UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 1, 2006 OR

o            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM             TO          

Commission file number:

 

001-31829

 

 

CARTER’S, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware		13-3912933
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
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 x     No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

Large Accelerated Filer x         Accelerated Filer o         Non-Accelerated Filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

CARTER’S, INC.
INDEX

				Page
Part I.		Financial Information
Item 1.		Financial Statements
		Unaudited Condensed Consolidated Balance Sheets as of April 1, 2006 and December 31, 2005		3
		Unaudited Condensed Consolidated Statements of Operations for the three-month periods ended April 1, 2006 and April 2, 2005		4
		Unaudited Condensed Consolidated Statements of Cash Flows for the three-month periods ended April 1, 2006 and April 2, 2005		5
		Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity for the three-month period ended April 1, 2006		6
		Notes to the Unaudited Condensed Consolidated Financial Statements		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		31
Item 4.		Controls and Procedures		32
Part II.		Other Information
Item 1.		Legal Proceedings		33
Item 1A.		Risk Factors		33
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		33
Item 3.		Defaults upon Senior Securities		33
Item 4.		Submission of Matters to a Vote of Security Holders		33
Item 5.		Other Information		33
Item 6.		Exhibits		34
Signatures				35
Certifications

 

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

		April 1, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents		$	59,662		$	84,276
Accounts receivable, net		108,014			96,144
Inventories, net		154,341			188,454
Prepaid expenses and other current assets		8,741			6,262
Deferred income taxes		21,818			23,909
Total current assets		352,576			399,045
Property, plant, and equipment, net		76,166			79,458
Tradenames		322,233			322,233
Cost in excess of fair value of net assets acquired		283,394			284,172
Deferred debt issuance costs, net		7,788			8,257
Licensing agreements, net		16,086			17,150
Leasehold interests, net		1,502			1,619
Other assets		6,154			4,793
Total assets		$	1,065,899		$	1,116,727
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt		$	4,231		$	3,241
Accounts payable		24,511			63,735
Other current liabilities		66,022			89,627
Total current liabilities		94,764			156,603
Long-term debt		415,720			426,791
Deferred income taxes		128,639			124,439
Other long-term liabilities		20,917			22,250
Total liabilities		660,040			730,083
Commitments and contingencies
Stockholders’ equity:
Preferred stock; par value $.01 per share; 100,000 shares authorized; none issued or outstanding at April 1, 2006 and December 31, 2005		—			—
Common stock, voting; par value $.01 per share; 40,000,000 shares authorized; 28,988,029 and 28,909,729 shares issued and outstanding at April 1, 2006 and December 31, 2005, respectively		290			289
Additional paid-in capital		260,053			260,414
Deferred compensation		—			(2,749		)
Accumulated other comprehensive income		2,395			1,354
Retained earnings		143,121			127,336
Total stockholders’ equity		405,859			386,644
Total liabilities and stockholders’ equity		$	1,065,899		$	1,116,727

See accompanying notes to the unaudited condensed consolidated financial statements

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CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except for share data)
 (unaudited)

		For the three-month periods ended
		April 1, 2006			April 2, 2005
Net sales		$	296,447		$	206,207
Cost of goods sold		188,304			130,442
Gross profit		108,143			75,765
Selling, general, and administrative expenses		82,966			51,996
Closure costs		81			—
Royalty income		(7,179		)	(3,523		)
Operating income		32,275			27,292
Interest expense, net		6,884			4,402
Income before income taxes		25,391			22,890
Provision for income taxes		9,606			9,041
Net income		$	15,785		$	13,849
Basic net income per common share		$	0.55		$	0.49
Diluted net income per common share		$	0.52		$	0.46
Basic weighted average number of shares outstanding		28,854,517			28,466,734
Diluted weighted average number of shares outstanding		30,567,639			30,181,110

 

See accompanying notes to the unaudited condensed consolidated financial statements

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CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)

		For the three-month periods ended
		April 1, 2006			April 2, 2005
Cash flows from operating activities:
Net income		$	15,785		$	13,849
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		6,169			4,088
Amortization of debt issuance costs		468			580
Accretion of debt discount		—			19
Income tax benefit from exercised options		—			912
Non-cash stock compensation expense		1,339			81
Loss on sale of property, plant, and equipment		75			37
Deferred tax benefit		5,691			1,639
Effect of changes in operating assets and liabilities:
Accounts receivable		(11,870		)	4,634
Inventories		34,113			13,950
Prepaid expenses and other assets		(2,199		)	(1,179		)
Accounts payable and other liabilities		(63,534		)	(13,962		)
Net cash (used in) provided by operating activities		(13,963		)	24,648
Cash flows from investing activities:
Capital expenditures		(2,150		)	(2,079		)
Proceeds from sale of property, plant, and equipment		364			—
Collections on loan		—			600
Net cash used in investing activities		(1,786		)	(1,479		)
Cash flows from financing activities:
Payments on term loan		(10,080		)	(20,130		)
Income tax benefit from exercised options		795			—
Proceeds from exercise of stock options		420			244
Net cash used in financing activities		(8,865		)	(19,886		)
Net (decrease) increase in cash and cash equivalents		(24,614		)	3,283
Cash and cash equivalents, beginning of period		84,276			33,265
Cash and cash equivalents, end of period		$	59,662		$	36,548

 

See accompanying notes to the unaudited condensed consolidated financial statements

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CARTER’S, INC.
 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(dollars in thousands, except for share data)
(unaudited)

		Common stock			Additional paid-in capital			Deferred compensation			Accumulated other comprehensive income			Retained earnings			Total stockholders’ equity
Balance at December 31, 2005		$	289		$	260,414		$	(2,749	)	$	1,354		$	127,336		$	386,644
Tax benefit from exercise of stock options		—			795			—			—			—			795
Exercise of stock options (41,200 shares)		1			419			—			—			—			420
Stock-based compensation expense		—			1,174			—			—			—			1,174
Reversal of deferred compensation (see Note 5)		—			(2,749		)	2,749			—			—			—
Comprehensive income:
Net income		—			—			—			—			15,785			15,785
Unrealized gain on interest rate swap, net of taxes of $600		—			—			—			1,041			—			1,041
Total comprehensive income		—			—			—			1,041			15,785			16,826
Balance at April 1, 2006		$	290		$	260,053		$	—		$	2,395		$	143,121		$	405,859

See accompanying notes to the unaudited condensed consolidated financial statements.

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CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1 — THE COMPANY:

Carter’s, Inc., and its wholly-owned subsidiaries (collectively, the “Company,” “we,” “us,” “its,” and “our”) design, source, and market branded childrenswear under the Carter’s, Child of Mine, Just One Year, OshKosh B’Gosh, and related labels. Our products are sourced through contractual arrangements with manufacturers worldwide. Products are sourced for wholesale distribution to major domestic retailers, including the mass channel, and for our 199 Carter’s brand and 142 OshKosh brand retail stores that market our brand name merchandise and other licensed products manufactured by other companies.

On July 14, 2005, Carter’s, Inc., through its wholly-owned subsidiary, The William Carter Company (“TWCC”), acquired all of the outstanding common stock of OshKosh B’Gosh, Inc. (“OshKosh”) for a purchase price of $312.1 million, which included payment for vested stock options (the “Acquisition”). Established in 1895, OshKosh designs, sources, and markets apparel for children sizes newborn to 16. The unaudited condensed consolidated financial statements include the financial results of OshKosh for the three-month period ended April 1, 2006. Financial results for the three-month period ended April 2, 2005 do not include the financial results of OshKosh.

NOTE 2 — BASIS OF PREPARATION:

The accompanying unaudited condensed consolidated financial statements comprise the consolidated financial statements of Carter’s, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

In our opinion, the Company’s accompanying unaudited condensed consolidated financial statements contain all adjustments necessary for a fair statement of our financial position as of April 1, 2006, the results of our operations for the three-month periods ended April 1, 2006 and April 2, 2005, cash flows for the three-month periods ended April 1, 2006 and April 2, 2005 and changes in stockholders’ equity for the three-month period ended April 1, 2006. Operating results for the three-month period ended April 1, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending December 30, 2006. Our accompanying condensed consolidated balance sheet as of December 31, 2005 is from our audited consolidated financial statements included in our most recently filed Annual Report on Form 10-K, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Certain information and footnote disclosure normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have 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 our most recently filed Annual Report on Form 10-K in the notes to our consolidated financial statements for the fiscal year ended December 31, 2005.

Our fiscal year ends on the Saturday in December or January nearest to the last day of December. The accompanying unaudited condensed consolidated financial statements for the first quarter of fiscal 2006 reflect our financial position as of April 1, 2006. The first quarter of fiscal 2005 ended on April 2, 2005.

Certain prior year amounts have been reclassified for comparative purposes.

NOTE 3 — BUSINESS COMBINATION AND REFINANCING:

As noted above, on July 14, 2005, we acquired all of the outstanding common stock of OshKosh. The Acquisition was accounted for under the purchase method of accounting. The purchase price for the Acquisition, including related fees and expenses, was allocated to the fair value of tangible and identifiable intangible assets and liabilities acquired with the remainder allocated to goodwill. As part of financing the Acquisition, the Company refinanced its existing debt (the “Refinancing”), including its senior credit facility (“former senior credit facility”) and its $113.8 million 10.875% Senior Subordinated Notes due 2011 (together with the Acquisition, the “Transaction”).

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Financing for the Transaction was provided by a new $500 million Term Loan B and a $125 million revolving credit facility (including a sub-limit for letters of credit of $80 million, the “Revolver”) entered into by TWCC with Bank of America, N.A., as administrative agent, Credit Suisse, and certain other financial institutions (the “Senior Credit Facility”). The term of the Revolver extends to July 14, 2011 and the term of the Term Loan B extends to July 14, 2012.

The proceeds of the Refinancing were used to purchase the outstanding common stock and vested stock options of OshKosh ($312.1 million), pay transaction expenses ($6.2 million), refinance the Company’s former senior credit facility ($36.2 million), repurchase the Company’s 10.875% Senior Subordinated Notes ($113.8 million), pay a redemption premium on the Company’s 10.875% Senior Subordinated Notes ($14.0 million), along with accrued and unpaid interest ($5.1 million), and pay debt issuance costs ($10.6 million). Other Transaction expenses paid prior and subsequent to the closing of the Transaction totaled $1.4 million, including $0.2 million in debt issuance costs.

As a result of the Refinancing, we expensed $4.5 million in unamortized debt issuance costs related to the former senior credit facility and 10.875% Senior Subordinated Notes and expensed $0.5 million related to the debt discount on the 10.875% Senior Subordinated Notes. Additionally, we expensed approximately $1.1 million of debt issuance costs associated with the Senior Credit Facility in accordance with Emerging Issues Task Force (“EITF”) No. 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments.” 

The Senior Credit Facility requires us to hedge at least 25% of our variable rate debt under the term loan. On September 22, 2005, we entered into a swap agreement to receive floating and pay fixed interest. This swap agreement is designated as a cash flow hedge of the variable interest payments on a portion of our variable rate Term Loan B debt. The swap agreement matures on July 30, 2010. The unrealized gain, net of taxes, related to the interest rate swap was $1.0 million for the three-month period ended April 1, 2006 and is included within accumulated other comprehensive income on the accompanying unaudited condensed consolidated balance sheet. During the three-month period ended April 1, 2006, we reclassified approximately $0.1 million related to the swap agreement into earnings.

A summary of the Acquisition purchase price allocation is as follows:

 

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During the three-month period ended April 1, 2006, the following adjustments were made to the purchase price allocation:

 

The following unaudited pro forma summary presents information as if OshKosh had been acquired at the beginning of fiscal 2005 with financing obtained as described above and assumes that there were no other changes in our operations. This pro forma information does not necessarily reflect the actual results that would have occurred had the Company been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies.

The results reflect the combined actual results of Carter’s and OshKosh B’Gosh, Inc. for the three-month period ended April 2, 2005, adjusted to reflect increased interest expense, amortization of the capitalized value of OshKosh licensing agreements and leasehold interests and incremental depreciation expense.

 

NOTE 4 — COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED AND OTHER
INTANGIBLE ASSETS:

In connection with the Acquisition, the Company recorded the cost in excess of fair value of net assets acquired and other intangible assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.”

As of April 1, 2006, cost in excess of net assets acquired and other intangible assets resulting from the acquisition of OshKosh were as follows:

 

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Amortization expense for intangible assets subject to amortization was approximately $1.2 million for the three-month period ended April 1, 2006. Annual amortization expenses for the OshKosh licensing agreements and leasehold interests are expected to be as follows:

 

As described in Note 2 to our consolidated financial statements in our most recently filed Annual Report on Form 10-K, our existing Carter’s tradename and cost in excess of net assets acquired have been deemed to have indefinite lives and are not being amortized.

NOTE 5 — STOCK-BASED COMPENSATION:

Under our Amended and Restated 2003 Equity Incentive Plan (the “Plan”), the compensation committee of our Board of Directors may award incentive stock options (ISOs and non-ISOs), stock appreciation rights (SARs), restricted stock, unrestricted stock, stock deliverable on a deferred basis, performance-based stock awards, and cash payments intended to help defray the cost of awards. On May 12, 2005, our Board of Directors adopted, and the stockholders approved an amendment to the Plan to increase the number of shares available to be delivered under the plan by 1,400,000 to 5,744,196, with no more than 630,000 of such additional shares able to be used for awards other than stock options and to reduce the number of shares for which stock options may be granted to any individual or which can be subject to SARs granted to any individual in any calendar year from 4,000,000 to 1,000,000. As of April 1, 2006, there were 1,134,128 shares available for grant under the Plan. The Plan makes provision for the treatment of awards upon termination of service or in the case of a merger or similar corporate transaction. Participation in the amended and restated Plan is limited to those key employees and others who are selected by the compensation committee. The limit on shares available under the Plan, the individual limits, and other award terms are subject to adjustment to reflect stock splits or stock dividends, combinations, and certain other events. All stock options issued under the Plan expire ten years from the date of grant. The Company believes that the current level of authorized shares is sufficient to satisfy future option exercises.

There are currently three types of stock options outstanding under the Plan:  basic, performance, and retained options. Basic options issued prior to May 12, 2005 vest ratably over 5 years. Basic options granted on and subsequent to May 12, 2005 vest ratably over 4 years. Performance options vest upon the achievement of pre-determined performance criteria. Retained stock options relate to options that were outstanding prior to the 2001 Acquisition and became fully vested in connection with the 2001 Acquisition.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”), and supercedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”). SFAS 123R requires companies to expense the fair value of employee stock options and similar awards. Effective January 1, 2006, the Company adopted SFAS 123R and began recognizing compensation expense for its share-based payments based on the fair value of the awards at the grant date. Under SFAS 123R, the pro forma

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disclosures previously permitted under SFAS 123 are no longer an alternative to financial statement recognition.

The Company adopted SFAS 123R using the modified prospective application method of transition. Therefore, prior period financial statements have not been restated. Under the modified prospective application method, for awards granted prior to January 1, 2006, compensation expense is recorded as options vest subsequent to January 1, 2006 based upon the grant date fair value estimated in accordance with the original provisions of SFAS 123, adjusted for estimated forfeitures. For stock options granted subsequent to January 1, 2006, compensation expense will be recorded as options vest based upon the grant date fair value estimated in accordance with SFAS 123R, with forfeitures estimated at the time of grant. Forfeiture estimates will be adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from previous estimates.

The fair value of stock options under SFAS 123R is determined using the Black-Scholes option pricing model, which is consistent with our valuation techniques previously utilized for stock options in pro forma footnote disclosure required under SFAS 123. Prior to the filing of our first Registration Statement on Form S-1 on August 23, 2002 in connection with our initial public offering, we used the minimum value method to value stock options, as provided by SFAS 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transaction and Disclosure” (“SFAS 148”). Under SFAS 123R, no compensation expense has been recorded for options recorded under the minimum value method.

The fair value of restricted stock is determined based on the number of shares granted and the quoted closing price of our common stock on the date of grant, consistent with our treatment of such awards under APB 25 prior to the adoption of SFAS 123R.

In connection with the adoption and provisions of SFAS 123R, the Company reversed its deferred compensation balance of $2,749,000 on January 1, 2006 related to restricted stock awards.

The adoption of SFAS 123R has resulted in additional pre-tax share-based compensation expense (a component of selling, general, and administrative expenses) in the amount of approximately $908,000 related to stock options for the three-month period ended April 1, 2006, than if the Company had continued to account for share-based compensation under APB 25. The impact on net income for the three-month period ended April 1, 2006 was a reduction of approximately $565,000. The impact for the three-month period ended April 1, 2006 on basic and diluted earnings per share was a reduction of approximately $0.02 per share. For the year-ended December 30, 2006, the adoption of SFAS 123R is expected to result in a reduction in net income of approximately $2.4 million, or $0.08 per basic and diluted earnings per share.

Prior to the adoption of SFAS 123R, we presented all tax benefits resulting from the exercise of stock options as operating cash inflows in the consolidated statements of cash flows, in accordance with the provisions of the Emerging Issues Task Force (“EITF”) Issue No. 00-15, “Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option.”  SFAS 123R requires the benefit of tax deductions in excess of the compensation cost recognized for exercised options and restricted stock that vests to be classified as financing cash inflows rather than operating cash inflows, on a prospective basis. This amount is now shown as “Income tax benefit from exercised options” on the unaudited condensed consolidated statement of cash flows. The tax benefit from exercised options during the three-month period ended April 1, 2006 was approximately $795,000. Prior periods have not been restated.

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Prior to the adoption of SFAS 123R, we accounted for stock-based compensation on stock options under the intrinsic value method consistent with APB 25. Under this method, we recorded 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. Forfeitures on stock option awards with expense recorded in accordance with APB 25 were accounted for as they occurred, rather than based on estimates of future forfeitures. There was no material impact or cumulative effect adjustment required as a result of estimating the impact of future forfeitures on awards previously expensed in accordance with APB 25. For disclosure purposes only, we also estimated the impact on our net income of applying the fair value method of measuring compensation cost on stock options with the fair value of Carter’s, Inc.’s common stock. In our pro forma disclosures we accounted for forfeitures as they occurred, rather than based on estimates of future forfeitures.

The following table provides supplemental information for the three-month period ended April 2, 2005 as if stock-based compensation had been computed under SFAS 123, as amended by SFAS 148:

 

 

A summary of stock option activity under the Plan (in number of shares that may be purchased) is as follows for the three-month period ended April 1, 2006:

Basic Stock Options

		Basic stock options		Weighted-average exercise price per share			Weighted-average grant-date fair value
Outstanding, December 31, 2005		2,422,064		$	12.45		$	5.52
Granted		73,400		$	68.63		$	31.19
Exercised		(41,200	)	$	10.19		$	5.16
Forfeited		—		$	—		$	—
Expired		—		$	—		$	—
Outstanding, April 1, 2006		2,454,264		$	14.16		$	6.30
Exercisable, April 1, 2006		1,511,241		$	8.16		$	3.59

 

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During the three months ended April 1, 2006, the Company granted 73,400 basic stock options. In connection with this grant of basic stock options, the Company recognized approximately $59,000 in compensation expense during the three-month period ended April 1, 2006.

A summary of basic stock options outstanding and exercisable at April 1, 2006 is as follows:

		Outstanding										Exercisable
Range of exercise prices		Number		Weighted- average remaining contractual life		Weighted average exercise price			Weighted average grant-date fair value			Number		Weighted average exercise price			Weighted average grant-date fair value
$ 6-$10		1,760,284		5.52 years		$	6.29		$	2.58		1,348,641		$	6.22		$	2.56
$13-$14		167,680		7.46 years		$	13.95		$	9.76		55,360		$	13.95		$	9.76
$27-$33		312,200		8.11 years		$	29.75		$	13.41		107,240		$	29.64		$	13.28
$44-$53		120,000		9.30 years		$	47.63		$	19.04		—		$	—		$	—
$62-$69		94,100		9.76 years		$	67.37		$	29.91		—		$	—		$	—
		2,454,264		6.33 years		$	14.16		$	6.30		1,511,241		$	8.16		$	3.59

 

At April 1, 2006, the aggregate intrinsic value of all outstanding basic options is approximately $131.0 million, and the aggregate intrinsic value of currently exercisable basic options is approximately $89.7 million. The intrinsic value of basic options exercised during the period was approximately $2.3 million. At April 1, 2006, the total estimated compensation cost related to non-vested basic options not yet recognized is approximately $7.6 million with a weighted average expense recognition period of 3.26 years.

Performance Stock Options

 

 

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A summary of performance stock options outstanding and exercisable at April 1, 2006 is as follows:

		Outstanding										Exercisable
Range of exercise prices		Number		Weighted average remaining contractual life		Weighted average exercise price			Weighted average grant date fair value			Number		Weighted average exercise price			Weighted average grant date fair value
$44-$63		300,000		9.28 years		$	50.12		$	18.79		—		$	—		$	—

 

At April 1, 2006, the aggregate intrinsic value of all outstanding performance options is approximately $5.2 million. No performance options are currently exercisable. At April 1, 2006, the total estimated compensation cost related to non-vested performance options not yet recognized is approximately $4.7 million with a weighted average expense recognition period of 3.16 years.

Retained Stock Options

 

The weighted-average contractual life of the 854,135 retained stock options outstanding and exercisable as of April 1, 2006 is 5.38 years. At April 1, 2006, the aggregate intrinsic value of all outstanding retained options, which are all currently exercisable, is approximately $56.4 million.

The weighted-average contractual life for the basic, performance, and retained stock options in aggregate as of Apri1 1, 2006 is approximately 6.35 years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing method with the following weighted average assumptions used for grants issued during the three-month period ended April 1, 2006:

 

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Volatility — This is a measure of the amount by which a stock price has fluctuated or is expected to fluctuate. The Company uses actual monthly historical changes in the market value of our stock since the Company’s initial public offering on October 29, 2003, supplemented by peer company data for periods prior to our initial public offering covering the expected life of options being valued. An increase in the expected volatility will increase compensation expense.

Risk-free interest rate — This is the U.S. Treasury rate as of the grant date having a term equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense.

Expected term — This is the period of time over which the options granted are expected to remain outstanding and is based on historical experience and estimated future exercise behavior. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. An increase in the expected term will increase compensation expense.

Dividend yield — The Company does not have plans to pay dividends in the foreseeable future. An increase in the dividend yield will decrease compensation expense.

Restricted Stock

All restricted stock awards issued under the plan vest based upon service. Restricted stock awards vest ratably over 4 years or cliff-vest after 3 or 4 years. As noted above, the fair value of restricted stock is determined based on the number of shares granted and the quoted closing price of our common stock on the date of grant.

The following table summarizes our restricted stock award activity during the three-month period ended April 1, 2006:

 

During the three-month period ended April 1, 2006, we granted 37,100 shares of restricted stock to employees. In connection with this issuance, we recorded approximately $59,000 of compensation expense. Compensation expense recorded during the three-month period ended April 1, 2006 for all restricted stock awards totaled approximately $264,000. The total amount of estimated compensation expense related to unvested restricted stock awards is approximately $4.8 million as of April 1, 2006.

Compensation expense related to outstanding stock options and restricted stock awards is expected to be recorded as follows:

(dollars in thousands)				Basic options			Performance options			Restricted stock			Total
2006 (period from April 2 through December 30)				$	1,787		$	1,129		$	1,090		$	4,006
2007				2,381			1,508			1,349			5,238
2008				2,271			1,520			1,321			5,112
2009				1,103			540			938			2,581
2010				60			—			73			133
Total				$	7,602		$	4,697		$	4,771		$	17,070

 

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NOTE 6 — INVENTORIES:

Inventories consisted of the following:

 

NOTE 7 — EMPLOYEE BENEFIT PLANS:

Under a defined benefit plan frozen in 1991, we offer a comprehensive post-retirement medical plan to current and certain future retirees and their spouses until they become eligible for Medicare or a Medicare supplement plan. We also offer life insurance to current and certain future retirees. We also have an obligation under a defined benefit plan covering certain former officers. See Note 7 “Employee Benefit Plans” to our consolidated financial statements in our most recently filed Annual Report on Form 10-K for further information.

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

 

The components of pension expense charged to operations are as follows:

 

The Company maintains two defined benefit pension plans acquired in connection with the Acquisition. The benefits under these pension plans were frozen as of December 31, 2005, and cover certain current and former employees of OshKosh.

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The Company’s net periodic pension benefit related to these plans is comprised of the following components:

 

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,” 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 operating segments.

The table below presents certain segment information for the periods indicated:

(dollars in thousands)				For the three-month period ended April 1, 2006			% of Total		For the three-month period ended April 2, 2005			% of Total
Net sales:
Wholesale-Carter’s				$	102,361		34.5	%	$	98,954		48.0	%
Wholesale-OshKosh				28,680			9.7	%	—			—
Retail-Carter’s				69,068			23.3	%	67,764			32.9	%
Retail-OshKosh				42,312			14.3	%	—			—
Mass Channel-Carter’s				54,026			18.2	%	39,489			19.1	%
Total net sales				$	296,447		100.0	%	$	206,207		100.0	%

 

					% of segment net sales					% of segment net sales
Operating income:
Wholesale-Carter’s		$	20,438		20.0	%	$	20,032		20.2	%
Wholesale-OshKosh		3,353			11.7	%	—			—
Retail-Carter’s		11,260			16.3	%	11,285			16.7	%
Retail-OshKosh		230			0.5	%	—			—
Mass Channel-Carter’s		8,177			15.1	%	4,029			10.2	%
Mass Channel-OshKosh (a)		130			—		—			—
Segment operating income		43,588			14.7	%	35,346			17.1	%
Other reconciling items		(11,313		)	(3.8	%)	(8,054		)	(3.9	%)
Total operating income		$	32,275		10.9	%	$	27,292		13.2	%

(a)          OshKosh mass channel consists of a licensing agreement with Target Stores. Operating income consists of royalty income, net of related expenses.

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NOTE 9 — RESTRUCTURING AND CLOSURE COSTS:

In connection with the Acquisition, management has developed a plan to restructure and integrate the operations of OshKosh. In accordance with emerging Issuance Task Force (“EITF”) No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” liabilities have been established for OshKosh severance and relocation, lease termination costs associated with the closure of OshKosh’s 15 Lifestyle stores and 14 outlet stores in 2005, contract termination costs, and other exit costs. These liabilities also cover costs related to the closure of the OshKosh Choloma, Honduras sewing facility, the Uman, Mexico sewing facility, and Liberty, Kentucky distribution center. The Choloma, Honduras and Liberty, Kentucky facilities were closed during the fourth quarter of fiscal 2005. The Uman, Mexico facility was closed during the first three months of fiscal 2006. We expect to pay these liabilities during fiscal 2006.

The following table summarizes restructuring activity related to the Acquisition:

(dollars in thousands)				Severance and relocation			Other exit costs			Lease termination costs			Contract termination costs			Total
Balance at July 14, 2005				$	9,840		$	2,075		$	7,020		$	2,000		$	20,935
Payments				(2,304		)	(71		)	(468		)	(934		)	(3,777		)
Adjustments to goodwill				673			(78		)	—			(168		)	427
Balance at December 31, 2005				8,209			1,926			6,552			898			17,585
Payments				(2,555		)	(261		)	(3,724		)	(39		)	(6,579		)
Adjustments to goodwill				(119		)	(338		)	—			—			(457		)
Balance at April 1, 2006				$	5,535		$	1,327		$	2,828		$	859		$	10,549

 

In May 2005, we decided to exit two Carter’s brand sewing facilities in Mexico. We have developed alternative capabilities to source comparable products in Asia at lower costs. Our Board of Directors approved the closure plans on June 15, 2005. For the majority of the affected employees, severance benefits were communicated on June 21, 2005. The total number of employees initially terminated is approximately 1,124. Thirty-six employees were retained through April 2006. Production at these facilities ceased on August 5, 2005.

As a result of these closures, in fiscal 2005, we recorded total charges of $8.4 million including $4.6 million of severance charges, $1.3 million of lease termination charges, $1.6 million of accelerated depreciation (included in cost of goods sold), $0.1 million of asset impairment charges, and $0.8 million of other exit costs. During the first three months of fiscal 2006, we recorded total charges of $81,000 including $65,000 of severance charges and $16,000 of other exit costs. Additional charges to be incurred during the second quarter of fiscal 2006 include severance charges and other exit costs. We estimate these charges for the second quarter of fiscal 2006 will be $0.1 million.

Restructuring provisions recorded as a result of these closures are as follows and are included in other current liabilities on the accompanying unaudited condensed consolidated balance sheet:

 

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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 year, whereas diluted earnings per share also gives effect to all potentially dilutive shares of common stock, including basic and retained stock options and unvested restricted stock, 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 stock options that are “in the money,” but that we use the proceeds of such stock option exercises (generally, cash to be paid plus future compensation expense to be recognized and the amount of tax benefits, if any, that will be credited to additional paid-in capital assuming exercise of the stock options) to repurchase shares at the average market value of Carter’s, Inc.’s stock for the respective periods. Unvested shares of restricted stock are reflected in the denominator using the treasury stock method with proceeds of the amount, if any, the employees must pay upon vesting, the amount of compensation cost attributed to future services and not yet recognized in earnings, and the amount of tax benefits, if any, that would be credited to additional paid-in capital (i.e., the amount of the tax deduction in excess of recognized compensation cost) assuming vesting of the shares at the current market price.

For the three months ended April 1, 2006, anti-dilutive shares of 181,200 and performance-based options of 300,000 were excluded from the computations of diluted earnings per share. There were no antidilutive shares for the first quarter ended April 2, 2005.

The following is a reconciliation of basic number of common shares outstanding to diluted number of common and common equivalent shares outstanding:

 

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NOTE 11 — PROPOSED STOCK SPLIT:

On March 1, 2006, we announced our intention to split the Company’s common stock on a two-for-one basis through a stock dividend that would entitle each stockholder of record to receive one additional share of common stock for every one share owned. To make the stock split possible, the Board of Directors has recommended that the Company’s stockholders approve an amendment to the Company’s certificate of incorporation increasing the number of authorized shares of the Company’s common stock from 40,000,000 to 150,000,000 at the Company’s May 11, 2006 annual stockholders meeting. If stockholders approve the amendment, and subject to then-current market conditions, the Company intends to announce the specific timing of the stock split and declare the stock dividend following the annual stockholders meeting. The Board of Directors, however, may determine not to declare the stock dividend.

 

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