s financial advisor.

 

In February 2006 and again in May 2006, members of senior management of the Company had general discussions with representatives of Lehman Brothers Inc. (“Lehman Brothers”) regarding strategic alternatives available to the Company. Lehman Brothers was not retained by the Company at those times.

 

In July 2006 the Company entered into a confidentiality agreement with another private equity sponsor that had been introduced to the Company by a member of the Board. Members of senior management and the introducing Board member met with representatives of the private equity sponsor to gauge the private equity sponsor’s interest in acquiring the Company. Shortly following the meeting the private equity sponsor informed the Company that it had no interest in proceeding and discussions with such party were terminated.

 

In August 2006 another financial advisor contacted the Company about a possible transaction involving another private equity sponsor (“Party A”), and arranged a meeting among the financial advisor’s representatives, senior management of the Company and representatives of Party A to discuss the potential acquisition of the Company by Party A. In September 2006, the Company engaged the financial advisor to represent the Company solely in connection with a potential transaction with Party A. Over a period of approximately six weeks, Party A conducted substantial due diligence on the Company’s business operations and finances. In November 2006, Party A expressed orally to representatives of the financial advisor an indication of interest to acquire the Company for between $23.00 and $25.00 per share, subject to additional financial and legal diligence and negotiation of definitive transaction documents. At that time, the Board determined to cease further discussions with Party A and on December 8, 2006 the Company terminated the engagement of its financial advisor.

 

On December 13, 2006, the Company engaged Lehman Brothers as its financial advisor to conduct a process relating to the possible sale of the Company due to Lehman Brothers’ capabilities in managing a corporate sale process. In addition, the Company believed that it was a good time to seek to sell the Company in light of favorable conditions in the capital markets and the increased level of merger and acquisition activity in the specialty retail sector that appeared, in part, to reflect an increased focus in this sector by private equity firms. The Company consulted with Lehman Brothers in December 2006 and January 2007, and indicated its frustration with its past efforts since July 2005 to sell the Company on acceptable terms to potential strategic and financial buyers. The Company’s management also expressed to Lehman Brothers their concern regarding the potential negative impact of a sale process or transaction involving a strategic buyer on employees and suppliers and of sharing potentially sensitive competitive information with strategic buyers in a diligence process.

 

After the Company’s consultation with Lehman Brothers, Lehman Brothers identified 31 potential acquirors of the Company, which Lehman Brothers reviewed with the Company in January 2007. The Company directed Lehman Brothers to contact 21 financial parties of the 31 parties identified by Lehman Brothers that the Company believed would be interested in a potential transaction with the Company. Following initial contact in late January 2007 by Lehman Brothers of the 21 financial parties, 14 parties, including Lee Equity, entered into confidentiality agreements with the Company under which confidential materials were provided to such parties in late February and early March 2007.

 

Following distribution of the materials, Lehman Brothers held numerous discussions with the various potential bidders regarding characteristics of the Company’s business and the overall sale process.

On March 21, 2007 and March 22, 2007, four parties, including Lee Equity, and three other private equity sponsors (“Party B”, “Party C” and “Party D”, respectively), submitted to Lehman Brothers preliminary indications of interest relating to an acquisition of the Company.

 

On March 26, 2007, a meeting of the Board was convened with representatives of Lehman Brothers present. Representatives of Lehman Brothers, participating telephonically, updated the Board regarding the Company’s process relating to a potential sale transaction and provided the Board with an overview of the preliminary indications of interest received. After general discussion, the Board directed Lehman Brothers to proceed with management presentations for the four bidders and to provide detailed business, operational, legal and financial information to the bidders in connection with their due diligence review of the Company.

 

On March 30, 2007, Party D attended a management presentation conducted by senior management of the Company, at which representatives of Lehman Brothers were also present.

 

On April 2, 2007, Lee Equity attended a management presentation conducted by senior management of the Company, at which representatives of Lehman Brothers were also present.

 

On April 6, 2007, Party B attended a management presentation conducted by senior management of the Company, at which representatives of Lehman Brothers were also present.

 

On April 9, 2007, Party C attended a management presentation conducted by senior management of the Company, at which representatives of Lehman Brothers were also present.

 

On April 12, 2007, the Company granted access to its online data room to Lee Equity, Party B, Party C and Party D.

 

On April 24, 2007, Party D contacted Lehman Brothers and provided a revised preliminary indication of interest based on Party D’s diligence conducted up until that time. Party D communicated to Lehman Brothers that it would be interested in proceeding with the pursuit of a potential transaction with the Company only if the Company paid for a third party consultant to be retained by Party D to assist with Party D’s diligence. After discussing Party D’s position with the Company’s management, on April 26, 2007, Lehman Brothers communicated to Party D that the Company was not interested in pursuing further a potential transaction with Party D under Party D’s proposed process terms.

 

On April 26, 2007, Lehman Brothers distributed the draft Merger Agreement that was prepared by Morgan, Lewis & Bockius LLP, the Company’s legal counsel (“Morgan Lewis”), to Lee Equity. On April 27, 2007, Lehman Brothers distributed the draft Merger Agreement to Party B and Party C.

 

On May 9, 2007, representatives of Lee Equity met with members of the Company’s management as well as representatives of Lehman Brothers, to discuss diligence matters relating to the Company’s business operations and finance. Lee Equity conducted a diligence review of the materials posted on the Company’s online data room and, in addition to the meeting with the Company’s management, from late April until mid-July 2007, Lehman Brothers and members of the Company’s management conducted several calls per week with representatives of Lee Equity regarding diligence related matters.

 

On May 10, 2007, members of the Company’s management, with representatives of Lehman Brothers present, met with representatives of Party B to discuss diligence matters relating to the Company’s business operations and finance. Party B also conducted a diligence review of the materials posted on the Company’s online data room.

 

On May 14, 2007, a representative of Party C met with the Company’s management and representatives of Lehman Brothers to discuss diligence matters relating to the Company’s business operations and finance. Party C also periodically reviewed diligence materials posted on the Company’s online data room.

 

The Board held its regularly scheduled annual meeting on May 16, 2007, and representatives of Lehman Brothers, participating telephonically, and Morgan Lewis attended a portion of the meeting. At this meeting, representatives of Morgan Lewis reviewed with the directors their fiduciary duties in connection with their review of strategic alternatives. Also at this meeting, the Board reviewed the process that Lehman Brothers had conducted to date with respect to strategic alternatives and discussed possible alternative approaches to that process. In addition, representatives of Lehman Brothers reviewed with the Board the terms of the preliminary indications of

interest that had been submitted. Following discussion, the Board of Directors directed Lehman Brothers, with the assistance of senior management, to provide each of the financial parties that had provided a preliminary indication of interest, including Lee Equity, with additional business, financial and legal information about the Company.

 

On May 21, 2007, representatives of Party C contacted representatives of Lehman Brothers and communicated that Party C’s revised indication of interest could potentially be significantly lower than Party C’s initial indication of interest. Party C also informed Lehman Brothers that an equity roll over, in which members of the Company’s senior management would convert their shares of Common Stock and Preferred Stock, as applicable, into shares of the surviving corporation in a possible sale transaction, would likely be required. Lehman Brothers discussed Party C’s position with members of the Company’s senior management. No further communications with Party C took place during the remainder of the sale process.

 

On May 22, 2007, Lehman Brothers distributed a bid and sale process letter to Lee Equity and Party C, and on May 25, 2007, Lehman Brothers distributed a bid and sale process letter to Party B.

 

Also on May 22, 2007, members of the Company’s management had an in person meeting with representatives of Lee Equity and representatives of Lehman Brothers during which store visits and discussion on various due diligence issues took place.

 

On June 6, 2007, Lee Equity delivered a non-binding proposal to the Company to acquire the Company for $26.50 per share in cash. Concurrently with submission of this non-binding proposal, Lee Equity provided drafts of its proposed debt financing commitment, as well as a comprehensive mark-up of the draft Merger Agreement previously distributed by Lehman Brothers to Lee Equity. In its bid, Lee Equity indicated that the acquisition would be financed from the following sources: (i) up to $110 million under a senior secured first lien term loan facility, (ii) up to $30 million under a senior secured revolving credit facility, (iii) up to $65 million under a senior secured second lien term loan facility, and (iv) a minimum of $108 million of equity financing. The term loan facilities and senior secured revolving credit facility would be provided by Barclays Capital, the investment banking division of Barclays Bank PLC (“Barclays”).

 

The Barclays debt financing commitment provided by Lee Equity with its initial bid was conditioned, among other things, on the Company’s achieving (i) EBITDA of not less than $33.3 million for the four fiscal quarter period ended with the fiscal quarter immediately prior to the closing, and (ii) an amount of same-store sales during the fiscal quarter ended immediately prior to the closing that represented a 1% increase over same store sales for the corresponding fiscal quarter of the prior fiscal year.

 

The mark-up of the draft Merger Agreement proposed by Lee Equity included, among other terms and conditions, a provision that Parent and Merger Sub would not be obligated to close in the event that Parent’s debt financing had not been obtained, and an indication that Lee Equity would require certain shareholders to enter into a voting agreement with Parent. In addition, Lee Equity indicated that the Company’s practice of paying regular quarterly dividends would not be permitted between the signing date and closing date.

 

On June 7, 2007, Lehman Brothers received an oral proposal from Party B to acquire the Company for $24.00 per share in cash. As a part of its proposal, Party B indicated that it would require additional due diligence estimated by Party B to take six weeks to complete, in addition to negotiation of definitive transaction documents, and that it would require an equity participation by the Company’s management as a part of the transaction. After discussion with the Company regarding Party B’s proposal and related terms, Lehman Brothers, when contacted by Party B on June 11, 2007, communicated to Party B that the Company was not interested in pursuing further a possible transaction with Party B.

 

Between June 6, 2007 and June 11, 2007, members of the Company’s senior management had several discussions with representatives of Lehman Brothers and Morgan Lewis regarding Lee Equity’s proposal.

 

On June 11, 2007, Lee Equity submitted an updated, non-binding proposal to acquire all of the shares of the Company at a purchase price of $27.00 per share in cash. Otherwise, Lee Equity’s original proposal was unchanged.

 

From June 11, 2007 to June 13, 2007, the Company’s management discussed with representatives of Lehman Brothers and Morgan Lewis the terms of the proposal submitted by Lee Equity and the revised purchase price. On

June 13, 2007, Lehman Brothers communicated to representatives of Lee Equity that the Company’s management would like to have an in-person meeting to continue negotiations.

 

On June 14, 2007, Marvin Rounick (our chief executive officer), Warren Weiner (our executive vice president) and Barry Susson (our chief financial officer), representatives from Morgan Lewis and representatives from Lehman Brothers met with Thomas H. Lee, the president of Lee Equity, and other representatives from Lee Equity and Lee Equity’s financial advisor, Bear, Stearns & Co., Inc. (“Bear Stearns”), during which the parties negotiated certain terms of Lee Equity’s proposal and discussed possible alternative structures for a transaction between Lee Equity and the Company. During the course of these discussions, Mr. Lee indicated that Lee Equity wanted to secure the services of each of Mr. Rounick and Mr. Weiner following the closing for transitional and other purposes, and that, accordingly, Lee Equity wished to enter into consulting agreements. Mr. Lee proposed three-year arrangements providing Mr. Rounick and Mr. Weiner with continuation during their consultancy of the current salary and certain benefits they were currently receiving from the Company. Although the parties did not agree on terms, Lee Equity also revised its offer by increasing the proposed per share price to $27.20 in cash.

 

On June 18, 2007, the Board of Directors held a telephonic meeting to receive an update on the potential sale process and to discuss the June 14 negotiations with Lee Equity. Representatives of Lehman Brothers and Morgan Lewis participated at the request of the Board. Lehman Brothers updated the Board regarding terms of the proposals that had been submitted, including the increase in Lee Equity’s non-binding offer to $27.20 per share in cash. Representatives from Morgan Lewis advised the Board regarding the negotiations of June 14 and the alternative transaction structures that were discussed with Lee Equity. In addition, representatives from Morgan Lewis discussed generally the proposed consulting arrangements and compensation and benefits for Messrs. Rounick and Weiner. The Board discussed Messrs. Rounick and Weiner obtaining separate legal counsel to represent them in their capacity as shareholders and in connection with possible consulting arrangements with Lee Equity. The Board also discussed Lee Equity’s financing commitment from Barclays and the related allocation of risks related to the certainty of completing the transaction among the parties.

 

On June 19, 2007, Morgan Lewis distributed comments on Lee Equity’s mark-up of the draft Merger Agreement to Weil, Gotshal and Manges LLP (“Weil”), Lee Equity’s legal counsel. The comments to the draft Merger Agreement reflected, among other things, that (i) the obligation of Parent and Merger Sub to consummate the merger would not be conditioned on Parent obtaining its debt financing, (ii) the Company expected to receive a $15 million “Parent Termination Fee” from Parent in the event that Parent did not close because it failed to obtain its debt financing, and (iii) the Company expected to continue the payment of its regular quarterly dividends. During the week of June 19, 2007, representatives from Morgan Lewis and Weil discussed these and other open issues with respect to the draft Merger Agreement.

 

On June 20, 2007, Weil distributed initial drafts of the consulting agreements for Messrs. Rounick and Weiner and the proposed voting agreement under which certain directors, officers and shareholders of the Company would agree to vote their shares in favor of the adoption of the Merger Agreement and the approval of the Merger. In addition, drafts of the consulting agreements and voting agreement were sent to counsel representing Messrs. Rounick and Weiner individually.

 

Between June 20, 2007 and July 20, 2007, Weil, Morgan Lewis, and separate counsel for each of Messrs. Rounick and Weiner continued discussions and negotiations regarding the terms of the consulting agreements and voting agreements. These discussions and negotiations included, with respect to the consulting agreements, the length and scope of the restrictive covenants that each of Messrs. Rounick and Weiner would agree to be bound by and the terms of the benefits to be provided to each. With respect to the voting agreement, the parties discussed, among other things, termination of the voting agreement upon termination of the Merger Agreement and the ability of the shareholders who are directors and officers of the Company to fulfill their fiduciary duties as directors and officers of the Company.

 

On June 21, 2007, Weil distributed the initial drafts of the equity commitment letter and limited guaranty, under which Lee Funding LP would agree to guaranty the payment of the “Parent Termination Fee” as described in the Merger Agreement, although payment of the “Parent Termination Fee” for failure of Parent to obtain its debt financing remained an open issue subject to further negotiation among the parties. Later that day, Morgan Lewis distributed to Weil the initial draft of the disclosure schedules to the Merger Agreement.

On June 22, 2007, Lehman Brothers communicated to Bear Stearns a number of the Company’s material issues with respect to the draft Merger Agreement, the equity financing commitment, the debt financing commitment and the proposed consulting and voting agreements. Among other issues, Lehman Brothers reiterated the Company’s position that it would require payment of the Parent Termination Fee if Parent failed to obtain its debt financing, and that the Company expected to continue payment of its regular quarterly dividends.

 

Between June 21, 2007 and July 22, 2007, representatives of Lehman Brothers and Morgan Lewis continued discussions with representatives of Bear Stearns and Weil, respectively, concerning outstanding issues under the Merger Agreement, the related disclosure schedules, the equity financing commitment, debt financing commitments, the proposed consulting and voting agreements and other outstanding matters. These discussions included details of the scope of representations, warranties and covenants contained in the Merger Agreement, the conditions to Lee Equity’s obligation to close the merger, and the Board’s ability to consider alternative transactions. Drafts of these documents were exchanged between Morgan Lewis and Weil.

 

On June 25, 2007, Lee Equity communicated to Lehman Brothers Lee Equity’s revised per share price of $27.25 conditioned on the Company’s agreement that the Company’s regular quarterly dividend payable in the third fiscal quarter of the 2008 fiscal year could be paid and that no other dividends would be paid by the Company. After discussion of the revised per share price with the Company, the parties agreed to the revised per share price and dividend payment terms.

 

With respect to the draft Merger Agreement, the parties continued to negotiate the allocation of the risks associated with Parent obtaining its debt financing, including the payment by Parent of the “Parent Termination Fee” in the event Parent failed to obtain its debt financing. In addition, Weil and Lee Equity indicated that same store sales and EBITDA conditions included in the debt financing commitment from Barclays would have to be satisfied in order for Parent and Merger Sub to close and that such terms should be reflected in the Merger Agreement. The parties continued negotiations regarding the inclusion of these conditions in the Merger Agreement and the debt commitment, as well as the specific terms related to these conditions.

 

On July 4, 2007, Weil distributed revised draft documents relating to Barclays’ debt financing commitment. The revised documents included a condition that, among other things, the Company achieve EBITDA of not less than $32 million for the four fiscal quarter period ended with the fiscal quarter immediately prior to the closing of the proposed transaction. In addition, the revised documents included a same store sales condition.

 

On July 7, 2007, the Company communicated to Lee Equity that it would be willing to agree to an EBITDA condition in the Merger Agreement and debt financing commitment of the Company achieving EBITDA of not less than $32 million for the twelve months ended July 31, 2007 and not less than $31 million for the twelve months ended October 31, 2007. The Company also communicated that it would not agree to a same store sales condition or an EBITDA condition if the transaction were to close anytime after November 15, 2007 in either the Merger Agreement or the debt financing commitment.

 

On July 13, 2007, representatives of Weil and Morgan Lewis discussed the outstanding open issues under the Merger Agreement, the voting agreement, the consulting agreements and the debt financing commitment. Later that day, Weil circulated revised drafts of the debt financing commitment, which did not include a same store sales condition. Weil also indicated that Lee Equity would like the Merger Agreement to include certain obligations of the Company to cooperate with Parent’s efforts to obtain its debt financing and that Lee Equity had agreed to the payment of the Parent Termination Fee in the event Parent is unable to obtain debt financing.

 

On July 23, 2007, in a telephone call between Mr. Rounick and Benjamin Hochberg (a principal of Lee Equity), in which a representative of Lehman Brothers participated, Mr. Hochberg indicated that Lee Equity would be interested in keeping the Company’s headquarters located in Philadelphia, maintaining the Company as a Pennsylvania corporation, and retaining the Company’s employees, including key senior management, for the foreseeable future.

 

On July 23, 2007 and July 24, 2007, representatives of the Company and Morgan Lewis had discussions and negotiations with representatives of Lee Equity and Weil, respectively, concerning all outstanding issues under the Merger Agreement, voting agreement and consulting agreements, as well as the guaranty of the Parent Termination

Fee. The debt financing commitment from Barclays, and the equity financing commitment, remained open and subject to ongoing negotiations between Lee Equity and Barclays.

 

On July 24, 2007, an in-person meeting of the Board of Directors was held in Philadelphia at which representatives from Morgan Lewis were present and representatives from Lehman Brothers participated telephonically. Also present were Mr. Susson and Stanley A. Uhr, the Company’s corporate counsel. At this meeting, Mr. Rounick and representatives from Lehman Brothers and Morgan Lewis advised the Board of Directors on the status of the Company’s discussions with Lee Equity. Representatives of Morgan Lewis and Lehman Brothers advised the Board of Directors regarding the legal standards applicable to its decision-making process and reviewed in detail the provisions of the Merger Agreement, the voting agreement and consulting agreements in their then-current draft form. Representatives from Lehman Brothers discussed with the Board its preliminary views on valuation based on the proposal from Lee Equity at the time. The Board of Directors engaged in extensive discussions concerning the potential benefits and considerations of the proposed merger transaction to the Company, the Company’s shareholders, and its employees. The Board, without Marvin Rounick, Warren Weiner and Jack Rounick present, considered the terms of the consulting agreements for Messrs. Rounick and Weiner and the voting agreement.

 

At the conclusion of the Board meeting on July 24, 2007, a telephonic meeting of the Company’s Board of Directors was scheduled for the late afternoon of July 25, 2007. During the course of the day of July 25, 2007, representatives of Weil communicated to representatives of Morgan Lewis that Lee Equity’s debt financing commitment from Barclays would not be finalized prior to the scheduled Board meeting as certain terms remained subject to on-going negotiations between Lee Equity and Barclays. Later that day, the telephonic meeting of the Board of Directors was rescheduled for the morning of July 26, 2007.

 

On July 26, 2007, during the course of the early morning, representatives of Weil communicated to representatives of Morgan Lewis that Lee Equity continued to negotiate the terms of the debt financing commitment with Barclays. At that time, a telephonic Board meeting was tentatively scheduled for later that afternoon, and then postponed until later that evening.

 

During the afternoon of July 26, Weil forwarded to Morgan Lewis the revised terms of the Barclays financing commitment, which included the condition that, among other things, the Company’s EBITDA for the four fiscal quarter period ended with the fiscal quarter immediately preceding the Merger and at least 15 days prior to the closing date of the Merger must not be less than $32 million; provided, that, if the closing has not occurred by November 15, 2007, the EBITDA for the four fiscal quarter period ended October 31, 2007 must not be less than $31 million and the Company’s ratio of maximum total indebtedness (giving pro forma effect to the Merger) to EBITDA must not exceed 5.47 to 1.0. Weil indicated that similar EBITDA conditions in the Merger Agreement would be acceptable to Lee Equity. Weil also delivered a revised equity financing commitment document that provided that Lee Equity’s equity commitment would be increased to a maximum amount of $128 million, to reflect the additional equity financing that may be required in order to meet the maximum total indebtedness test under Barclay’s financing commitment. Representatives of Morgan Lewis discussed the revised terms with representatives of Lehman Brothers and the Company’s management and the parties agreed to the revised terms.

 

On the evening of July 26, 2007, a telephonic meeting of the Board of Directors was held at which representatives from Morgan Lewis and Lehman Brothers were present. Also present were Mr. Susson and Mr. Uhr. At this meeting, Mr. Rounick and representatives from Lehman Brothers and Morgan Lewis advised the Board of Directors on the status of the Company’s discussions with Lee Equity. During the meeting, representatives of Lehman Brothers updated the Board on the events that had occurred since the meeting of the Board on July 24. Representatives of Morgan Lewis reviewed with the Board the updated, final terms of the proposed Merger Agreement, the voting agreement and the consulting agreements and further discussed the Board’s fiduciary duties. Representatives of Lehman Brothers and Morgan Lewis also reviewed with the Board the final terms of the debt financing commitments and equity financing commitments. Also at this meeting, representatives of Lehman Brothers reviewed with the Board its financial analysis of the merger consideration, and upon the request of the Board rendered to the Board an oral opinion, which opinion was confirmed by delivery of a written opinion dated July 26, 2007, to the effect that, as of that date and based on and subject to the matters described in its opinion, the merger consideration to be offered to the Company’s shareholders was fair, from a financial point of view, to the

Company’s shareholders. A copy of Lehman Brothers’ written opinion dated July 26, 2007, describing the assumptions made, matters considered and review undertaken by Lehman Brothers, is attached to the proxy statement as Annex B . By unanimous vote, the Board approved and declared advisable the Merger Agreement and the Merger and resolved to recommend that the Company’s shareholders adopt the Merger Agreement.

 

On the evening of July 26, 2007, the Company, Merger Sub and DSI Holdings, LLC executed the Merger Agreement. On the morning of July 27, 2007, the Company issued a press release announcing the Merger.

 

Reasons for the Merger; Recommendation of Our Board of Directors

 

Our Board of Directors believes that the Merger Agreement and the Merger are fair to the Company’s shareholders. In reaching these conclusions, the Board of Directors consulted with the Company’s management and legal and financial advisors, and considered the short-term and long-term interests and prospects of the Company and its shareholders and other constituencies. In reaching its determinations, the Board of Directors considered the following material factors that it believed supported its determinations:

 

advisor and outside legal counsel, that such proposal would result in a transaction that, if consummated, is more favorable to the Company’s shareholders from a financial point of view than the Merger;

 

 

The Board of Directors also considered a variety of risks and other potentially negative factors concerning the Merger. These factors included the following:

 

 

Our Board of Directors considered all of the factors listed above as a whole and decided that in their totality such factors support the decision to approve, adopt and authorize the Merger Agreement, the Merger and the other transactions contemplated therein and to recommend that the shareholders vote “FOR” the adoption of the Merger Agreement and the approval of the Merger. The discussion of the information and factors considered by our Board of Directors is not intended to be exhaustive and may not include all of the factors considered by our Board of Directors. Our Board of Directors did not quantify, rank or otherwise assign relative or specific values to any of the above factors or the other factors it considered. In addition, our Board of Directors did not reach any specific conclusion on each factor considered, but conducted an overall assessment of these factors. Individual members of our Board of Directors may have given different weight to different factors.

 

Our Board of Directors recommends that you vote “FOR” the adoption of the Merger Agreement and the approval of the Merger.

 

Opinion of the Company’s Financial Advisor

 

In December 2006, the Board of Directors engaged Lehman Brothers to act as its financial advisor with respect to exploring strategic alternatives, including a possible sale. On July 26, 2007, Lehman Brothers rendered its oral opinion (subsequently confirmed in writing) to the Board of Directors that, as of such date and based upon and subject to the matters stated in its opinion, the per share consideration of $27.25 in cash to be offered to our shareholders in the Merger was fair from a financial point of view to our shareholders.

 

The full text of Lehman Brothers’ written opinion, dated July 26, 2007, is attached as Annex B to this proxy statement. Shareholders are encouraged to read Lehman Brothers’ opinion carefully in its entirety for a description of the assumptions made, procedures followed, factors considered and limitations upon the review undertaken by Lehman Brothers in rendering its opinion. The following is a summary of Lehman Brothers’ opinion and the methodology that Lehman Brothers used to render its opinion. This summary is qualified in its entirety by reference to the full text of the opinion.

 

Lehman Brothers’ advisory services and opinion were provided for the information and assistance of the Board of Directors in connection with its consideration of the Merger. Lehman Brothers’ opinion is not intended to be and does not constitute a recommendation to any holder of Deb Common Stock as to how such shareholder should vote in connection with the Merger. Lehman Brothers was not requested to opine as to, and Lehman Brothers’ opinion does not address, Deb’s underlying business decision to proceed with or effect the Merger.

 

In arriving at its opinion, Lehman Brothers reviewed and analyzed, among other things:

 

 

In addition, Lehman Brothers had discussions with the management of Deb concerning its business, operations, assets, financial condition and prospects and undertook such other studies, analyses and investigations as Lehman Brothers deemed appropriate.

 

In arriving at its opinion, Lehman Brothers assumed and relied upon the accuracy and completeness of the financial and other information used by Lehman Brothers without assuming any responsibility for independent

verification of such information. Lehman Brothers further relied upon the assurances of the management of Deb that they were not aware of any facts or circumstances that would make such information inaccurate or misleading. With respect to the Management Case, upon advice of Deb, Lehman Brothers assumed that such projections were reasonably prepared on a basis reflecting the best currently available estimates and judgments of the management of Deb as to the future financial performance of Deb. Lehman Brothers also considered certain somewhat more conservative assumptions and estimates than those reflected in the Management Case (the “Sensitivity Analysis”). Lehman Brothers discussed these assumptions and estimates with the management of Deb who permitted Lehman Brothers to use such assumptions and estimates in performing its analysis. In arriving at its opinion, Lehman Brothers did not conduct a physical inspection of the properties and facilities of Deb and did not make or obtain any evaluations or appraisals of the assets or liabilities of Deb. Lehman Brothers’ opinion was necessarily based upon market, economic and other conditions as they existed on, and could be evaluated as of, July 26, 2007. Lehman Brothers was not requested by Deb to solicit, and Lehman Brothers did not solicit, any indications of interest from strategic buyers with respect to a potential sale of Deb. In performing its analysis, Lehman Brothers did review and consider the history of and the circumstances surrounding the indications of interest received by Deb from potential strategic buyers prior to the commencement of the sale process which resulted in the Merger.

 

The following is a summary of the material financial analyses used by Lehman Brothers in connection with providing its opinion to the Board of Directors. The financial analyses summarized below include information presented in tabular format. The tables alone do not constitute a complete description of the financial analyses. Accordingly, the analyses listed in the tables and described below must be considered as a whole. In order to fully understand the financial analyses used by Lehman Brothers, the tables must be read together with the text of each summary. Considering any portion of such analyses and of the factors considered, without considering all analyses and factors, could create a misleading or incomplete view of the process underlying Lehman Brothers’ opinion.

 

Historical Share Price Analysis

 

Lehman Brothers considered historical data with regard to the trading price of Deb Common Stock for the period from January 1, 2005 to July 25, 2007 and the relative stock price performances during this same period of Deb Common Stock, the Standard & Poors 500 Index and a composite of equities comprised of the Common Stocks of the selected companies listed under the caption “Selected Companies Analysis” below. The foregoing historical share price analysis was presented to the Board of Directors to provide it with background information and perspective with respect to the relative historical share price of Deb Common Stock. Lehman Brothers noted that during this period, the closing share price of Deb Common Stock ranged from a low of $21.30 to a high of $32.39, as compared to the per share Merger Consideration of $27.25.

 

Selected Companies Analysis

 

In order to assess how the public market values shares of similar publicly traded companies, Lehman Brothers, based on its experience with companies in the specialty retail and mall-based apparel retailing industries, reviewed and compared specific financial and operating data relating to Deb with selected companies that Lehman Brothers deemed relevant to Deb, including

 

 

 

As part of its selected companies analysis, Lehman Brothers calculated and analyzed, among other things, the multiples implied by Deb’s and each selected company’s enterprise value in relation to trailing twelve months and projected 2007 and 2008 earnings before interest, taxes, depreciation and amortization (“EBITDA”), as well as projected 2007 and 2008 P/E and P/E to Long-Term Growth multiples. The enterprise value of each company was obtained by adding its short and long term debt to the sum of the market value of its common equity and the book value of any minority interest, and subtracting its cash and cash equivalents. All of these calculations were performed, and based on publicly available financial data and estimates and closing prices, as of July 25, 2007, the last trading date prior to the delivery of Lehman Brothers’ oral opinion.

 

Lehman Brothers selected the companies listed above because their businesses and operating profiles were believed to be reasonably similar to that of Deb. However, because of the inherent differences between the business, operations and prospects of Deb and the businesses, operations and prospects of the selected companies, no selected company is exactly the same as Deb. Therefore, Lehman Brothers believed that it was inappropriate to, and therefore did not, rely solely on the quantitative results of the selected companies analysis. Accordingly, Lehman Brothers also made qualitative judgments concerning differences between the financial and operating characteristics and prospects of Deb and the companies included in the selected companies analysis that would affect the public trading values of each in order to provide a context in which to consider the results of the quantitative analysis. These qualitative judgments related primarily to the differing sizes, growth prospects, profitability levels and degree of operational risk between Deb and the companies included in the selected companies analysis.

 

Applying a selected range of multiples derived from the selected companies to the corresponding financial data for Deb prepared by the management of Deb, Lehman Brothers calculated an implied per share equity reference range of $24.32 to $26.66 for Deb. Lehman Brothers noted that the per share Merger Consideration of $27.25 was above this range of implied per share equity values.

 

Selected Transactions Analysis

 

Using publicly available information, Lehman Brothers reviewed and compared the purchase prices and financial multiples paid in 41 acquisitions of companies that Lehman Brothers, based on its experience with merger and acquisition transactions, deemed relevant to arriving at its opinion. Lehman Brothers chose the transactions used in the selected transactions analysis based on the similarity of the target companies in the transactions to Deb in terms of the industry, size, mix, margins and other characteristics of their businesses. Lehman Brothers reviewed the following transactions:

 

 

As part of its selected transactions analysis, Lehman Brothers calculated and analyzed, among other things, transaction values as multiples of the then (i) last twelve months sales of the target companies, (ii) last twelve months EBITDA of the target companies and (iii) last twelve months earnings before interest and taxes (“EBIT”) of the target companies.

 

The reasons for and the circumstances surrounding each of the transactions analyzed were diverse and there are inherent differences in the company size, business, operations, financial conditions and prospects of Deb, and the businesses, operations, financial conditions and prospects of the companies included in the selected transactions analysis. Therefore, Lehman Brothers believed that a purely quantitative selected transactions analysis would not be particularly meaningful in the context of the Merger and therefore did not rely solely on the quantitative results of the selected transactions analysis. Accordingly, Lehman Brothers also made qualitative judgments concerning differences between the characteristics of the transactions and the Merger. Lehman Brothers applied a range of multiples that it believed reflected the appropriate range of transaction value multiples applicable to Deb on a full change-in-control basis.

 

Applying the selected range of multiples derived from the selected transactions to the corresponding financial data for Deb, Lehman Brothers calculated an implied per share equity reference range of $26.93 to $31.69 for Deb.

Lehman Brothers noted that the per share Merger Consideration of $27.25 was within this range of implied per share equity values.

 

Discounted Cash Flow Analysis

 

As part of its analysis, and in order to derive an implied per share equity reference range for Deb, Lehman Brothers performed a 4.75-year discounted cash flow analysis for Deb of estimated after-tax unlevered free cash flows for 4/30/2007 through 1/31/2012.

 

A discounted cash flow analysis is a traditional valuation methodology used to derive a valuation of an asset by calculating the “present value” of estimated future cash flows of the asset. “Present value” refers to the current value of future cash flows or amounts and is obtained by discounting those future cash flows or amounts by a discount rate that takes into account macro-economic assumptions and estimates of risk, the opportunity cost of capital, expected returns and other appropriate factors. Lehman Brothers performed a discounted cash flow analysis for Deb by adding (1) the estimated present value of Deb’s projected after-tax unlevered free cash flows for 4/30/2007 through 1/31/2012 to (2) the estimated present value of the “terminal value” of Deb as of fiscal 2012. “Terminal value” refers to the value of all future cash flows from an asset at a particular point in time.

 

Lehman Brothers estimated a range of terminal EBITDA multiples of 6.0x to 7.5x. Lehman Brothers discounted the estimated unlevered free cash flow streams and the estimated terminal value to a present value at a range of discount rates from 13.0% to 15.0%. The discount rates utilized in this analysis were chosen by Lehman Brothers based on its expertise and experience with the specialty retail and mall-based apparel retailing industries and also on an analysis of the weighted average cost of capital of Deb and other selected companies. Lehman Brothers calculated per share equity reference ranges by first determining a range of enterprise values of Deb by adding the present values of the estimated after-tax unlevered free cash flows and terminal values for each EBITDA terminal multiple and discount rate scenario, and then subtracting from the enterprise values the net debt (which is total debt minus cash) of Deb, and dividing those amounts by the number of fully diluted shares of Deb. The discounted cash flow analysis for Deb was performed for two scenarios — one based on the Management Case and another based on the Sensitivity Analysis, reflecting somewhat more conservative assumptions and estimates relating to, among other things, lower growth in number of stores, lower increases in comparable store sales, lower gross margins, a gradual increase in selling, general and administrative expenses as a percentage of sales and lower capital expenditures, which assumptions and estimates were discussed with Deb management and Deb management permitted Lehman Brothers to use for purposes of its analysis.

 

Based on the Management Case, the discounted cash flow analysis of Deb yielded an implied per share equity reference range for Deb of $28.57 to $32.66, and $22.16 to $25.81, based on the Sensitivity Analysis. Lehman Brothers noted that the per share Merger Consideration of $27.25 was below the range of implied equity value calculated based on the Management Case, and above the range of implied equity values calculated based on the Sensitivity Analysis.

 

General

 

In connection with the review of the Merger by the Board of Directors, Lehman Brothers performed a variety of financial and comparative analyses for purposes of rendering its opinion. The preparation of a fairness opinion is a complex process and is not necessarily susceptible to partial analysis or summary description. In arriving at its opinion, Lehman Brothers considered the results of all of its analyses as a whole and did not attribute any particular weight to any analysis or factor considered by it. Furthermore, Lehman Brothers believes that the summary provided and the analyses described above must be considered as a whole and that selecting any portion of its analyses, without considering all of them, would create an incomplete view of the process underlying its analyses and opinion. In addition, Lehman Brothers may have given various analyses and factors more or less weight than other analyses and factors and may have deemed various assumptions more or less probable than other assumptions, so that the ranges of valuations resulting from any particular analysis described above should not be taken to be Lehman Brothers’ view of the actual value of Deb Common Stock.

 

In performing its analyses, Lehman Brothers made numerous assumptions with respect to industry risks associated with industry performance, general business and economic conditions and other matters, many of which

are beyond the control of Deb. Any estimates contained in Lehman Brothers’ analyses are not necessarily indicative of future results or actual values, which may be significantly more or less favorable than those suggested by such estimates. The analyses performed were prepared solely as part of Lehman Brothers’ analysis of the fairness from a financial point of view to holders of Deb Common Stock of the Merger Consideration and were prepared in connection with the delivery by Lehman Brothers of its opinion, dated July 26, 2007, to the Board of Directors. The analyses do not purport to be appraisals or to reflect the prices at which Deb Common Stock might trade following announcement of the Merger.

 

The terms of the Merger were determined through arm’s length negotiations between Deb and Lee Equity and were approved by the Board of Directors. Lehman Brothers did not recommend any specific amount or form of consideration to Deb or that any specific amount or form of consideration constituted the only appropriate consideration for the Merger. Lehman Brothers’ opinion was provided to the Board of Directors to assist it in its consideration of the proposed Merger. Lehman Brothers’ opinion does not address any other aspect of the proposed Merger and does not constitute a recommendation to any shareholder as to how to vote or to take any other action with respect to the Merger. Lehman Brothers’ opinion was one of the many factors taken into consideration by the Board of Directors in making its determination to approve the Merger Agreement. Lehman Brothers’ analyses summarized above should not be viewed as determinative of the opinion of the Board of Directors with respect to the value of Deb or of whether the Board of Directors would have been willing to agree to a different amount or form of consideration.

 

Lehman Brothers is an internationally recognized investment banking firm and, as part of its investment banking activities, is regularly engaged in the valuation of businesses and their securities in connection with mergers and acquisitions, negotiated underwritings, competitive bids, secondary distributions of listed and unlisted securities, private placements and valuations for corporate and other purposes. The Board of Directors selected Lehman Brothers because of its expertise, reputation and familiarity with Deb and the specialty retail and mall-based apparel retailing industries generally and because its investment banking professionals have substantial experience in transactions comparable to the Merger.

 

As compensation for its services in connection with the Merger, Deb has agreed to pay Lehman Brothers a financial advisory fee of approximately $3.5 million, a portion of which became payable upon the announcement of the Merger and a significant portion of which is contingent upon completion of the Merger. In addition, Deb has agreed to reimburse Lehman Brothers for reasonable out-of-pocket expenses incurred in connection with the Merger and to indemnify Lehman Brothers for certain liabilities that may arise out of its engagement by Deb and the rendering of the Lehman Brothers’ opinion.

 

In the ordinary course of its business, Lehman Brothers may actively trade in the securities of Deb for its own account and for the accounts of its customers and, accordingly, may at any time hold a long or short position in such securities.

 

Certain Effects of the Merger

 

Conversion of Outstanding Deb Common Stock and Preferred Stock and Cancellation of Stock Options

 

If the Merger Agreement is approved by our shareholders and the other conditions to the completion of the Merger are either satisfied or waived, Merger Sub will be merged with and into the Company, with the Company continuing as the surviving corporation. Upon the completion of the Merger, each issued and outstanding share of Common Stock, other than shares held by the Company, Parent, Merger Sub or their subsidiaries, will be converted into the right to receive $27.25 in cash. In addition, each issued and outstanding share of Preferred Stock will be converted into the right to receive $1,000.00 in cash. Our shareholders will be required to surrender their shares upon the completion of the Merger in exchange for such cash payments. After completion of the Merger, shareholders will not have the opportunity to liquidate their shares at a time and for a price of their own choosing. If all eligible shares are converted, the total merger consideration (excluding consideration to be paid to option holders) expected to be paid is approximately $391 million.

 

Each option to acquire shares of our Common Stock that is outstanding immediately prior to the effective time of the Merger, will become fully-vested and exercisable and each holder of an option will be entitled to receive a

cash payment with respect to each option held by the holder equal to the product of the number of shares subject to such option multiplied by the excess of (a) $27.25 per share less (b) the exercise price of such option, without interest. The total amount expected to be paid in respect of options is approximately $463,550.

 

Effect on Listing; Registration and Status of Deb Common Stock

 

Our Common Stock is registered as a class of equity securities under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is traded on the NASDAQ Global Select Market under the symbol “DEBS.” As a result of the Merger, Deb will be a privately-held company, with no public market for its Common Stock. After the Merger, our Common Stock will cease to be traded on the NASDAQ Stock Market (“NASDAQ”), and price quotations with respect to sales of shares of our Common Stock in the public market will no longer be available. In addition, registration of our Common Stock under the Exchange Act will be terminated. This termination and the delisting of Deb’s Common Stock from NASDAQ will make certain provisions of the Exchange Act inapplicable to Deb as a stand-alone company, such as:

 

 

In addition, Deb will no longer be required to file periodic reports with the SEC after the effective time of the Merger.

 

Considerations Relating to the Proposed Merger

 

Set forth below are certain risks relating to the proposed Merger. The following is not intended to be an exhaustive list of the risks relating to the Merger and should be read in conjunction with the other information in this proxy statement. In addition, you should refer to the section entitled “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2007, which is incorporated in this proxy statement by reference, for other risks relating to the Company’s business:

 

Failure to complete the Merger could negatively affect the market price of the Company’s Common Stock.

 

If the Merger is not completed for any reason, the Company will be subject to a number of material risks, including the following:

 

 

If the Merger is not approved by our shareholders at the special meeting, the Company, Parent and Merger Sub will not be permitted under Pennsylvania law to complete the Merger, and each of the Company and Parent will have the right to terminate the Merger Agreement. Upon such termination, the Company may be required, under certain circumstances, to pay Parent a termination fee. See “Terms of the Merger Agreement — Termination of the Merger Agreement” beginning on page 46 of this proxy statement.

Further, if the Merger is terminated and our Board of Directors seeks another merger or business combination, shareholders cannot be certain that we will be able to find a party willing to pay an equivalent or better price than the price to be paid in the proposed merger.

 

Unless the Merger Agreement is terminated, the Company will not be able to enter into a merger or business combination with another party at a favorable price because of restrictions in the Merger Agreement.

 

Unless and until the Merger Agreement is terminated, subject to specified exceptions, the Company is restricted from initiating, soliciting, or taking any action to facilitate or encourage the submission of any offer or proposal relating to an alternative transaction with any person or entity other than Parent. In addition, the Company will not be able to enter into an alternative transaction at a more favorable price, unless and until the Merger Agreement is terminated, which may result in the Company incurring potentially significant liability to Parent. See “Terms of the Merger Agreement — Conduct of Business Pending the Merger — Restrictions on Solicitations” beginning on page 42 of this proxy statement and “Terms of the Merger Agreement — Termination of the Merger Agreement” beginning on page 46 of this proxy statement.

 

Uncertainties associated with the Merger may cause the Company to lose key personnel.

 

Our current and prospective employees may be uncertain about their future roles and relationships with the Company following the completion of the Merger. This uncertainty may adversely affect our ability to attract and retain key management and personnel.

 

Financing of the Merger

 

The total amount of funds required to complete the Merger and the related transactions, including the payment of fees and expenses in connection with the Merger, is anticipated to be approximately $410 million. Lee Equity has advised us that this amount is expected to be provided through a combination of:

 

 

The Merger Agreement contemplates a period of 21 consecutive calendar days, which we refer to as the “Marketing Period,” to consummate the transactions contemplated by the debt commitment letter. The Marketing Period will commence after the later of (i) September 4, 2007 and (ii) the second business day following the mailing of this proxy statement.

 

The following arrangements are in place with regard to financing for the Merger, including the payment of related transaction costs, charges, fees and expenses:

 

Debt Commitment Letter

 

Lee Equity has advised us that Parent has entered into a commitment letter, dated as of July 26, 2007, which we refer to in this proxy statement as the “debt commitment letter,” with Barclays. Under the debt commitment letter, Barclays will act as the sole and exclusive administrative agent for the Facilities and Barclays Capital, the investment banking division of Barclays, will act as sole lead arranger, bookrunner and syndication agent for the facilities. Pursuant to, and subject to the terms and conditions of, the debt commitment letter, Barclays, as sole administrative agent, has committed to provide to Parent and, after the closing of the Merger, Deb, as the surviving

corporation and the borrower, the Facilities. The financing described in the debt commitment letter is referred to in this proxy statement as the “bank financing.”

 

Although the bank financing is not subject to Barclays’ satisfaction with their due diligence or to a “market out,” such financing might not be funded on the closing date because of failure to meet the closing conditions listed below or for other reasons. As of the date of this proxy statement, Parent and Merger Sub have not made alternative financing arrangements or alternative financing plans in the event the bank financing described herein is not available as anticipated. The commitments to provide the bank financing are subject to customary conditions for financings of these types, including but not limited to, the following:

 

 

 

The Company’s EBITDA, calculated in accordance with the terms of the Merger Agreement, for the twelve months ending July 31, 2007 was $33.6 million.

 

The commitments of Barclays Capital under the debt commitment letter will terminate on the earliest to occur of:

 

 

Since the final terms of the Facilities have not been agreed upon, the final terms and amounts may differ from those set forth above and below and, in certain cases, such differences may be significant. Except to the extent required by applicable law, the Company does not intend to update or otherwise revise the description of any of the terms of the financing included in this proxy statement to reflect circumstances existing after the date when such statements were made or to reflect the occurrence of future events, even in the event that any of the statements regarding the financing arrangements are shown to no longer be appropriate. After giving effect to the contemplated draws under the Facilities, Lee Equity currently expects total new debt outstanding at the closing of the Merger to be approximately $175 million.

 

Equity Financing

 

Lee Equity has advised us that on July 26, 2007, Lee Funding and Parent entered into a commitment letter, which we refer to in this proxy statement as the “equity commitment letter,” pursuant to which Lee Funding committed to purchase up to $128 million of certain equity securities of Parent. The proceeds of this equity investment will be contributed by Parent to Merger Sub. The equity commitment is subject to the satisfaction or waiver by Parent of the conditions to the obligations of Merger Sub and Parent to complete the Merger as set forth in the Merger Agreement. Lee Funding may assign its interests and obligations under the equity commitment letter only to any one or more of its affiliates, provided that Lee Funding remains obligated to perform the obligations in the event of a failure to perform by the affiliate. Neither Deb nor any other person or entity other than Parent has any rights under the equity commitment letter.

 

Lee Funding’s equity commitment will terminate upon the termination of the Merger Agreement pursuant to its terms.

 

Limited Guarantee; Remedies

 

In connection with the Merger Agreement, Lee Funding has agreed with Deb to guarantee the due and prompt payment of the termination fee payable by Parent under the Merger Agreement, up to a maximum amount of $15 million, if applicable. The limited guarantee will remain in full force and effect until the effective time of the Merger or the termination of the Merger Agreement in circumstances where no termination fee is payable by Parent.

 

If Deb terminates the Merger Agreement and is entitled to receive a termination fee, Deb’s exclusive remedy for the failure of Parent and Merger Sub to complete the Merger is a termination fee of $15 million payable to Deb in the circumstances described under “Terms of the Merger Agreement — Fees and Expenses — Termination Fees Payable by Parent.”

 

Interests of Deb’s Directors and Officers in the Merger

 

In considering the recommendation of our Board of Directors, you should be aware that Deb’s directors and executive officers may be deemed to have interests in the transaction that are different from or in addition to the interests of Deb shareholders generally and that may present a conflict of interest. Our Board of Directors was aware of these interests and considered that the interests may be different from or in addition to the interests of our shareholders generally, among other matters, in approving the Merger Agreement and the transactions contemplated thereby and in determining to recommend that our shareholders vote for adoption of the Merger Agreement and approval of the Merger.

 

Consulting Agreements

 

Messrs. Rounick and Weiner have each entered into consulting agreements with Merger Sub, under which each has agreed, for a period of three years following the closing of the Merger, to serve as a consultant to the surviving corporation to assist the surviving corporation in conducting its business. The agreements provide that there is no minimum time commitment required of Messrs. Rounick and Weiner. As compensation for their services, the surviving corporation will provide the following benefits to Messrs. Rounick and Weiner:

 

 

Messrs. Rounick and Weiner will be subject to non-solicitation and non-competition restrictions during the three year period of the consultancy, and will be subject to confidentiality restrictions. Based on the Company’s current health policy costs, and assuming actuarial life expectancies and a 10% cost of capital, the present value of the estimated costs of the health benefits for Messrs. Rounick and Weiner and their spouses are approximately $81,000 and $83,000, respectively. There is no incremental cost to the Company for the other benefits, other than the consultant fees and legal fee reimbursements, provided to Messrs. Rounick and Weiner.

 

Treatment of Stock Options

 

The Merger Agreement provides that immediately prior to the effective time of the Merger, each outstanding option to purchase our Common Stock granted under any Deb stock option or compensation plan will become fully-vested and exercisable and each holder will be entitled to receive a cash payment with respect to each option held by the holder equal to the product of the number of shares subject to such option multiplied by (a) the excess of $27.25 per share less (b) the exercise price of such option, without interest.

The table provides information, for each of our directors and executive officers that currently hold options to purchase our Common Stock, regarding the aggregate number of shares of Common Stock subject to outstanding vested and unvested options as of September 18, 2007, the aggregate number of shares of Common Stock subject to outstanding unvested options that will become fully-vested in connection with the Merger, the exercise price and the value of the unvested options, and the exercise price and value of all options. The information in the table assumes that all options will remain outstanding as of the effective time of the Merger.

 

 

 

 

Severance Payments and Benefits Under Employment Agreements

 

Consummation of the Merger will constitute a change of control under the employment agreement between the Company and Allan Laufgraben, Senior Vice President, Merchandising. Under Mr. Laufgraben’s employment agreement, if his employment is terminated by Deb without cause, or by Mr. Laufgraben for “good reason” (each as defined in the employment agreement) during the term of his employment agreement, following a change of control, Mr. Laufgraben is entitled to receive (a) an amount equal to his base salary for the remainder of the term of the employment agreement which expires on January 31, 2008 and (b) continued medical benefits for him and his spouse until their deaths. The value of the severance pay is $150,000 assuming a termination following a change of control as of September 30, 2007. Based on the Company’s current health policy costs, and assuming actuarial life expectancies and a 10% cost of capital, the present value of the estimated cost of the health benefits to Mr. Laufgraben and his spouse is approximately $79,000.

 

Indemnification of Executive Officers and Directors

 

The Merger Agreement contains provisions relating to the indemnification of and insurance for Deb’s directors and officers. Under the Merger Agreement, Parent and the surviving corporation will indemnify and hold harmless Deb’s current and former officers, directors and employees for acts or omissions occurring at or prior to the effective time of the Merger to the fullest extent provided under Deb’s articles of incorporation and bylaws or any indemnification agreements or other applicable contract of Deb (in each case, as in effect as of the date of the Merger Agreement). Without limiting the foregoing, Parent has agreed, for six years after the effective date of the Merger, to indemnify and hold harmless such persons for claims arising out of any acts or omissions of such persons in their corporate capacities, or the Merger, the Merger Agreement and transactions contemplated by the Merger Agreement.

Directors’ and Officers’ Insurance

 

Under the Merger Agreement, Parent has agreed that for a period of six years following the effective time of the Merger, Parent will provide, or cause the surviving corporation to provide, (i) officers’ and directors’ liability insurance that provides coverage for events occurring at or prior to the effective time of the Merger, covering each person currently covered by Deb’s officers’ and directors’ liability insurance policy that is no less favorable in any material respect in the aggregate than the policy currently in effect or, if substantially equivalent coverage is unavailable, the best available coverage; provided, however that Parent and the surviving corporation will not be obligated to pay an aggregate premium in excess of 300% of the amount currently paid by Deb for such insurance; provided further, that if the annual premiums of such insurance coverage exceed such amount, Parent or the surviving corporation will be obligated to obtain a policy with the greatest coverage available for a cost not exceeding such amount or (ii) a non-cancelable “tail” coverage insurance policy under Deb’s current officers’ and directors’ liability insurance policies (providing coverage not less favorable than currently provided by such insurance) with respect to matters existing or occurring prior to the effective time of the Merger.

 

If the surviving corporation (i) consolidates with or merges into any other person and is not the continuing or surviving entity of such consolidation or merger, or (ii) transfers or conveys all or a majority of its properties and assets to any person, then, and in each such case, proper provision shall be made so that the successors and assigns of the surviving corporation will assume the obligations described above.

 

The foregoing summary of the indemnification of executive officers and directors’ and executive officers’ insurance is not complete and is qualified in its entirety by reference to the Merger Agreement, which is attached to this proxy statement as Annex A .

 

Arrangements with Parent and Lee Equity

 

As of the date of this proxy statement and except for the consulting agreements described above, none of our executive officers has entered into any agreement, arrangement or understanding with Lee Equity or its affiliates regarding employment with, or the right to participate in the equity of, Deb on a going-forward basis following completion of the Merger. In addition no member of our Board of Directors has entered into any agreement, arrangement or understanding with Lee Equity or its affiliates regarding the right to participate in the equity of Deb following completion of the Merger.

 

Lee Equity has informed us that it intends to retain members of our existing senior management team after the Merger is completed.

 

Material U.S. Federal Income Tax Consequences of the Merger to Our Shareholders

 

The following is a summary of the material U.S. federal income tax consequences of the Merger to certain holders of our Common Stock. This summary is based on the Internal Revenue Code of 1986, as amended, referred to as the “Code” in this proxy statement, regulations promulgated under the Code, administrative rulings and pronouncements issued by the Internal Revenue Service and court decisions now in effect. All of these authorities are subject to change, possibly with retroactive effect so as to result in tax consequences different from those described below. We have not sought any ruling from the IRS with respect to statements made and conclusions reached in this discussion, and the statements and conclusions in this proxy are not binding on the IRS or any court. We can provide no assurances that the tax consequences described below will not be challenged by the IRS or will be sustained by a court if so challenged.

 

This summary does not address all of the U.S. federal income tax consequences that may be applicable to a particular holder of our Common Stock. In addition, this summary does not address the U.S. federal income tax consequences of the Merger to holders of our Common Stock who are subject to special treatment under U.S. federal income tax laws, including, for example, banks and other financial institutions, insurance companies, tax-exempt investors, S corporations, U.S. expatriates, dealers in securities, traders in securities who elect the mark-to-market method of accounting for their securities, regulated investment companies, mutual funds, controlled foreign corporations, holders who hold their Common Stock as part of a hedge, straddle or conversion transaction, holders whose functional currency is not the U.S. dollar, holders who own 5% or more of all our Common Stock, holders

who acquired our Common Stock through the exercise of employee stock options or other compensatory arrangements, holders who are subject to the alternative minimum tax provisions of the Code and holders who do not hold their shares of our Common Stock as “capital assets” within the meaning of Section 1221 of the Code.

 

This discussion does not address the U.S. federal income tax consequences to any holder of our Common Stock who or which, for U.S. federal income tax purposes, is a nonresident alien individual, a foreign corporation, a foreign partnership or a foreign estate or trust. In addition, this discussion does not address U.S. Federal estate or gift tax consequences of the Merger, or the tax consequences of the merger under state, local, or foreign tax laws.

 

If a partnership or other passthrough entity (including any entity treated as a partnership for U.S. federal income tax purposes) is a beneficial owner of our Common Stock, the tax treatment of a partner in the partnership generally will depend upon the status of the partner and the activities of the partnership. A beneficial owner that is a partnership and partners in such a partnership should consult their tax advisors about the U.S. federal income tax consequences of the Merger.

 

This summary is provided for general information purposes only and is not intended as a substitute for individual tax advice. Each holder of Deb Common Stock should consult the holder’s individual tax advisors as to the particular tax consequences of the Merger to such holder, including the application and effect of any state, local, foreign or other tax laws and the possible effect of changes to such laws.

 

Exchange of Common Stock for Cash.   Generally, the Merger will be taxable to the holders of our Common Stock for U.S. federal income tax purposes. A holder of our Common Stock receiving cash in the Merger generally will recognize gain or loss for U.S. federal income tax purposes in an amount equal to the difference between the amount of cash received and the holder’s adjusted tax basis in our Common Stock surrendered. Any such gain or loss generally will be capital gain or loss if our Common Stock is held as a capital asset at the effective time of the Merger. Any capital gain or loss will be taxed as long-term capital gain or loss if the holder has held our Common Stock for more than one year prior to the effective time of the Merger. If the holder has held our Common Stock for one year or less prior to the effective time of the Merger, any capital gain or loss will be taxed as short-term capital gain or loss. Currently, most long-term capital gains for non-corporate taxpayers are taxed at a maximum federal tax rate of 15%. The deductibility of capital losses is subject to certain limitations. If a holder acquired different blocks of Deb Common Stock at different times and different prices, such holder must determine the adjusted tax basis and holding period separately with respect to each such block of Deb Common Stock.

 

Information Reporting and Backup Withholding.   Generally, holders of Deb Common Stock will be subject to information reporting on the cash received in the Merger unless such a holder is a corporation or other exempt recipient. In addition, under the U.S. federal backup withholding tax rules, the paying agent will be required to withhold 28% of all cash payments to which a holder of Deb Common Stock is entitled in connection with the Merger unless such holder provides under penalties of perjury on a Form W-9 (or appropriate substitute form) a tax identification number, certifies that such holder is a U.S. person and that tax identification number is correct and that no backup withholding is otherwise required, and otherwise complies with such backup withholding rules. Each holder of Deb Common Stock should complete and sign the Form W-9 (or appropriate substitute form) included as part of the letter of transmittal and return it to the paying agent, in order to certify that the holder is exempt from backup withholding or to provide the necessary information to avoid backup withholding. Backup withholding is not an additional tax. Any amount withheld from a payment to a holder of Deb Common Stock under these rules will be allowed as a credit against such holder’s U.S. federal income tax liability and may entitle such holder to a refund, provided that the required information is furnished timely to the IRS.

 

HOLDERS OF DEB COMMON STOCK ARE STRONGLY URGED TO CONSULT THEIR TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING THE APPLICABILITY AND EFFECT OF UNITED STATES FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX LAWS IN THEIR PARTICULAR CIRCUMSTANCES.

 

Regulatory and Other Governmental Approvals

 

The HSR Act and related rules provide that transactions such as the Merger may not be completed until certain information and documents have been submitted to the FTC and the Antitrust Division and specified waiting period requirements have been observed. On August 14, 2007, the Company and Parent, an affiliate of Lee Equity Partners, LLC, each filed a Notification and Report Form with the Antitrust Division and the FTC and requested early termination of the waiting period. On August 27, 2007, the Company and Parent were notified that early termination of the waiting period under the HSR Act had been granted.

 

Under the Merger Agreement, the Company, Parent and Merger Sub have agreed to use their reasonable best efforts to obtain all required governmental approvals in connection with the execution of the Merger Agreement and completion of the Merger. In addition, the Company, Parent and Merger Sub have agreed to use their reasonable best efforts to take those actions that may be necessary to resolve any objections asserted on antitrust grounds with respect to the Merger, including agreeing to hold separate or to divest any businesses or assets of Parent, Merger Sub or the Company.

 

Except as noted above with respect to the required filings under the HSR Act, at or before the effective date of the Merger, we are unaware of any material federal, state or foreign regulatory requirements or approvals required for the execution of the Merger Agreement or completion of the Merger.

 

TERMS OF THE MERGER AGREEMENT

 

The following is a summary of the material provisions of the Merger Agreement and is qualified in its entirety by reference to the complete text of the Merger Agreement which is attached as Annex A to this proxy statement. We urge you to read the Merger Agreement carefully and in its entirety because it, and not this proxy statement, is the legal document that governs the Merger.

 

General; The Merger

 

At the effective time of the Merger, upon the terms and subject to the satisfaction or waiver of the conditions of the Merger Agreement and in accordance with the Pennsylvania Business Corporation Law, Merger Sub will merge with and into Deb and the separate corporate existence of Merger Sub will end. Deb will be the surviving corporation in the Merger and will continue to be a Pennsylvania corporation after the Merger and a wholly-owned subsidiary of Parent. Deb’s articles of incorporation will be the articles of incorporation and Merger Sub’s bylaws will be the bylaws of the surviving corporation.

 

The directors of Merger Sub at the effective time of the Merger will, from and after the effective time of the Merger, be the initial directors of Deb, as the surviving corporation. Our officers at the effective time of the Merger will, from and after the effective time of the Merger, be the initial officers of Deb, as the surviving corporation; provided, however, that Marvin Rounick and Warren Weiner will resign from all positions as officers and directors of Deb as of the effective time of the Merger. Other than Messrs. Rounick and Weiner, our current officers are Allan Laufgraben, Senior Vice President, Merchandising, Barry J. Susson, Vice President, Chief Financial Officer and Assistant Secretary, Stanley A. Uhr, Vice President and Corporate Counsel, John DeAngelis, Vice President, Real Estate, Stephen P. Smith, Vice President, Information Systems, Joan M. Nolan, Vice President and Chief Accounting Officer and Lorraine K. Koc, Vice President and General Counsel.

 

When the Merger Becomes Effective

 

Deb and Merger Sub will file articles of merger with the Department of State of the Commonwealth of Pennsylvania, after the satisfaction or waiver of the conditions to the Merger Agreement as soon as practicable (and in any event within five (5) business days) after the satisfaction or waiver of the conditions to the Merger Agreement. Unless otherwise agreed to by the parties, in no event shall the closing for the Merger take place prior to the earlier of (i) a date during Marketing Period specified by Parent, provided Parent provides Deb with at least five business days prior notice; and (ii) the final day of the Marketing Period.

 

The Merger will become effective at the time the articles of merger are duly filed with the Department of State of the Commonwealth of Pennsylvania or at such other later date and time as Deb and Parent agree and specify in the articles of merger.

 

If our shareholders approve the Merger Agreement, the Company and Parent intend to complete the Merger as soon as practicable thereafter. Because the Merger is subject to certain conditions, the exact timing of the Merger cannot be determined.

 

Consideration to be Received Pursuant to the Merger

 

 

 

Treatment of Our Stock Options

 

Prior to the completion of the Merger, each outstanding unvested stock option will automatically accelerate and become fully-vested and exercisable. Upon the completion of the Merger, all outstanding stock options will be cancelled and the holders of each stock option will be entitled to receive a cash payment equal to the product of:

 

 

 

Subject to any applicable withholding taxes, the payment for options will be made, without interest, through our payroll systems.

 

We are required to ensure that there will be no stock options exercisable for our capital stock outstanding following the effective time of the Merger.

 

Payment for Deb Common Stock in the Merger

 

On the closing date, Parent will deposit or will cause the Company to deposit with American Stock Transfer & Trust Company, the paying agent, in a separate fund established for the benefit of the holders of Deb’s Common Stock, Preferred Stock and holders of options, sufficient cash to pay those shareholders the amounts they are entitled to receive under the Merger Agreement. At the close of business on the closing date of the Merger, there will be no further transfers in the records of Deb or its transfer agent of certificates representing Deb’s Common Stock or Preferred Stock (each a “Certificate” and together the “Certificates”). On or after the effective time of the Merger, any Certificates presented to the paying agent or Parent will be converted into the merger consideration. After the effective time of the Merger, subject to the right to surrender Certificates in exchange for payment of the merger consideration, our shareholders will cease to have any rights as a shareholder of Deb.

 

As soon as reasonably practical after the effective time of the Merger (and in any event within five (5) business days), the paying agent will mail to each record holder of Deb Common Stock and Preferred Stock a letter of transmittal and instructions for use in effecting the surrender of their Certificates in exchange for the merger consideration.

 

Upon surrender of a shareholder’s certificates to the paying agent with a properly executed letter of transmittal and any other items specified by the letter of transmittal and instructions, the paying agent will promptly deliver to a shareholder the appropriate common and/or preferred stock per share merger consideration multiplied by the number of shares formerly represented by the surrendered certificates. The surrendered certificates will be cancelled upon delivery of the merger consideration. Parent or the paying agent may reduce the amount of any merger consideration paid to you by any applicable withholding taxes as required under federal, stated, local or foreign tax law.

 

Lost Certificates

 

If any Certificate is lost, stolen or destroyed, the paying agent will deliver the applicable merger consideration due in respect of the shares formerly represented by that Certificate if:

 

 

Unclaimed Amounts

 

Any portion of the exchange fund which remains undistributed to our shareholders after the one year anniversary of the effective time of the Merger will be delivered by the paying agent to Parent upon demand, and any of our shareholders who have not previously surrendered their Certificates will be entitled to look only to Parent for payment of the merger consideration due in respect of the shares formerly represented by their Certificates. Subject to other terms of the Merger Agreement, if any Certificates are not surrendered prior to six years after the effective time of the Merger, any merger consideration attributable to the shares formerly represented by such certificates will, to the extent permitted by law, become property of Parent, free and clear of all claims or interests.

 

Representations and Warranties

 

The Merger Agreement contains representations and warranties of Deb, Merger Sub and Parent, negotiated between the parties and made as of specific dates solely for purposes of the Merger Agreement, including setting forth the respective rights of the parties with respect to their obligation to complete the Merger. The representations and warranties are qualified by information in confidential disclosure schedules provided by the Company to Parent and Merger Sub in connection with the signing of the Merger Agreement, and may be subject to important limitations and qualifications as set forth in the Merger Agreement, including a contractual standard of materiality different from that generally applicable under federal securities laws. The confidential disclosure schedules contain information that modifies, qualifies and creates exceptions to the representations and warranties set forth in the Merger Agreement. Moreover, certain representations and warranties in the Merger Agreement were used for the purpose of allocating risk between the Company on one hand and Parent and Merger Sub on the other hand, rather than establishing matters as facts. Accordingly, you should not rely on the representations and warranties in the Merger Agreement as characterizations of the actual state of facts about the Company, Parent or Merger Sub.

 

The Merger Agreement contains a number of representations and warranties made by the Company, Parent and Merger Sub that relate to, among other things:

 

 

The Company’s representations and warranties relate to, among other things:

 

 

 

Parent and Merger Sub also make representations and warranties relating to financing of the merger consideration, absence of litigation, the privacy of information provided for this proxy statement and lack of ownership of our Common Stock or Preferred Stock. The financing of the merger consideration is discussed below under “Parent Financing” on page 45.

 

Many of our representations and warranties are qualified as to “materiality” or “material adverse effect.” For purposes of the Merger Agreement, “material adverse effect” means, with respect to the Company, any change, event, development or effect that individually or in the aggregate has had or would be reasonably expected to have a material adverse effect on the business, financial condition or results of operations, properties or assets of the Company and its subsidiaries, taken as a whole, other than any material adverse effect resulting from:

 

 

The representations and warranties of the parties to the Merger Agreement will expire upon the effective time of the Merger or the termination of the Merger Agreement.

 

Conduct of Business Pending the Merger

 

Interim Operations of Deb

 

We have agreed to restrictions on the operation of the business of the Company and our subsidiaries until either the effective time of the Merger or the termination of the Merger Agreement. In general, we have agreed to conduct business in the ordinary course consistent with past practice and to use commercially reasonable efforts to preserve intact the present business organization and keep available the services of all officers, employees and consultants who are integral to the current operation of the business of the Company and our subsidiaries. In addition, we have agreed that, among other things and subject to certain exceptions, we are restricted from and must prevent any of our subsidiaries from, without Parent’s prior written consent:

 

 

 

Parent and Merger Sub are restricted from taking any action that would, individually or in the aggregate, prevent, materially delay or materially impede their ability to consummate the Merger.

 

Special Meeting of Deb’s Shareholders; Board of Director’s Recommendation

 

Our Board of Directors unanimously voted to recommend the adoption of the Merger Agreement and approval of the Merger by our shareholders and to call a special meeting for this purpose. Our Board of Directors, however, can withdraw or modify its recommendation with respect to the adoption of the Merger Agreement and approval of the Merger if certain conditions and circumstances are satisfied as discussed in the following section, “Restrictions on Solicitations.”

 

Restrictions on Solicitations

 

We have agreed that prior to the effective time of the Merger we will not, and we will ensure that our representatives do not, directly or indirectly:

 

 

Notwithstanding the restrictions on solicitation set forth above, at any time prior to the adoption of the Merger Agreement by our shareholders, we may, subject to our Board of Directors determination that a Competing Proposal constitutes or would reasonably be expected to result in a Superior Proposal and providing prior written notice to Parent that our Board of Directors intends to take such action:

 

 

In the event that our Board of Directors concludes in good faith that a Competing Proposal constitutes a Superior Proposal, and provides Parent and Merger Sub with four (4) business days prior written notice, which notice shall specify the material terms and conditions of such Superior Proposal (and be updated upon any material revisions of such Superior Proposal), our Board of Directors may:

 

 

Parent has the right during the four day notice period to propose changes to the Merger Agreement. In the event that our Board of Directors were to change their recommendation and/or terminate the agreement to enter into an agreement with respect to a Superior Proposal, we would be required to pay Parent a termination fee of $15 million.

 

As set forth in the Merger Agreement:

 

 

Other Covenants

 

Indemnification and Insurance

 

Under the Merger Agreement, Parent has agreed that for a period of six years following the effective time of the Merger, Parent will provide, or cause the surviving corporation to provide:

 

 

If the surviving corporation (i) consolidates with or merges into any other person and is not the continuing or surviving entity of such consolidation or merger, or (ii) transfers or conveys all or a majority of its properties and assets to any person, then, and in each such case, proper provision shall be made so that the successors and assigns of the surviving corporation will assume the obligations described above.

 

Reasonable Best Efforts Covenant

 

The Company, Parent and Merger Sub have agreed to use their reasonable best efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to complete the Merger and the other transactions contemplated by the Merger Agreement. The Company, Parent and Merger Sub agree to make appropriate filings pursuant to any applicable competition laws,

including a notification and report form pursuant to the HSR Act within fifteen business days of the date of the Merger Agreement.

 

Financing

 

Parent and the Company have agreed to a number of covenants regarding Parent’s financing of the Merger discussed below under “Parent Financing” on page 45.

 

Certain Other Covenants

 

The Merger Agreement contains additional mutual covenants, including covenants relating to preparation of this proxy statement, cooperation regarding filings with governmental and other agencies and organizations and obtaining any governmental or third-party consents or approvals, public announcements, and further assurances.

 

Conditions to the Completion of the Merger

 

Mutual Closing Conditions

 

The obligations of each of Parent, Merger Sub and the Company to consummate the Merger are subject to the satisfaction or waiver at or before the effective time of the Merger of the following conditions:

 

 

Additional Closing Conditions for the Benefit of Parent and Merger Sub

 

The obligation of Parent and Merger Sub to complete the Merger is subject to the satisfaction or waiver at or before the effective time of the following additional conditions:

 

 

The Company’s EBITDA, calculated in accordance with the terms of the Merger Agreement, for the twelve months ending July 31, 2007 was $33.6 million.

 

Additional Closing Conditions for the Benefit of the Company

 

The obligation of the Company to complete the Merger is subject to the satisfaction or waiver at or before the effective time of the following additional conditions: Parent and Merger Sub have performed in all material respects their obligations required to be performed by them at or prior to the effective time of the Merger; the representations and warranties of Parent and Merger Sub must be true and correct in all material respects as of the effective time of the Merger; and the Company has received a certificate signed by the chief executive officer or another senior officer of Parent to the foregoing effect.

 

Employee Benefit Matters

 

For a period of one year after effective time of the Merger, Parent is obligated to provide, or cause the surviving corporation to provide, to employees of the Company and any of our subsidiaries who become employees of the surviving corporation (such employees referred to in this proxy statement as “company employees”) compensation and benefits that are in the aggregate no less favorable than the compensation and benefits being provided to company employees immediately prior to the effective time of the Merger.

 

For a period of one year after the effective time of the Merger, Parent is obligated to provide, or cause the surviving corporation to provide, to company employees that are terminated severance benefits that are no less favorable than the severance benefits that would have been provided to such company employees upon termination immediately prior to the effective time of the Merger. In addition, Parent agrees to honor, fulfill and discharge, and must cause the surviving corporation to honor, fulfill and discharge, the Company’s obligations to any company employees or other participants under of the Company’s benefit plans.

 

Each company employee will be credited with his or her years of service with the Company, our subsidiaries and affiliates prior to the consummation of the Merger for purposes of vesting and eligibility under any benefit plans covering company employees after the effective time of the Merger. In addition, each company employee is immediately eligible to participate in any employee benefit plan provided after the effective time of the Merger to the extent that the company employee was enrolled in a comparable benefit plan prior to the Merger.

 

With respect to any employee benefit plan providing medical, dental, pharmaceutical and/or vision benefits in which any such employee first becomes eligible to participate, on or after the effective time of the Merger Parent will: (i) waive all pre-existing conditions, exclusions and waiting periods with respect to participation and coverage requirements, and (ii) provide credit towards any deductible or out-of-pocket expense maximum under any such plans for out-of-pocket amounts expended by such employee under the employee plans during the current plan year.

 

For a more detailed description of other employee-related matters, see “The Merger — Interests of Deb’s Directors and Officers in the Merger,” beginning on page 32 of this proxy statement.

 

Parent Financing

 

At the time of the execution of the Merger Agreement, Parent obtained an equity commitment letter from Lee Funding, L.P. and a debt commitment letter from Barclays Capital, the investment banking division of Barclays Bank PLC. For a more detailed description of Parent’s financing commitments and risk associated with the financing, see “The Merger — Financing of the Merger,” beginning on page 29 of this proxy statement. Pursuant to the terms of the Merger Agreement, Parent is obligated to use its reasonable best efforts to (a) arrange its financing on the terms and conditions described in the equity and debt commitment letters, (b) enter into definitive agreements to be in effect no later than the closing date of the Merger and (c) consummate the financing no later than the last day of the Marketing Period. If any portion of the financing contemplated in the equity and debt commitment letters becomes unavailable, Parent must inform Deb immediately and use reasonable best efforts to obtain alternative financing on terms no more adverse to Deb than were contained in the equity and debt commitment letters. Parent further agreed to comply with all covenants under the equity and debt commitment letters or any alternative financing commitment, inform Deb of a breach by any party under its financing commitments and to keep Deb informed of the status of its efforts to consummate its financing. Any breach by Parent under its equity and debt commitments or alternative financing commitments will be deemed a breach of a covenant under the Merger Agreement.

 

Deb is obligated, at Parent’s sole expense and subject to certain limitations, to cooperate with any reasonable requests by Parent in connection with the arrangement of its financing including, among other things, entering into agreements and agreeing to pledge or grant security interests in the Company’s assets to be effective only after the consummation of the Merger, providing financial information, making its senior officers available to attend rating agency presentations and bank meetings, obtaining or providing auditor comfort letters or legal opinions, and taking any other corporate actions necessary to permit the consummation of Parent’s financing.

 

Pursuant to the Merger Agreement, Parent is obligated to consummate the transactions contemplated by the debt financing commitment no later than the last day of the Marketing Period.

 

Termination of the Merger Agreement

 

The Merger Agreement may be terminated at any time before the effective time of the Merger, whether before or after approval of the matters presented in connection with the Merger by our shareholders, in any of the following ways:

 

(a) by mutual written consent of Parent and the Company,

 

(b) by either Parent or the Company if:

 

 

(c) by Parent if:

 

 

(d) by the Company if:

 

 

If the Merger Agreement is validly terminated, the agreement will become void without any liability on the part of any party other than the payment of a termination fee in certain circumstances discussed below. However, the provisions of the Merger Agreement relating to the non-survival of representations, warranties and agreements, termination fees and expenses, governing law, succession and assignment and jurisdiction and waiver of jury trial, will continue in effect notwithstanding termination of the Merger Agreement. In addition, no termination will relieve any party of any liability or damages resulting from any breach by that party.

 

Fees and Expenses

 

The Merger Agreement generally provides that each party will pay its own fees and expenses in connection with the Merger Agreement and the transactions contemplated by the Merger Agreement, whether or not the Merger is completed.

 

Termination Fees Payable by Deb

 

We have agreed to pay Parent a termination fee of $15 million if any of the following payment events occur:

 

 

Termination Fees Payable by Parent

 

Parent has agreed to pay us a termination fee of $15 million if any of the following payment events occur:

 

 

 

In the event we terminate the Merger Agreement as described above, our receipt of the termination fee from Parent is our sole and exclusive remedy against Parent, Merger Sub and any of their representatives for any damages resulting from the Merger Agreement and the transaction contemplated under the Merger Agreement. Lee Funding, L.P. has provided a guaranty of the termination fee payable by Parent as described under “The Merger — Financing of the Merger — Limited Guarantee; Remedies” on page 31.

 

If either Deb or Parent fails promptly to pay any of the termination fees described above, Deb or Parent, as the case may be, also agrees to pay any costs and expenses (including attorneys’ fees) incurred by the other party in connection with any legal enforcement action for payment of the termination fees described above with interest on

any amount of the termination fee at a rate per annum equal to the prime lending rate in effect on the date such payment should have been made.

 

Amendments; Waivers

 

Any provision of the Merger Agreement may be amended or waived before the effective time of the Merger if, but only if, the amendment or waiver is in writing and signed, in the case of an amendment, by each party to the Merger Agreement or, in the case of a waiver, by each party against whom the waiver is to be effective; provided that, after approval of the Merger Agreement by our shareholders and without their further approval, no amendment or waiver that requires shareholder approval under applicable law or NASDAQ rules may be made.

 

VOTING AGREEMENT

 

The following description summarizes the material provisions of the voting agreement and is qualified in its entirety by reference to the complete text of the voting agreement. The voting agreement, attached as Annex C , contains the complete terms of that agreement and shareholders should read it carefully and in its entirety.

 

Voting Arrangements and Related Provisions

 

In connection with the execution of the Merger Agreement, each of Marvin Rounick (our chief executive officer and one of our directors), Jack Rounick (one of our directors) and Warren Weiner (our executive vice president and one of our directors), and several trusts and partnerships that are affiliated with Marvin Rounick, Jack Rounick and Warren Weiner who are shareholders of the Company, entered into a voting agreement with Parent. These directors, executive officers and other shareholders have agreed to vote the shares of our capital stock owned by them (representing, in the aggregate, approximately 64% of the outstanding shares of our Common Stock and 100% of our Preferred Stock as of the record date), in favor of the adoption of the Merger Agreement and the approval of the Merger.

 

Each of these shareholders also agreed, until any termination of the voting agreement, to vote these shares of Common Stock and Preferred Stock held by that shareholder against the following actions:

 

 

In connection with the voting agreement, the shareholders further agreed not to:

 

 

Notwithstanding the foregoing, the voting agreement provides that it will not restrict a director or officer of Deb from taking any action in his capacity as a director or officer necessary for him to comply with his fiduciary duties as a director or officer of the Company.

 

Each of the parties to the voting agreement has irrevocably granted to, and appointed Parent and its designees, as the shareholders proxy and attorney-in-fact to vote all of such shareholder’s shares of the Company’s Common Stock and Preferred Stock in accordance with the voting agreements described above. The proxy granted by each shareholder party to the voting agreement is irrevocable until the termination of the voting agreement and will automatically terminate upon the termination of the voting agreement.

 

Termination

 

The voting agreement terminates on the earlier to occur of the first business day after the effective date of the Merger or the date of termination of the Merger Agreement. However, if the Merger Agreement is terminated by the Company in connection with the Board’s determination that a Competing Proposal constitutes a Superior Proposal pursuant to the terms of the Merger Agreement, the voting agreement will not terminate until the Parent receives the $15 million termination fee payable by the Company as described in “Terms of the Merger Agreement — Fees and Expenses” on page 47 of this proxy statement.

 

with the Company’s chief financial officer, who permitted Lehman Brothers to use such adjustments in the Sensitivity Analysis. The Sensitivity Analysis was also provided to our Board of Directors.

 

 

 

 

Cautionary Statement Regarding Management Case and Sensitivity Analysis

 

The Management Case and Sensitivity Analysis described above were prepared by our management and Lehman Brothers, respectively, and were not prepared with a view towards public disclosure or compliance with generally accepted accounting principles or with published guidelines of the SEC or the guidelines established by the American Institute of Certified Public Accountants regarding forecasts or projections. Our independent registered public accounting firm, BDO Seidman, LLP, has neither examined nor compiled the projections or analysis and, accordingly, BDO Seidman, LLP does not express an opinion or any other form of assurance with respect thereto. The BDO Seidman, LLP report included in documents that are incorporated by reference in this proxy statement relates to our historical financial information. It does not extend to these projections or analysis and should not be read to do so. Our internal financial forecasts (upon which the projections and analysis were based in part) are, in general, prepared solely for internal use and capital budgeting and other management decisions and are subjective in many respects and thus susceptible to interpretation and periodic revision based on actual experience and business developments. The Management Case and Sensitivity Analysis also reflect numerous assumptions made by our management with respect to industry performance, general business, economic, market and financial conditions and other matters, all of which are difficult to predict and many of which are beyond our control. Accordingly, we cannot assure you that the projected results will be realized or that actual results will not be significantly higher or lower than projected. In addition, the projections and analysis do not consider the effect of the Merger.

 

Readers of this proxy statement are cautioned not to rely on the Management Case or Sensitivity Analysis. These projections and analysis are forward-looking statements and are based on expectations and assumptions at the time they were prepared. The Management Case and Sensitivity Analysis are not guarantees of future performance and involve risks and uncertainties that may cause future financial results and shareholder value of Deb to materially differ from those expressed in the Management Case or Sensitivity Analysis. Accordingly, we cannot assure you that the Management Case or Sensitivity Analysis will be realized or that our future financial results will not materially vary from the Management Case or Sensitivity Analysis. The Management Case and Sensitivity Analysis do not take into account the Merger or any of the transactions contemplated by the Merger Agreement. We do not intend to update or revise the Management Case or Sensitivity Analysis. For a discussion of the risks and uncertainties that may be relevant to Deb’s results, see “Cautionary Statement Regarding Forward-Looking Statements” on page 10.

 

PAST CONTACTS, TRANSACTIONS OR NEGOTIATIONS

 

Except as described under “The Merger — Background of the Merger” beginning on page 14 of this proxy statement, there have not been any negotiations, transactions or material contacts during the past two years concerning any merger, consolidation, acquisition, tender offer or other acquisition of any class of Deb’s securities, election of Deb’s directors or sale or other transfer of a material amount of Deb’s assets (i) between Deb or any of its affiliates, on the one hand, and Deb, Parent and Merger Sub, their respective executive officers, directors, members or controlling persons, on the other hand, (ii) between any affiliates of Deb or (iii) between Deb and its affiliates, on the one hand, and any person not affiliated with Deb who would have a direct interest in such matters, on the other hand.

 

MARKET PRICES OF COMMON STOCK

 

Our Common Stock is traded on the NASDAQ Global Select Market under the symbol “DEBS” The following table sets forth the high and low sales prices per share of our Common Stock on the NASDAQ Global Market for the periods indicated.

 

 

The closing sale price of our Common Stock on the NASDAQ Global Select Market on July 26, 2007, which was the last trading day before we announced the Merger, was $26.68. On September 18, 2007, the closing price for our Common Stock on the NASDAQ Global Select Market was $27.15. You are encouraged to obtain current market quotations for the Common Stock in connection with voting your shares.

 

Shareholders should obtain a current market quotation for Deb Common Stock before making any decision with respect to the Merger.

 

ABSENCE OF DISSENTERS RIGHTS

 

Under Section 1571 of the Pennsylvania Business Corporation Law (“PBCL”), the holders of any class or series of shares of a corporation are not entitled to exercise dissenters rights if the shares of the corporation are listed on a national securities exchange. Consequently, since our Common Stock is currently listed on NASDAQ, which is a national securities exchange, the holders of our Common Stock will not have the right to exercise dissenters’ rights in connection with the proposed Merger.

 

Section 1571 of the PBCL further provides that holders of any preferred or special class of securities will be granted dissenters rights, even if they otherwise would be denied such rights under the provision described above, unless the holders of the preferred or special class of securities are granted the right to vote separately as a class to approve the proposed transaction. In order to eliminate the provision of dissenters rights, we are enabling the holders of our Preferred Stock to vote separately as a class to adopt the Merger Agreement and approve the Merger pursuant to the Merger Agreement. Consequently, the holders of Deb’s Preferred Stock will not have the right to exercise dissenter’s rights in connection with the proposed Merger. Under the voting agreement, the holders of all outstanding shares of Preferred Stock have agreed to vote their shares in favor of the adoption of the Merger Agreement and the approval of the Merger.

 

If the Merger Agreement is adopted and the Merger is completed, holders of Deb’s Common Stock and Preferred Stock who voted against the adoption of the Merger Agreement will be treated the same as shareholders who voted for the adoption of the Merger Agreement and their shares will automatically be converted into the right to receive $27.25 per share and $1,000.00 per share, respectively.

 

BENEFICIAL OWNERSHIP OF COMMON STOCK

 

Beneficial Ownership Table

 

The following table sets forth certain information regarding beneficial ownership of our Common Stock as of September 18, 2007 for: (1) each person who we know beneficially owns 5% or more of the outstanding shares of our voting securities, (2) each director and named executive officer, and (3) all directors and executive officers as a group. Except as indicated in the footnotes to the table, and subject to the terms of the voting agreement, each person named in the table has sole voting and investment power with respect to all shares of securities shown as beneficially owned by them, subject to community property laws where applicable.

 

 

 

 

 

 

The Company incorporates by reference each document it files under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of the initial filing of this proxy statement and before the special meeting. The Company also incorporates by reference in this proxy statement the following documents filed by it with the SEC under the Exchange Act:

 

 

The Company undertakes to provide without charge to each person to whom a copy of this proxy statement has been delivered, upon request, by first class mail or other equally prompt means, a copy of any or all of the documents incorporated by reference in this proxy statement, other than the exhibits to these documents, unless the exhibits are specifically incorporated by reference into the information that this proxy statement incorporates. You may obtain documents incorporated by reference by requesting them in writing or by telephone at the following address and telephone number:

 

Deb Shops, Inc.
9401 Blue Grass Road
Philadelphia, Pennsylvania 19114

 

Telephone number: (215) 676-6000

 

Documents should be requested by October 9, 2007 in order to receive them before the special meeting. You should be sure to include your complete name and address in your request.

 

Parent and Merger Sub have supplied, and the Company has not independently verified, the information in this proxy statement relating to Parent and Merger Sub.

 

This proxy statement does not constitute the solicitation of a proxy in any jurisdiction to or from any person to whom or from whom it is unlawful to make such a proxy solicitation in such jurisdiction.

 

Shareholders should not rely on information other than that contained in or incorporated by reference in this proxy statement. The Company has not authorized anyone to provide information that is different from that contained in this proxy statement. This proxy statement is dated September 24, 2007. No assumption should be made that the information contained in this proxy statement is accurate as of any date other than that date, and the mailing of this proxy statement will not create any implication to the contrary. Notwithstanding the foregoing, in the event of any material change in any of the information previously disclosed, the Company will, where relevant and if required by applicable law, update such information through a supplement to this proxy statement.

Annex A

 

 

Agreement and Plan of Merger

By and Among

DSI Holdings, LLC,

DSI Acquisition, Inc.

and

Deb Shops, inc.

Dated as of July 26, 2007

 

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