UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

FORM 10-Q

 

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  FOR THE QUARTERLY PERIOD ENDED OCTOBER 2, 2004
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file numbers:

 

001-31829 and 333-22155

 

 

CARTER’S, INC.
THE WILLIAM CARTER COMPANY
(Exact names of registrants as specified in their charters)

 

Delaware		13-3912933
Massachusetts		04-1156680
(States or other jurisdictions of		(I.R.S. Employer Identification Nos.)
Incorporation or Organization)

 

The Proscenium
1170 Peachtree Street NE, Suite 900
Atlanta, Georgia  30309
(Address of principal executive offices, including zip code)

 

(404) 745-2700
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý

 

The common equity of Carter’s, Inc. was not publicly traded as of the end of the second fiscal quarter of our most recently completed fiscal year.  Accordingly, Carter’s, Inc. does not meet the definition of an accelerated filer under Rule 12b-2 of the Securities Exchange Act of 1934.

 

Applicable only to corporate issuers:

 

Carter’s, Inc. has one class of common stock.  There were 28,421,417 shares of Carter’s, Inc.’s common stock, par value of $0.01 per share, outstanding as of the close of business on November 12, 2004.

 

This Form 10-Q is a combined quarterly report being filed separately by two registrants:  Carter’s, Inc. and The William Carter Company, the wholly-owned operating subsidiary of Carter’s, Inc.  Unless the context indicates otherwise, any reference in this report to “TWCC” refers to The William Carter Company. “Carter’s,” “we,” “us,” and “our” refer to Carter’s, Inc. together with TWCC.

 

The William Carter Company meets the conditions set forth in general instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format.

 

 

CARTER’S, INC.

AND THE WILLIAM CARTER COMPANY

INDEX

 

Part I.	Financial Information
	Item 1.	Financial Statements
		Unaudited Condensed Consolidated Balance Sheets as of October 2, 2004 and January 3, 2004
		Unaudited Condensed Consolidated Statements of Income for the three and nine-month periods ended October 2, 2004 and October 4, 2003
		Unaudited Condensed Consolidated Statements of Cash Flows for the nine-month periods ended October 2, 2004 and October 4, 2003
		Notes to the Unaudited Condensed Consolidated Financial Statements
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk
	Item 4.	Controls and Procedures
Part II.	Other Information
	Item 1.	Legal Proceedings
	Item 2.	Change in Securities
	Item 3.	Defaults upon Senior Securities
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits and Reports on Form 8-K
Signatures
Certifications

 

2

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CARTER’S, INC.
AND THE WILLIAM CARTER COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except for share data)
(unaudited)

 

		October 2, 2004				January 3, 2004
ASSETS
Current assets:
Cash and cash equivalents		$	12,004			$		36,061
Accounts receivable, net		103,108				65,318
Inventories, net		148,414				104,760
Prepaid expenses and other current assets		2,680				6,575
Assets held for sale		864				50
Deferred income taxes		10,692				9,045
Total current assets		277,762				221,809
Property, plant, and equipment, net		51,177				50,502
Tradename		220,233				220,233
Cost in excess of fair value of net assets acquired		139,282				139,282
Licensing agreements, net of accumulated amortization of $15,000 and $11,875		—				3,125
Deferred debt issuance costs, net		6,486				7,666
Other assets		2,881				3,485
Total assets		$	697,821			$	646,102
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt		$		927		$	3,336
Accounts payable		42,371				30,436
Other current liabilities		37,274				37,405
Total current liabilities		80,572				71,177
Long-term debt		213,788				209,377
Deferred income taxes		82,078				83,196
Other long-term liabilities		9,816				9,816
Total liabilities		386,254				373,566
Commitments and contingencies
Stockholders’ equity:
Carter’s, Inc., preferred stock; par value $.01 per share; 100,000 shares authorized; none issued or outstanding at October 2, 2004 and January 3, 2004		—				—
Carter’s, Inc., common stock, voting; par value $.01 per share; 40,000,000 shares authorized; 28,331,337 shares issued and outstanding at October 2, 2004 and 27,985,360 shares issued and outstanding at January 3, 2004 (TWCC’s common stock, voting; par value $.01 per share; 200,000 shares authorized; 1,000 shares issued and outstanding at October 2, 2004 and January 3, 2004)		283				280
Additional paid-in capital		246,166				241,780
Retained earnings		65,118				30,476
Total stockholders’ equity		311,567				272,536
Total liabilities and stockholders’ equity		$		697,821		$	646,102

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

 

3

 

CARTER’S, INC.
AND THE WILLIAM CARTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except for share data)

 (unaudited)

 

		For the three-month periods ended										For the nine-month periods ended
		October 2, 2004					October 4, 2003					October 2, 2004				October 4, 2003
Net sales		$	251,357				$	212,135				$	590,384			$		518,136
Cost of goods sold		163,490					136,451					376,656				331,993
Gross profit		87,867					75,684					213,728				186,143
Selling, general, and administrative expenses		56,280					51,896					151,674				138,660
Closure costs		49					115					589				115
Royalty income		(3,589				)	(3,692				)	(9,257			)	(8,149			)
Operating income		35,127					27,365					70,722				55,517
Interest expense, net		4,666					6,788					13,654				20,309
Income before income taxes		30,461					20,577					57,068				35,208
Provision for income taxes		12,049					7,922					22,426				13,555
Net income		$		18,412			$		12,655			$	34,642			$	21,653
Carter’s, Inc.
Basic net income per common share		$			0.65		$			0.56		$		1.24		$	0.96
Diluted net income per common share		$			0.62		$			0.52		$		1.16		$	0.90
Basic weighted average number of shares outstanding		28,109,978					22,564,856					28,032,520				22,560,872
Diluted weighted average number of shares outstanding		29,902,137					24,236,255					29,887,853				24,084,183

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

4

 

CARTER’S, INC.
AND THE WILLIAM CARTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)

(unaudited)

 

		For the nine-month periods ended
		October 2, 2004				October 4, 2003
Cash flows from operating activities:
Net income		$	34,642			$	21,653
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		15,145				16,009
Amortization of debt issuance costs		1,180				1,264
Accretion of debt discount		56				99
Tax benefit from exercise of stock options		2,887				—
Non-cash stock compensation expense		294				256
Non-cash closure costs		—				115
Loss (gain) on sale of property, plant, and equipment		84				(21		)
Deferred tax (benefit) provision		(2,765			)	1,440
Effect of changes in operating assets and liabilities:
Accounts receivable		(37,790			)	(17,293		)
Inventories		(43,654			)	(12,380		)
Prepaid expenses and other assets		3,899				1,515
Accounts payable and other liabilities		11,934				(3,245		)
Net cash (used in) provided by operating activities		(14,088			)	9,412
Cash flows from investing activities:
Capital expenditures		(13,967			)	(9,367		)
Proceeds from sale of property, plant, and equipment		408				275
Collections on loan		600				600
Net cash used in investing activities		(12,959			)	(8,492		)
Cash flows from financing activities:
Payments of term loan		(8,054			)	(6,040		)
Payments on revolving loan facility		(79,760			)	(89,700		)
Proceeds from revolving loan facility		89,760				91,600
Payment of dividend		—				(24,893		)
Payment of debt issuance costs		—				(799		)
Payments of capital lease obligations		(164			)	(195		)
Proceeds from exercise of stock options		1,208				—
Proceeds from sale of common stock		—				600
Net cash provided by (used in) financing activities		2,990				(29,427		)
Net decrease in cash and cash equivalents		(24,057			)	(28,507		)
Cash and cash equivalents, beginning of period		36,061				35,562
Cash and cash equivalents, end of period		$		12,004		$	7,055

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

5

 

CARTER’S, INC.
AND THE WILLIAM CARTER COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 

NOTE 1 — THE COMPANY:

 

        On September 30, 2003, Carter Holdings, Inc., a Massachusetts corporation, re-incorporated in Delaware and changed its name by forming and subsequently merging with and into its new wholly-owned Delaware subsidiary, Carter’s, Inc.  The surviving company in the merger was Carter’s, Inc.  In connection with the re-incorporation, Carter’s, Inc. effected a 4-for-1 split of its common stock.

 

        Carter’s, Inc. conducts its operations and derives all of its operating income and cash flow through its wholly-owned subsidiary, The William Carter Company (“TWCC”).  Carter’s, Inc., together with TWCC (collectively “Carter’s,” “we,” “us,” and “our”) design, source, manufacture, and market branded childrenswear under the Carter’s, Carter’s Classics, Child of Mine, and Tykes labels.  We intend to replace the Tykes brand name with our Just One Year brand beginning in December 2004.  Our products are sourced through contractual arrangements with numerous manufacturers throughout the world and through production at company-managed sewing facilities in Mexico.  Our sewing operations in Costa Rica were closed in the fourth quarter of fiscal 2003.  (See Note 9 regarding the closure of our Costa Rican facilities).  Products are manufactured for wholesale distribution to major domestic retailers, including the mass channel, and for our 177 retail stores, which market our brand name merchandise and certain products manufactured by other companies.

 

        On October 29, 2003, we completed an initial public offering of Carter’s, Inc.’s common stock (the “offering”) including the sale of 5,390,625 shares by us and 1,796,875 shares by the selling stockholders, primarily Berkshire Partners LLC and its affiliates.  Net proceeds to us from the offering totaled $93.9 million.  On November 28, 2003, we used approximately $68.7 million of the proceeds to redeem approximately $61.3 million in outstanding senior subordinated notes and pay a redemption premium of approximately $6.7 million and related accrued interest charges of $0.7 million.  We used approximately $2.6 million of the net proceeds to terminate a management agreement with Berkshire Partners LLC and used approximately $11.3 million to prepay amounts outstanding under our term loan, as required by our senior credit facility.  The remaining proceeds were utilized for working capital and other general corporate purposes.

 

NOTE 2 — BASIS OF PREPARATION:

 

        The accompanying financial statements comprise the consolidated financial statements of Carter’s, Inc. and TWCC.  Carter’s, Inc.’s only asset is its investment in the common stock of TWCC, its wholly-owned subsidiary.  As a result, the consolidated financial positions, results of operations, and cash flows of Carter’s, Inc. and TWCC are substantially the same.

 

        In our opinion, the accompanying unaudited condensed consolidated financial statements of Carter’s, Inc. and TWCC contain all adjustments necessary to present fairly our financial position as of October 2, 2004, the results of our operations for the three and nine-month periods ended October 2, 2004 and October 4, 2003, and cash flows for the nine-month periods ended October 2, 2004 and October 4, 2003.  Operating results for the nine-month period ended October 2, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending January 1, 2005.  Our accompanying condensed consolidated balance sheet as of January 3, 2004 is from our audited consolidated financial statements included in our most recently filed annual report on Form 10-K.

 

        Certain information and footnote disclosure normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America has been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission and the instructions to Form 10-Q.  The accounting policies we follow are set forth in the notes to our consolidated financial statements contained in our most recently filed annual report on Form 10-K for the fiscal year ended January 3, 2004.

 

6

 

        Our fiscal year ends on the Saturday in December or January nearest to the last day of December.  Consistent with this policy, fiscal 2003 ended on January 3, 2004 and fiscal 2004 will end on January 1, 2005.  As a result, fiscal 2003 contained 53 weeks of financial results and fiscal 2004 will contain 52 weeks of financial results.  The additional week in fiscal 2003 was included in the first nine months of fiscal 2003.  Therefore, the accompanying unaudited consolidated financial statements for the first nine months of fiscal 2004 reflect our financial position as of October 2, 2004 and for the 39-week period then ended.  The first nine months of fiscal 2003 ended on October 4, 2003 and included 40 weeks of financial results.  The accompanying unaudited consolidated financial statements for the third quarter periods ended October 2, 2004 and October 4, 2003 each contain 13 weeks of financial results.

 

        During the first nine months of fiscal 2004, we contracted with a third-party service to provide us with the fair value of co-op advertising arrangements entered into with certain of our major wholesale and mass channel customers.  Such fair value is determined based upon, among other factors, comparable market analysis for similar advertisements.  In accordance with Emerging Issues Task Force Issue No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer/Reseller” (“EITF 01-09”), we have included the fair value of these arrangements of approximately $930,000 in the third quarter of fiscal 2004 and $2,582,000 in the first nine months of fiscal 2004 as a component of selling, general, and administrative expenses on the accompanying unaudited condensed consolidated statements of income rather than as a reduction of revenue.  We treated co-op advertising arrangements in fiscal 2003 as a reduction of revenue in accordance with EITF 01-09 as we had determined that it was impracticable to obtain the fair value of those arrangements in order to classify these costs as a component of selling, general, and administrative expenses.

 

NOTE 3 — STOCK-BASED COMPENSATION:

 

        We account for stock-based compensation on stock options under the intrinsic value method consistent with Accounting Principles Board Opinion No. 25.  Under this method, we record compensation expense equal to the difference between the exercise price of the stock option and the fair market value of the underlying stock as of the date of the option grant.  For disclosure purposes only, we also estimate the impact on our net income of applying the fair value method of measuring compensation cost on stock options with the fair value of our common stock, prior to our initial public offering, determined under the minimum value method as provided by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”).  Stock options granted subsequent to our initial public offering have been valued using the Black-Scholes option pricing model.

 

7

 

        The following table illustrates, for disclosure purposes only, the effect on net income if compensation expense for our stock option grants had been determined based on the fair value as of the grant dates consistent with the methodology of SFAS 123 and SFAS 148 (dollars in thousands, except per share data):

 

		For the three-month periods ended								For the nine-month periods ended
		October 2, 2004				October 4, 2003				October 2, 2004			October 4, 2003
Net income, as reported		$	18,412			$	12,655			$	34,642		$		21,653
Add:
Stock-based employee compensation (under APB 25) included in reported net income, net of related tax effects		33				35				114			43
Deduct:
Total stock-based employee compensation expense determined under the fair value based method (under SFAS 123 and SFAS 148) for all awards, net of related tax effects		(497			)	(168			)	(1,020		)	(435			)
Pro forma net income		$	17,948			$	12,522			$	33,736		$	21,261
Carter’s, Inc.’s net income per common share:
Basic-as reported		$		0.65		$		0.56		$	1.24		$	0.96
Basic-pro forma		$		0.64		$		0.55		$	1.20		$	0.94
Diluted-as reported		$		0.62		$		0.52		$	1.16		$	0.90
Diluted-pro forma		$		0.60		$		0.52		$	1.13		$	0.88

 

        For basic stock options, using a minimum value method, the fair value of each stock option as of the date of grant was estimated to range from $3.08 to $9.76 per share for stock options granted in fiscal 2003.  For basic stock options, using a fair value method, the fair value of each stock option at the date of the grant was estimated to range from $12.81 to $14.15 per share for stock options granted in fiscal 2004 and range from $6.40 to $13.55 per share for stock options granted in fiscal 2003.  These per share stock option values were calculated at an assumed risk-free interest rate of 3.2% to 4.5% for fiscal 2004 and 3.8% to 4.2% for 2003, with an expected life of 7 to 10 years and expected volatility from 36.7% to 50.0%.  No dividends were assumed.

 

        For performance stock options, using a minimum value method, the fair value of each stock option as of the date of grant was estimated to range from $3.08 to $9.76 per share for stock options granted in fiscal 2003.  For performance stock options, using a fair value method, the fair value of each stock option at the date of grant was estimated to range from $6.40 to $13.55 per share for stock options granted in fiscal 2003.  These per share stock option values were calculated at the same assumed risk-free interest rates shown above with an expected life of 10 years and expected volatility of 50.0%.  No dividends were assumed.

 

8

 

        Coincident with the completion of the secondary offering as discussed in Note 5, certain performance objectives have been met and a determination event, as defined, has occurred. Accordingly, performance options will now vest ratably over a five-year period from the grant date.

 

NOTE 4 — INVENTORIES:

 

        Inventories consisted of the following ($000):

 

 

NOTE 5 — STOCK TRANSACTIONS OF CARTER’S, INC:

 

        On July 31, 2003, we paid a dividend of approximately $24.9 million on the outstanding shares of our common stock to the stockholders of record as of July 30, 2003.  At the same time, we paid a special bonus of approximately $2.5 million to our vested option holders.  This special bonus was recorded as compensation expense during the third quarter of fiscal 2003.

 

        During the nine-month period ended October 2, 2004, we issued 366,200 stock options to purchase Carter’s, Inc.’s common stock to certain employees.  During the first nine months of fiscal 2003, we issued 398,000 stock options to purchase Carter’s, Inc.’s common stock to one of our directors and to certain employees.  No compensation expense was recorded during the first nine months of fiscal 2004 as a result of options granted during that period as the options were issued as of the date of grant with an exercise price equal to the fair market value of a share of stock.  We recorded approximately $50,000 in compensation expense during the third quarter of fiscal 2003 related to stock option grants.

 

        Additionally, during the first nine months of fiscal 2003, we sold shares of our common stock to two of our directors for cash proceeds of $600,000 (one during the second quarter and one during the third quarter).  In connection with these transactions, we recorded additional paid-in capital in the amount of $600,000.  Additionally, we recorded approximately $206,000 in compensation expense during the first nine months of fiscal 2003 related to these stock sales.

 

        During the second and third quarters of fiscal 2004, certain employees exercised 87,743 and 258,234 options for cash proceeds of $200,000 and $1,008,000.

 

        On September 29, 2004, we completed a secondary offering of 8,687,457 shares of Carter’s, Inc.’s common stock, including the underwriters’ over-allotment option, which was sold by Berkshire Partners LLC and its affiliates and certain members of management.  We did not receive any of the proceeds from this offering except for proceeds from the exercise of stock options exercised in connection with this offering.  The sale reduced the beneficial ownership, on a fully-diluted basis, of Berkshire Partners LLC and its affiliates to 36.2% from 66.0% and management’s ownership to 8.9% from 10.1%.  We incurred $553,000 of costs related to the offering in the third quarter of fiscal 2004 that are recorded as a component of selling, general, and administrative expenses in the unaudited condensed consolidated statements of income.

 

9

 

NOTE 6 — GOODWILL AND OTHER INTANGIBLE ASSETS:

 

        In connection with our 2001 acquisition by Berkshire Partners LLC and affiliates (the “Acquisition”), as more fully described in Note 1 to our consolidated financial statements in our most recently filed annual report on Form 10-K, we adopted provisions of SFAS No. 141, “Business Combinations” and applied the required provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.”  Accordingly, our tradename and goodwill have been deemed to have indefinite lives and are no longer being amortized.  Our licensing agreements were amortized over the average three-year life of such agreements.  Amortization expense for the third quarter and first nine-month period of fiscal 2003 was $1.3 million and $3.8 million.  Amortization expense for the third quarter and first nine-month period of fiscal 2004 was $0.6 million and $3.1 million.  The licensing agreements were fully amortized as of October 2, 2004.

 

NOTE 7 — EMPLOYEE BENEFIT PLANS:

 

        We have an obligation under a defined benefit plan covering certain former officers.  We also offer a comprehensive post-retirement medical plan and life insurance to current and certain future retirees and their spouses until they become eligible for Medicare or a Medicare supplement plan.  See Note 7 “Employee Benefit Plans” to the consolidated financial statements in our most recently filed annual report on Form 10-K for further information.

 

        The components of pension benefit expense charged to operations are as follows ($000):

 

		For the three-month periods ended						For the nine-month periods ended
		October 2, 2004			October 4, 2003			October 2, 2004			October 4, 2003
Service cost — benefits attributed to service during the period		$	—		$	—		$	—		$	—
Interest cost on accumulated pension benefit obligation		20			22			59			65
Amortization of prior service cost		—			—			—			—
Amortization of net actuarial loss		—			15			—			47
Total net periodic pension benefit cost		$	20		$	37		$	59		$	112

 

                The components of post-retirement life and medical benefit expense charged to operations are as follows ($000):

 

		For the three-month periods ended						For the nine-month periods ended
		October 2, 2004			October 4, 2003			October 2, 2004			October 4, 2003
Service cost — benefits attributed to service during the period		$	23		$	20		$	70		$	60
Interest cost on accumulated post-retirement benefit obligation		162			158			468			473
Amortization of net actuarial loss		—			—			—			—
Total net periodic post-retirement benefit cost		$	185		$	178		$	538		$	533

 

10

 

NOTE 8 — SEGMENT INFORMATION:

 

        We report segment information in accordance with the provisions of SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information” (“SFAS 131”), which requires segment information to be disclosed based upon a “management approach.”  The management approach refers to the internal reporting that is used by management for making operating decisions and assessing the performance of our reportable segments.

 

        Under our methodology, segment results include the direct costs of each segment and all other costs are allocated based upon detailed estimates and analysis of actual time and expenses incurred to support the operations of each segment or units produced or sourced to support each segment’s revenue.  Certain costs, including incentive compensation for certain employees, the Berkshire Partners LLC management fee (terminated in connection with our initial public offering, see Note 1 to the unaudited condensed consolidated financial statements), and various other general corporate costs that are not specifically allocable to our segments, are included in other reconciling items below.  Intersegment sales and transfers are recorded at cost and treated as a transfer of inventory.  The accounting policies of the segments are the same as those described in Note 2 “Summary of Significant Accounting Policies” to the consolidated financial statements in our most recently filed annual report on Form 10-K.

 

        The table below presents certain segment information for the periods indicated ($000):

 

		For the three-month periods ended												For the nine-month periods ended
		October 2, 2004				% of Total		October 4, 2003				% of Total		October 2, 2004			% of Total		October 4, 2003			% of Total
Net sales:
Wholesale		$	113,932			45.3%		$	103,341			48.7%		$	278,020		47.1%		$	265,573		51.2%
Retail		86,186				34.3%		77,471				36.5%		205,421			34.8%		190,992			36.9%
Mass Channel		51,239				20.4%		31,323				14.8%		106,943			18.1%		61,571			11.9%
Total net sales		$	251,357			100.0%		$	212,135			100.0%		$	590,384		100.0%		$	518,136		100.0%
EBITDA:						% of Net Sales						% of Net Sales					% of Net Sales					% of Net Sales
Wholesale		$		20,155		17.7%		$		16,891		16.3%		$	47,989		17.3%		$	42,716		16.1%
Retail		22,547				26.2%		19,690				25.4%		45,010			21.9%		42,115			22.1%
Mass Channel		5,150				10.1%		4,898				15.6%		13,199			12.3%		6,602			10.7%
Other reconciling items		(8,527			)	(3.4)%		(8,096			)	(3.8)%		(20,331		)	(3.4)%		(19,907		)	(3.8)%
Total EBITDA		$		39,325		15.6%		$		33,383		15.7%		$	85,867		14.5%		$	71,526		13.8%

 

        EBITDA shown above represents earnings before interest, income tax expense, depreciation, and amortization.  EBITDA is presented because it is one measurement used by management in assessing financial performance, and we believe it is helpful to investors, securities analysts, and other interested parties in evaluating performance of companies in our industry.  EBITDA is also a measure used as a basis for calculating our financial covenants under our senior credit facility.  EBITDA is not a measurement of financial performance under generally accepted accounting principles in the United States of America.  It should not be considered as an alternative to cash flow from operating activities, as a measure of liquidity,

 

11

 

an alternative to net income, or any other measure of performance derived in accordance with generally accepted accounting principles in the United States of America.  Our definition and calculation of EBITDA may not be comparable to similarly titled measures used by other companies.

 

        A reconciliation of EBITDA to net income is presented below ($000):

 

		For the three-month periods ended							For the nine-month periods ended
		October 2, 2004			October 4, 2003				October 2, 2004				October 4, 2003
Total EBITDA		$	39,325		$		33,383		$	85,867			$		71,526
Depreciation and amortization expense		(4,198		)	(6,018			)	(15,145			)	(16,009			)
Interest expense, net		(4,666		)	(6,788			)	(13,654			)	(20,309			)
Provision for income taxes		(12,049		)	(7,922			)	(22,426			)	(13,555			)
Net income		$	18,412		$	12,655			$		34,642		$	21,653

 

NOTE 9 — CLOSURE COSTS:

 

          On July 3, 2004, we closed our distribution facility located in Leola, Pennsylvania in order to consolidate shipping operations with our remaining three distribution facilities located in Georgia.  This closure was announced to affected employees on June 1, 2004.  Total employees terminated as of October 2, 2004 were 33.  As a result of this closure, we recorded approximately $77,000 in other exit costs and reversed approximately $28,000 of previously estimated severance during the third quarter of fiscal 2004.  During the first nine months of fiscal 2004, we recorded approximately $67,000 in severance and $77,000 in other exit costs.  During the fourth quarter of fiscal 2004, we expect to incur approximately $31,000 in additional severance and other exit costs.

 

          In July 2003, we decided to exit our sewing facilities located in Costa Rica given our ability to obtain lower costs from third-party suppliers.  The facilities were held and used for production through the end of November 2003.  Total employees terminated as of October 2, 2004 were approximately 1,492.  As a result of the Costa Rican closures, we recorded approximately $1,306,000 in accelerated depreciation during the third and fourth quarters of fiscal 2003 (included in cost of goods sold) and plant closure costs of approximately $1,041,000 comprised of $184,000 of asset impairment charges, $483,000 of severance, and $374,000 in other exit costs.  We also incurred approximately $424,000 in the fourth quarter of fiscal 2003 and $11,000 in the first quarter of fiscal 2004 of federal income tax expense related to the dissolution of our Costa Rican subsidiary (included in the provision for income taxes).  In the first nine months of fiscal 2004, we reversed approximately $136,000 of severance costs and other termination benefits previously estimated for this closure and recorded approximately $74,000 of severance and $371,000 of other closure costs.

 

        Activity associated with the closure cost reserves for our Costa Rican sewing facility and our distribution facility in Leola, Pennsylvania for the three-month period ended October 2, 2004 is as follows:

 

 

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Activity for the nine-month period ended October 2, 2004 is as follows:

 

 

NOTE 10 — EARNINGS PER SHARE:

 

        In accordance with SFAS No. 128, “Earnings Per Share,” basic earnings per share is based on the weighted average number of common shares outstanding during the period, whereas diluted earnings per share also gives effect to all potentially dilutive common shares, which include stock options, that were outstanding during the period.  All such stock options are reflected in the denominator using the treasury stock method.  This method assumes that shares are issued for options that are “in the money,” but that we use the proceeds of such option exercises (generally, cash to be paid plus future compensation expense to be recognized) to repurchase shares at the average market value of our shares for the respective periods.  We have used our best estimate of the average fair market value of our shares for the respective periods prior to our initial public offering completed on October 29, 2003.

 

        The following is a reconciliation of basic number of Carter’s, Inc.’s common shares outstanding to diluted number of common and common equivalent shares outstanding:

 

		For the three-month periods ended								For the nine-month periods ended
		October 2, 2004				October 4, 2003				October 2, 2004				October 4, 2003
Net income		$	18,412,000			$	12,655,000			$	34,642,000			$	21,653,000
Carter’s, Inc.’s weighted average number of common and common equivalent shares outstanding:
Basic number of common shares outstanding		28,109,978				22,564,856				28,032,520				22,560,872
Dilutive effect of stock options		1,792,159				1,671,399				1,855,333				1,523,311
Diluted number of common and common equivalent shares outstanding		29,902,137				24,236,255				29,887,853				24,084,183
Basic net income per common shares		$		0.65		$		0.56		$		1.24		$	0.96
Diluted net income per common shares		$		0.62		$		0.52		$		1.16		$	0.90

 

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ITEM 2.                             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:

 

        The following is a discussion of our results of operations and current financial position.  You should read this discussion in conjunction with our unaudited condensed consolidated financial statements and notes included elsewhere in this quarterly report.  Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed in the section entitled “Risks Factors” in our final prospectus dated September 23, 2004.  Those risk factors expressly qualify all subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf.  Except for any ongoing obligations to disclose material information as required by the federal securities laws, we do not have any intention or obligation to update forward-looking statements after we file this quarterly report.

 

        Our fiscal year ends on the Saturday in December or January nearest to the last day of December.  Consistent with this policy, fiscal 2003 ended on January 3, 2004 and fiscal 2004 will end on January 1, 2005.  As a result, fiscal 2003 contained 53 weeks of financial results and fiscal 2004 will contain 52 weeks of financial results.  The additional week in fiscal 2003 was included in the first half of fiscal 2003.  Therefore, the accompanying unaudited condensed consolidated financial statements for the first nine months of fiscal 2004 reflect our financial position as of October 2, 2004 and for the 39-week period then ended.  The first nine months of fiscal 2003 ended on October 4, 2003 and included 40 weeks of financial results.  The three-month periods ended October 2, 2004 and October 4, 2003 each contained 13 weeks of financial results.

 

RESULTS OF OPERATIONS

 

        The following table sets forth, for the periods indicated, (i) selected statement of income data expressed as a percentage of net sales and (ii) the number of retail stores open at the end of each period:

 

 

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