form10-k.htm



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


FORM 10-K

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2007

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 incorporation or organization)
(I.R.S. Employer Identification No.)

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)
 



SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 
TITLE OF EACH CLASS
NAME OF EACH EXCHANGE ON
 
 
Carter’s, Inc.’s common stock
WHICH REGISTERED:
 
 
par value $0.01 per share
New York Stock Exchange
 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
 


Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  x  No o
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes o  No x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Check one:

Large Accelerated Filer x   Accelerated Filer o   Non-Accelerated Filer  o    Smaller Reporting Company  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

The approximate aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 29, 2007 (the last business day of our most recently completed second quarter) was $1,460,972,006.

There were 57,671,315 shares of Carter’s, Inc.’s common stock with a par value of $0.01 per share outstanding as of the close of business on February 27, 2008.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A relating to the Annual Meeting of Stockholders of Carter’s, Inc., to be held on May 9, 2008, will be incorporated by reference in Part III of this Form 10-K.  Carter’s, Inc. intends to file such proxy statement with the Securities and Exchange Commission not later than 120 days after its fiscal year ended December 29, 2007.
 
 



 
 

 


 
CARTER’S, INC.

 
INDEX TO ANNUAL REPORT ON FORM 10-K
 
 
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2007
 
     
 
Page
Business
1
Risk Factors
7
Unresolved Staff Comments
11
Properties
11
Legal Proceedings
11
Submission of Matters to a Vote of Security Holders
11
   
Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
12
Selected Financial Data
14
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
Quantitative and Qualitative Disclosures about Market Risk
30
Financial Statements and Supplementary Data
31
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
64
Controls and Procedures
64
Other Information
64
   
Directors and Executive Officers of the Registrant
65
Executive Compensation
65
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
65
Certain Relationships and Related Transactions
65
Principal Accountant Fees and Services
65
   
Exhibits and Financial Statement Schedules
66
67
CERTIFICATIONS
 

 
 

 

PART I

Our market share data is based on information provided by the NPD Group, Inc.  Unless otherwise indicated, references to market share in this Annual Report on Form 10-K mean our share expressed as a percentage of total retail sales of a market.  NPD has restated historical data, therefore, the market data reported prior to 2006 is not directly comparable to the data reported in this Annual Report on Form 10-K.  The baby and young children’s market includes apparel products from sizes newborn to seven.

Unless the context indicates otherwise, in this filing on Form 10-K, “Carter’s,” the “Company,” “we,” “us,” “its,” and “our” refers to Carter’s, Inc. and its wholly owned subsidiaries.

ITEM 1. BUSINESS

We are the largest branded marketer in the United States of apparel exclusively for babies and young children.  We own two of the most highly recognized and most trusted brand names in the children’s apparel industry, Carter’s and OshKosh.  We have extensive experience in the young children’s apparel market and focus on delivering products that satisfy our consumers’ needs.  We market high-quality, essential core products at prices that deliver an attractive value proposition for consumers.

We have developed a business model that we believe has multiple platforms for growth and is focused on high volume and productivity.  We believe each of our brands has its own unique positioning in the marketplace and strong growth potential.  Our brands compete in the $24 billion children’s apparel market, for children sizes newborn to seven, with our Carter’s brand achieving the #1 branded position with a 7.4% market share.  Our OshKosh brand has a 2.7% market share.  We offer multiple product categories, including baby, sleepwear, playclothes, and other accessories.  Our distribution strategy enables us to reach a broad range of consumers through channel, price point, and region.  We sell our products to national department stores, chain and specialty stores, discount retailers, and, as of December 29, 2007, through 228 Carter’s and 163 OshKosh outlet and brand retail stores.

In fiscal 2005, we acquired OshKosh B’Gosh, Inc.  Established in 1895, OshKosh is recognized and trusted by consumers for its line of high-quality apparel for children sizes newborn to 16.  In fiscal 2007, sales from OshKosh totaled $320.3 million, or 22.7%, of our consolidated net sales.  Including OshKosh, over the past five fiscal years, we have increased consolidated net sales at a compound annual growth rate of 19.5%.

Our pre-tax results have ranged from income of $38.9 million in fiscal 2003 to a loss of $29.1 million in fiscal 2007.  Our pre-tax results were decreased in fiscal 2003 by debt extinguishment charges of $9.5 million and a management fee termination charge of $2.6 million, both resulting from the Company’s initial public offering in October 2003, and closure costs of $1.0 million related to the closure of two offshore sewing facilities.  In fiscal 2007, our pre-tax results were decreased by OshKosh-related intangible asset impairment charges of $154.9 million and distribution facility closure costs of $7.4 million related to further integrating OshKosh.

The Company’s principal executive offices are located at The Proscenium, 1170 Peachtree Street NE, Suite 900, Atlanta, Georgia 30309, and our telephone number is (404) 745-2700.

OUR BRANDS, PRODUCTS, AND DISTRIBUTION CHANNELS

CARTER’S BRANDS

Under our Carter’s brand, we design, source, and market a broad array of products, primarily for sizes newborn to seven.  Our Carter’s brand is sold in department stores, national chains, specialty stores, off-price sales channels, and through our Carter’s retail stores.  Additionally, we sell our Just One Year and Child of Mine brands through the mass channel at Target and Wal-Mart, respectively.  In fiscal 2007, we sold over 205 million selling units of Carter’s, Just One Year, and Child of Mine products to our wholesale customers, mass channel customers, and through our Carter’s retail stores, an increase of approximately 8% from fiscal 2006.  Under our Carter’s, Just One Year, and Child of Mine brands, sales growth has been driven by our focus on essential, high-volume, core apparel products for babies and young children.  Such products include bodysuits, pajamas, blanket sleepers, gowns, bibs, towels, washcloths, and receiving blankets.  Our top ten baby and sleepwear core products accounted for 78% of our baby and sleepwear net sales in fiscal 2007, including the mass channel.  We believe these core products are consumer staples and are insulated from changes in fashion trends.  Whether they are shopping for their own children or purchasing gifts, consumers provide consistent demand for our products as they purchase the first garments and related accessories for the more than four million babies born each year and replace clothing their children outgrow.


 
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We have four cross-functional product teams focused on the development of our baby, sleepwear, playclothes, and mass channel products.  These teams are skilled in identifying and developing high-volume, core products.  Each team includes members from merchandising, design, sourcing, product development, forecasting, and supply chain logistics.  These teams follow a disciplined approach to fabric usage, color rationalization, and productivity and are supported by a dedicated art department and state-of-the-art design systems.  We also license our brand names to other companies to create a complete collection of lifestyle products, including bedding, hosiery, underwear, shoes, room décor, furniture, and toys.  The licensing team directs the use of our designs, art, and selling strategies to all licensees.

We believe this disciplined approach to core product design reduces fashion risk and supports efficient operations.  We conduct product testing in our own stores, and we analyze quantitative measurements such as pre-season bookings, weekly over-the-counter selling results, and daily re-order rates in order to assess productivity.

CARTER’S BRAND POSITIONING

Our strategy has been to drive our brand image as the leader in baby and young children’s apparel and to consistently provide quality products at a great value to consumers.  We employ a disciplined marketing strategy which identifies and focuses on core products.  We believe that we have strengthened our brand image with the consumer by differentiating our core products through fabric improvements, new artistic applications, and new packaging and presentation strategies.  We also attempt to differentiate our products through store-in-store shops and advertising with wholesale and mass channel customers.  We have invested in display units for our major wholesale customers that clearly present our core products on their floors to enhance brand and product presentation.  We also strive to provide our wholesale and mass channel customers with consistent, premium service, including delivering and replenishing products on time to fulfill customer and consumer needs.
 
CARTER’S PRODUCTS

Baby

Carter’s brand baby products include bodysuits, undershirts, towels, washcloths, receiving blankets, layette gowns, bibs, caps, and booties.  In fiscal 2007, we generated $342.7 million in net sales of these products, excluding the mass channel, representing 24.3% of our consolidated net sales.

Our Carter’s brand is the leading brand in the baby category.  In fiscal 2007, in the department store, national chain, outlet, specialty store, and off-price sales channels, our aggregate market share under the Carter’s brand was approximately 21.6% for baby, which represents greater than three times the market share of the next largest brand.  We sell a complete range of baby products for newborns, primarily made of cotton.  We attribute our leading market position to our brand strength, distinctive print designs, artistic applications, reputation for quality, and ability to manage our dedicated floor space for our retail customers.  We tier our products through marketing programs targeted toward gift-givers, experienced mothers, and first-time mothers.  Our Carter's Starters product line, the largest component of our baby business, provides mothers with essential core products and accessories, including value-focused multi-packs.  Our Carter's Classics product line consists of coordinated baby programs designed for first-time mothers and gift-givers.

Playclothes

Carter’s brand playclothes products include knit and woven cotton apparel for everyday use in sizes three months to size seven.  In fiscal 2007, we generated $297.3 million in net sales of these products, excluding the mass channel, or 21.1%, of our consolidated net sales.

We have focused on building our Carter’s brand in the playclothes market by developing a base of essential, high-volume, core products that utilize original print designs and innovative artistic applications.  Our 2007 Carter’s brand playclothes market share was 7.3% in the $9.8 billion department store, national chain, outlet, specialty store, and off-price sales channels.

Sleepwear

Carter’s brand sleepwear products include pajamas, cotton long underwear, and blanket sleepers in sizes 12 months to size seven.  In fiscal 2007, we generated $152.3 million in net sales of these products, excluding the mass channel, or 10.8%, of our consolidated net sales.

 
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Our Carter’s brand is the leading brand of sleepwear for babies and young children within the department store, national chain, outlet, specialty store, and off-price sales channels in the United States.  In fiscal 2007, in these channels, our Carter’s brand market share was approximately 22.9%.  As in our baby product line, we differentiate our sleepwear products by offering high-volume, core products with creative artwork and soft fabrications.

Mass Channel Products

Our mass channel product team focuses on baby, sleepwear, and playclothes and develops differentiated products specifically for the mass channel, including different fabrications, artwork, and packaging.  Our 2007 market share was 5.9% in the $9.5 billion mass channel children’s apparel market.  Our Child of Mine product line, which is sold in substantially all Wal-Mart stores nationwide, includes layette, sleepwear, and playclothes along with a range of licensed products, such as hosiery, bedding, toys, and gifts.  We also sell our Just One Year brand to Target, which includes baby, sleepwear, and baby playclothes along with a range of licensed products, such as hosiery, bedding, toys, and gifts.  In fiscal 2007, we generated $243.3 million in net sales of our Child of Mine and Just One Year products, or 17.2%, of our consolidated net sales.

Other Products

Our other product offerings include bedding, outerwear, shoes, socks, diaper bags, gift sets, toys, room décor, and hair accessories.  In fiscal 2007, we generated $56.3 million in net sales of these other products in our Carter’s retail stores, or 4.0%, of our consolidated net sales.

Royalty Income
 
We currently extend our Carter’s, Child of Mine, and Just One Year product offerings by licensing our brands to 13 domestic marketers in the United States.  These licensing partners develop and sell products through our multiple sales channels while leveraging our brand strength, customer relationships, and designs.  Licensed products provide our customers and consumers with a range of products that complement and expand upon our core baby and young children’s apparel offerings.  Our license agreements require strict adherence to our quality and compliance standards and to a multi-step product approval process.  We work in conjunction with our licensing partners in the development of their products and ensure that they fit within our vision of high-quality, core products at attractive values to the consumer.  In addition, we work closely with our wholesale and mass channel customers and our licensees to gain dedicated floor space for licensed product categories.  In fiscal 2007, our Carter’s brand and mass channel licensees generated wholesale and mass channel net sales of $174.4 million on which we earned $15.3 million in royalty income.

CARTER’S DISTRIBUTION CHANNELS

As described above, we sell our Carter’s brand products to leading retailers throughout the United States in the wholesale and mass channels and through our own Carter’s retail outlet and brand stores.  In fiscal 2007, sales of our Carter’s brand products through the wholesale channel, including off-price sales, accounted for 34.2% of our consolidated net sales, sales through our retail stores accounted for 25.9% of our consolidated net sales, and sales through the mass channel accounted for 17.2% of our consolidated net sales.

Business segment financial information for our Carter’s brand wholesale, Carter’s brand retail, and Carter’s brand mass channel segments is contained in ITEM 8 “Financial Statements and Supplementary Data,” Note 13 -- “Segment Information” to the accompanying audited consolidated financial statements.

Our Carter’s brand wholesale customers include major retailers, such as Kohl’s, Toys “R” Us, Costco, JCPenney, Macy’s, and Sam’s Club.  Our mass channel customers are Wal-Mart and Target.  Our sales professionals work with their department or specialty store accounts to establish annual plans for our baby products, which we refer to as core basics.  Once we establish an annual plan with an account, we place the majority of our accounts on our automatic reorder plan for core basics.  This allows us to plan our sourcing requirements and benefits both us and our wholesale and mass channel customers by maximizing our customers’ in-stock positions, thereby improving sales and profitability.  We intend to drive continued growth with our wholesale and mass channel customers through our focus on managing our key accounts' business through product mix, fixturing, brand presentation, and advertising.  We believe that we maintain strong account relationships and drive brand growth through frequent meetings with the senior management of our major wholesale and mass channel customers.


 
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As of December 29, 2007, we operated 228 Carter’s retail stores, of which 163 were outlet stores and 65 were brand stores.  These stores carry a complete assortment of first-quality baby and young children’s apparel, accessories, and gift items.  Our stores average approximately 4,700 square feet per location and are distinguished by an easy, consumer-friendly shopping environment.  We believe our brand strength and our assortment of core products has made our stores a destination location within many outlet and strip centers.  Our outlet stores are generally located within 20 to 30 minutes of densely-populated areas.  Our brand stores are generally located in high-traffic, strip centers located in or near major cities.

We have established a real estate selection process whereby we fully assess all new locations based on demographic factors, retail adjacencies, and population density.  We believe that we are located in many of the premier outlet centers in the United States and we continue to add new strip center locations to our real estate portfolio.

OSHKOSH BRANDS

Under our OshKosh brand, we design, source, and market a broad array of young children’s apparel, primarily for children in sizes newborn to 16.  Our OshKosh brand is currently sold in our OshKosh retail stores, department stores, national chains, specialty stores, and through off-price sales channels.  In fiscal 2007, we sold over 42 million selling units of OshKosh products to our retail stores and through our wholesale customers.  We also have a licensing agreement with Target through which Target sells products under our Genuine Kids from OshKosh brand.  Given its long history of durability, quality, and style, we believe our OshKosh brand continues to be a market leader in the children’s branded apparel industry and represents a significant long-term growth opportunity for us, especially in the $9.8 billion young children’s playclothes market, excluding the mass channel.  While we have made significant progress integrating the OshKosh business, our plans to grow the OshKosh brand in the wholesale and retail store channels have not met our expectations to date.  We continue to focus on our core product development and marketing disciplines, leveraging our relationships with major wholesale accounts, leveraging our infrastructure and supply chain, and improving the productivity of our OshKosh retail stores.

OSHKOSH BRAND POSITIONING

We believe our OshKosh brand stands for high-quality, authentic, active products for children sizes newborn to 16.  Our core OshKosh brand products include denim, overalls, fleece tops and bottoms, and other playclothes for children.  Our OshKosh brand is generally positioned towards an older age segment (ages two to seven) and at higher average prices than our Carter’s brand.  We believe our OshKosh brand has significant brand name recognition, which consumers associate with rugged, durable, and active playclothes for young children.

OSHKOSH PRODUCTS

Playclothes

Our OshKosh brand is best known for its playclothes products.  In fiscal 2007, we generated $229.3 million in net sales of OshKosh brand playclothes products, which accounted for approximately 16.2% of our consolidated net sales.  OshKosh brand playclothes products include denim apparel products with multiple wash treatments and coordinating garments, overalls, woven tops and bottoms, and apparel products for everyday use in sizes newborn to 16.  We plan to grow this business by continuing to reduce product complexity, leveraging our strong customer relationships and global supply chain expertise, and improving product value.

We believe our OshKosh brand represents a significant opportunity for us to increase our share in the $16.7 billion young children’s playclothes market, which includes the mass channel.  The market for baby and young children’s playclothes in fiscal 2007 was more than five times the size of the baby and sleepwear markets combined.  The $16.7 billion playclothes market for babies and young children is highly fragmented.

Our OshKosh brand’s playclothes market share in the department store, national chain, outlet, specialty store, and off-price sales channels in fiscal 2007, exclusive of the mass channel, was approximately 4.8% in the $9.8 billion market in these channels.  We are continuing to develop a base of high-volume, core playclothes products for our OshKosh brand.

Baby

In fiscal 2007, we generated approximately $47.7 million in net sales from our OshKosh brand baby products in our OshKosh retail stores, which accounted for approximately 3.4% of our consolidated net sales.


 
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Other Products

The remainder of our OshKosh brand product offering includes outerwear, shoes, hosiery, and accessories.  In fiscal 2007, we generated $43.3 million in net sales of these other products in our OshKosh retail stores, which accounted for 3.1% of our consolidated net sales.

Royalty Income

We partner with a number of domestic and international licensees to extend the reach of our OshKosh brand.  We currently have nine domestic licensees, as well as 24 international licensees selling apparel and accessories products in approximately 16 countries.  Our largest licensing agreement is with Target.  All Genuine Kids from OshKosh products sold by Target are sold pursuant to this licensing agreement.  Our licensed products provide our customers and consumers with a range of OshKosh products including outerwear, underwear, swimwear, socks, shoes, bedding, and accessories.  In fiscal 2007, our licensees generated wholesale and mass channel net sales of approximately $288.5 million on which we earned approximately $15.4 million in royalty income.

OSHKOSH DISTRIBUTION CHANNELS

In fiscal 2007, sales of our OshKosh brand products through our OshKosh retail stores accounted for 16.6% of our consolidated net sales and sales through the wholesale channel, including off-price sales, accounted for 6.1% of our consolidated net sales.

Business segment financial information for our OshKosh brand wholesale and OshKosh brand retail segments is contained in ITEM 8 “Financial Statements and Supplementary Data,” Note 13 -- “Segment Information” to the accompanying audited consolidated financial statements.

As of December 29, 2007, we operated 163 OshKosh retail stores, of which 154 were outlet stores and nine were brand stores.  These stores carry a wide assortment of young children’s apparel, accessories, and gift items and average approximately 4,800 square feet per location.

Our OshKosh brand wholesale customers include major retailers, such as Kohl’s, Costco, JCPenney, Bon Ton, and Babies “R” Us.  We continue to work with our department and specialty store accounts to establish seasonal plans for playclothes products.  The majority of our OshKosh brand playclothes products will be planned and ordered seasonally as we introduce new products.

GLOBAL SOURCING NETWORK                                                                                    
 
   We have significant experience in sourcing products from the Far East, with expertise that includes the ability to evaluate vendors, familiarity with foreign supply sources, and experience with sourcing logistics particular to the Far East.  We also have relationships with both leading and certain specialized sourcing agents in the Far East.

Our sourcing network consists of approximately 130 vendors located in approximately 15 countries.  We believe that our sourcing arrangements are sufficient to meet our current operating requirements and provide capacity for growth.

DEMOGRAPHIC TRENDS
 
In the United States, there were approximately 4.3 million births reported in 2006, and demographers project an increase in births over the next 20 years.  Favorable demographic trends support continued strength in the market for baby and young children's products.  Highlights of these trends include:

·  
  the young children’s apparel market grew over two times faster than the adult apparel market in 2006;
·  
  parents are having children later in life and are earning higher incomes when their children are born;
·  
  40% of all births are first children, which we believe leads to higher initial spending; and
·  
  grandparents are a large and growing market and are spending more money on their grandchildren than previous generations.

 
 
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COMPETITION

The baby and young children's apparel market is highly competitive.  Competition is generally based upon product quality, brand name recognition, price, selection, service, and convenience.  Both branded and private label manufacturers compete in the baby and young children's apparel market.  Our primary competitors in the wholesale and mass channels include Disney, Gerber, and private label product offerings.  Our primary competitors in the retail store channel include Old Navy, The Gap, The Children’s Place, Gymboree, and Disney.  Most retailers, including our customers, have significant private label product offerings that compete with us.  Because of the highly-fragmented nature of the industry, we also compete with many small manufacturers and retailers.  We believe that the strength of our Carter’s and OshKosh brand names combined with our breadth of product offerings and operational expertise position us well against these competitors.

ENVIRONMENTAL MATTERS

We are subject to various federal, state, and local laws that govern activities or operations that may have adverse environmental effects.  Noncompliance with these laws and regulations can result in significant liabilities, penalties, and costs.  Generally, compliance with environmental laws has not had a material impact on our operations, but there can be no assurance that future compliance with such laws will not have a material adverse effect on our operations.

TRADEMARKS, COPYRIGHTS, AND LICENSES

We own many copyrights and trademarks, including Carter’s®, Carter’s® Classics, Celebrating Childhood™, Celebrating Imagination®, Child of Mine®, Just One Year®, OshKosh, OshKosh B’Gosh®, At Play Since 1895™, OshKosh Est. 1895®, and Genuine Kids®, many of which are registered in the United States and in more than 120 foreign countries.

We license various Company trademarks, including Carter’s, Just One Year, Child of Mine, OshKosh, OshKosh B’Gosh, OshKosh Est. 1895, and Genuine Kids to third parties to produce and distribute children’s apparel and related products such as hosiery, outerwear, swimwear, underwear, shoes, boots, slippers, diaper bags, furniture, room décor, bedding, giftwrap, baby books, party goods, plush toys, rattles, and dolls.

AVAILABLE INFORMATION

Our Internet address is www.carters.com.  We are not including the information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10-K.  There we make available, free of charge, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, proxy statements, director and officer reports on Forms 3, 4, and 5, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”).  Our SEC reports can be accessed through the investor relations section of our website.  The information found on our website is not part of this or any other report we file with or furnish to the SEC.  We also make available on our website, the Carter’s Code of Business Ethics and Professional Conduct, our Corporate Governance Principles, and the charters for the Compensation, Audit, and Nominating and Corporate Governance Committees of the Board of Directors.  Our SEC filings are also available for reading and copying at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.  Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet site, www.sec.gov, containing reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

EMPLOYEES

As of December 29, 2007, we had 7,630 employees, 2,750 of whom were employed on a full-time basis and 4,880 of whom were employed on a part-time basis.  None of our employees is unionized.  We have had no labor-related work stoppages and believe that our labor relations are good.


 
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ITEM 1A. RISK FACTORS

You should carefully consider each of the following risk factors as well as the other information contained in this Annual Report on Form 10-K and other filings with the Securities and Exchange Commission in evaluating our business.  The risks and uncertainties described below are not the only we face.  Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impact our business operations.  If any of the following risks actually occur, our operating results may be affected.

Risks Relating to Our Business

The loss of one or more of our major customers could result in a material loss of revenues.

In fiscal 2007, we derived approximately 44.1% of our consolidated net sales from our top eight customers, including mass channel customers.  Wal-Mart and Kohl’s each accounted for approximately 10% of our consolidated net sales in fiscal 2007.  We expect that these customers will continue to represent a significant portion of our sales in the future.  However, we do not enter into long-term sales contracts with our major customers, relying instead on long-standing relationships with these customers and on our position in the marketplace.  As a result, we face the risk that one or more of our major customers may significantly decrease its or their business with us or terminate its or their relationships with us.  Any such decrease or termination of our major customers' business could result in a material decrease in our sales and operating results.

The acceptance of our products in the marketplace is affected by consumers’ tastes and preferences, along with fashion trends.

We believe that continued success depends on our ability to provide a unique and compelling value proposition for our consumers in the Company’s distribution channels.  There can be no assurance that the demand for our products will not decline, or that we will be able to successfully evaluate and adapt our product to be aware of consumers’ tastes and preferences and fashion trends.  If consumers’ tastes and preferences are not aligned with our product offerings, promotional pricing may be required to move seasonal merchandise.  Increased use of promotional pricing would have a material adverse affect on our sales, gross margin, and results of operations.

The value of our brand, and our sales, could be diminished if we are associated with negative publicity.

Although our employees, agents, and third-party compliance auditors periodically visit and monitor the operations of our vendors, independent manufacturers, and licensees, we do not control these vendors, independent manufacturers, licensees, or their labor practices.  A violation of our vendor policies, licensee agreements, labor laws, or other laws by these vendors, independent manufacturers, or licensees could interrupt or otherwise disrupt our supply chain or damage our brand image.  As a result, negative publicity regarding our Company, brands, or products, including licensed products, could adversely affect our reputation and sales.

The security of the Company’s databases that contain personal information of our retail customers could be breached, which could subject us to adverse publicity, litigation, and expenses.  In addition, if we are unable to comply with security standards created by the credit card industry, our operations could be adversely affected.

Database privacy, network security, and identity theft are matters of growing public concern.  In an attempt to prevent unauthorized access to our network and databases containing confidential, third-party information, we have installed privacy protection systems, devices, and activity monitoring on our network.  Nevertheless, if unauthorized parties gain access to our networks or databases, they may be able to steal, publish, delete, or modify our private and sensitive third-party information.  In such circumstances, we could be held liable to our customers or other parties or be subject to regulatory or other actions for breaching privacy rules.  This could result in costly investigations and litigation, civil or criminal penalties, and adverse publicity that could adversely affect our financial condition, results of operations, and reputation.  Further, if we are unable to comply with the security standards, established by banks and the credit card industry, we may be subject to fines, restrictions, and expulsion from card acceptance programs, which could adversely affect our retail operations.


 
7

 

The Company’s royalty income is greatly impacted by the Company’s brand reputation.

The Company’s brand image, which is associated with providing a consumer product with outstanding quality and name recognition, makes it valuable as a royalty source.  The Company is able to license complementary products and obtain royalty income from use of its Carter’s, Child of Mine, Just One Year, OshKosh, Genuine Kids from OshKosh, and related trademarks.  The Company also generates foreign royalty income as our OshKosh B’Gosh label carries an international reputation for quality and American style.  While the Company takes significant steps to ensure the reputation of its brand is maintained through its license agreements, there can be no guarantee that the Company’s brand image will not be negatively impacted through its association with products outside of the Company’s core apparel products.

There are deflationary pressures on the selling price of apparel products.

In part due to the actions of discount retailers, and in part due to the worldwide supply of low cost garment sourcing, the average selling price of children’s apparel continues to decrease.  To the extent these deflationary pressures are offset by reductions in manufacturing costs, there could be an affect on the gross margin percentage.  However, the inability to leverage certain fixed costs of the Company’s design, sourcing, distribution, and support costs over its gross sales base could have an adverse impact on the Company’s operating results.

Our business is sensitive to overall levels of consumer spending, particularly in the apparel segment.

The Company believes that spending on children’s apparel is somewhat discretionary.  While certain apparel purchases are less discretionary due to size changes as children grow, the amount of clothing consumers desire to purchase, specifically brand name apparel products, is impacted by the overall level of consumer spending.  Overall economic conditions that affect discretionary consumer spending include employment levels, gasoline and utility costs, business conditions, tax rates, interest rates, and levels of consumer indebtedness.  Reductions in the level of discretionary spending or shifts in consumer spending to other products may have a material adverse affect on the Company’s sales and results of operations.

We source substantially all of our products through foreign production arrangements.  Our dependence on foreign supply sources could result in disruptions to our operations in the event of political instability, international events, or new foreign regulations and such disruptions may increase our cost of goods sold and decrease gross profit.

We source substantially all of our products through a network of vendors primarily in the Far East, coordinated by our Far East agents.  The following could disrupt our foreign supply chain, increase our cost of goods sold, decrease our gross profit, or impact our ability to get products to our customers:

 
·
political instability or other international events resulting in the disruption of trade in foreign countries from which we source our products;

 
·
the imposition of new regulations relating to imports, duties, taxes, and other charges on imports including the China safeguards;

 
·
the occurrence of a natural disaster, unusual weather conditions, or an epidemic, the spread of which may impact our ability to obtain products on a timely basis;

 
·
changes in United States customs procedures concerning the importation of apparel products;

 
·
unforeseen delays in customs clearance of any goods;

 
·
disruption in the global transportation network such as a port strike, world trade restrictions, or war.  The risk of labor-related disruption in the ports on the West Coast of the United States in 2008 is considered to be reasonably likely;

 
·
the application of foreign intellectual property laws; and

 
·
exchange rate fluctuations between the United States dollar and the local currencies of foreign contractors.


 
8

 

These and other events beyond our control could interrupt our supply chain and delay receipt of our products into the United States.

We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a loss of market share and, as a result, a decrease in revenues and gross profit.

The baby and young children's apparel market is highly competitive.  Both branded and private label manufacturers compete in the baby and young children's apparel market.  Our primary competitors in our wholesale and mass channel businesses include Disney, Gerber, and private label product offerings.  Our primary competitors in the retail store channel include Old Navy, The Gap, The Children’s Place, Gymboree, and Disney.  Because of the fragmented nature of the industry, we also compete with many other manufacturers and retailers.  Some of our competitors have greater financial resources and larger customer bases than we have and are less financially leveraged than we are.  As a result, these competitors may be able to:

 
·
adapt to changes in customer requirements more quickly;

 
·
take advantage of acquisition and other opportunities more readily;

 
·
devote greater resources to the marketing and sale of their products; and

 
·
adopt more aggressive pricing strategies than we can.

The Company’s retail success and future growth is dependent upon identifying locations and negotiating appropriate lease terms for retail stores.

The Company’s retail stores are located in leased retail locations across the country.  Successful operation of a retail store depends, in part, on the overall ability of the retail location to attract a consumer base sufficient to make store sales volume profitable.  If the Company is unable to identify new retail locations with consumer traffic sufficient to support a profitable sales level, retail growth may consequently be limited.  Further, if existing outlet and strip centers do not maintain a sufficient customer base that provides a reasonable sales volume, there could be a material adverse impact on the Company’s sales, gross margin, and results of operations.

Our leverage could adversely affect our financial condition.

On December 29, 2007, we had total debt of approximately $341.5 million.

Our indebtedness could have negative consequences.  For example, it could:

 
·
increase our vulnerability to interest rate risk;

 
·
limit our ability to obtain additional financing to fund future working capital, capital expenditures, and other general corporate requirements, or to carry out other aspects of our business plan;

 
·
require us to dedicate a substantial portion of our cash flow from operations to pay principal of, and interest on, our indebtedness, thereby reducing the availability of that cash flow to fund working capital, capital expenditures, or other general corporate purposes, or to carry out other aspects of our business plan;

 
·
limit our flexibility in planning for, or reacting to, changes in our business and the industry; and

 
·
place us at a competitive disadvantage compared to our competitors that have less debt.

In addition, our senior credit facility contains financial and other restrictive covenants that may limit our ability to engage in activities that may be in our long-term best interests such as selling assets, strategic acquisitions, paying dividends, and borrowing additional funds.  Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debt which could leave us unable to meet some or all of our obligations.


 
9

 

Profitability could be negatively impacted if we do not adequately forecast the demand for our products and, as a result, create significant levels of excess inventory or insufficient levels of inventory.

If the Company does not adequately forecast demand for its products and purchases inventory to support an inaccurate forecast, the Company could experience increased costs due to the need to dispose of excess inventory or lower profitability due to insufficient levels of inventory.

We may not achieve sales growth plans, cost savings, and other assumptions that support the carrying value of our intangible assets.

In connection with the 2001 acquisition of the Company, we recorded cost in excess of fair value of net assets acquired of $136.6 million and a Carter’s brand tradename asset of $220.2 million.  Additionally, in connection with the acquisition of OshKosh, we recorded cost in excess of fair value of net assets acquired of $142.9 million and an OshKosh brand tradename asset of $102.0 million.  The carrying value of these assets is subject to annual impairment reviews as of the last day of each fiscal year or more frequently, if deemed necessary, due to any significant events or changes in circumstances.  During the second quarter of fiscal 2007, the Company performed an interim impairment review of the OshKosh intangible assets due to continued negative trends in sales and profitability of the Company’s OshKosh wholesale and retail segments.  As a result of this review, the Company wrote off our OshKosh cost in excess of fair value of net assets acquired asset of $142.9 million and wrote down the OshKosh tradename by $12.0 million.

Estimated future cash flows used in these impairment reviews could be negatively impacted if we do not achieve our sales plans, planned cost savings, and other assumptions that support the carrying value of these intangible assets, which could result in potential impairment of the remaining asset value.

The Company’s success is dependent upon retaining key individuals within the organization to execute the Company’s strategic plan.

The Company’s ability to attract and retain qualified executive management, marketing, merchandising, design, sourcing, operations, and support function staffing is key to the Company’s success.  If the Company were unable to attract and retain qualified individuals in these areas, an adverse impact on the Company’s growth and results of operations may result.


 
10

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

ITEM 2. PROPERTIES

Location
 
Approximate floor space in square feet
 
Principal use
 
Lease expiration date
 
Renewal options
 
Stockbridge, Georgia
    505,000  
Distribution/warehousing
 
April 2010
 
13 years
 
Hogansville, Georgia
    258,000  
Distribution/warehousing
 
Owned
    --  
Barnesville, Georgia
    149,000  
Distribution/warehousing
 
Owned
    --  
White House, Tennessee
    284,000  
Distribution/warehousing *
 
Owned
    --  
Chino, California        
   118,000 
 
    Distribution/warehousing
   March 2011      2 years  
Griffin, Georgia
    219,000  
Finance/information technology/benefits administration/rework
 
Owned
    --  
Griffin, Georgia
    12,500  
Carter’s customer service
 
Owned
    --  
Griffin, Georgia
    11,000  
Information technology
 
December 2008
    --  
Atlanta, Georgia
    102,000  
Executive offices/Carter’s design and merchandising
 
June 2015
 
5 years
 
Oshkosh, Wisconsin
    99,000  
OshKosh’s operating offices
 
Owned
    --  
Shelton, Connecticut
    42,000  
Finance and retail store administration
 
December 2008
   
--
 
Shelton, Connecticut
    51,000  
New finance and retail store administration office
 
October 2018
 
10 years
 
New York, New York
    16,000  
Carter’s and OshKosh sales offices/showroom
 
January 2015
    --  
New York, New York
    21,000  
OshKosh’s design center
 
August 2008
    --  

 
* As of December 29, 2007, this property is classified as an asset held for sale on the accompanying audited consolidated balance sheet.

As of December 29, 2007, we operate 391 leased retail stores located primarily in outlet and strip centers across the United States, having an average size of approximately 4,800 square feet.  Generally, leases have an average term of approximately five years with additional five-year renewal options.

Aggregate lease commitments as of December 29, 2007 for the above leased properties are as follows:  fiscal 2008—$46.3 million; fiscal 2009—$41.3 million; fiscal 2010—$35.1 million; fiscal 2011—$26.3 million; fiscal 2012—$17.9 million, and $41.7 million for the balance of these commitments beyond fiscal 2012.

ITEM 3. LEGAL PROCEEDINGS

Not applicable

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable

 
11

 

PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on the New York Stock Exchange under the symbol CRI.  The last reported sale price per share of our common stock on February 19, 2008 was $20.99.  On that date there were approximately 43,573 holders of record of our common stock.

On June 6, 2006, the Company effected a two-for-one stock split (the “stock split”) through a stock dividend to stockholders of record as of May 23, 2006 of one share of our common stock for each share of common stock outstanding.

The following table sets forth for the periods indicated the high and low sales prices per share of common stock as reported by the New York Stock Exchange (all periods prior to June 6, 2006 have been adjusted for the stock split):

2007
 
High
   
Low
 
First quarter                                                               
  $ 26.90     $ 20.53  
Second quarter                                                               
  $ 29.00     $ 24.62  
Third quarter                                                               
  $ 26.93     $ 18.92  
Fourth quarter                                                               
  $ 23.13     $ 18.35  

2006
 
High
   
Low
 
First quarter                                                               
  $ 35.24     $ 29.27  
Second quarter                                                               
  $ 34.93     $ 24.10  
Third quarter                                                               
  $ 27.76     $ 21.08  
Fourth quarter                                                               
  $ 30.18     $ 25.36  

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

The following table provides information about purchases by the Company during the fourth quarter of fiscal 2007 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

Period
 
Total number of shares purchased
   
Average price paid
 per share
   
Total number of shares purchased as part of publicly announced plans or programs
(1)
   
Approximate dollar value of shares that may yet be purchased under the plans or programs
(1)
 
                         
September 30, 2007 through October 27, 2007
    --     $ --       --     $ 52,594,393  
October 28, 2007 through November 24, 2007
    438,900 (2)   $ 20.67       438,900     $ 43,523,891  
November 25, 2007 through December 29, 2007
     48,800 (2)   $ 20.31       48,800     $ 42,532,888  
                                 
Total                                                            
    487,700     $ 20.63       487,700     $ 42,532,888  

(1)  
On February 16, 2007, our Board of Directors approved a stock repurchase program, pursuant to which the Company is authorized to purchase up to $100 million of its outstanding common shares.  Such repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise.  This program has no time limit.  The timing and amount of any repurchases will be determined by the Company’s management, based on its evaluation of market conditions, share price, and other factors.  This program was announced in the Company’s report on Form 8-K, which was filed on February 21, 2007.  The total remaining authorization under the repurchase program was $42,532,888 as of December 29, 2007.

(2)  
Represents repurchased shares which were retired.


 
12

 

DIVIDENDS

Provisions in our senior credit facility currently restrict the ability of our operating subsidiary, The William Carter Company (“TWCC”), from paying cash dividends to our parent company, Carter’s, Inc., in excess of $15.0 million, which materially restricts Carter’s, Inc. from paying cash dividends on our common stock.  We do not anticipate paying cash dividends on our common stock in the foreseeable future but intend to retain future earnings, if any, for reinvestment in the future operation and expansion of our business and related development activities.  Any future decision to pay cash dividends will be at the discretion of our Board of Directors and will depend upon our financial condition, results of operations, terms of financing arrangements, capital requirements, and any other factors as our Board of Directors deems relevant.

RECENT SALES OF UNREGISTERED SECURITIES

Not applicable

 
13

 

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial and other data as of and for the five fiscal years ended December 29, 2007 (fiscal 2007).

On October 29, 2003, we completed an initial public offering of our common stock including the sale of 10,781,250 shares by us and 3,593,750 shares by the selling stockholders (adjusted for the June 6, 2006 stock split).  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 10.875% Senior Subordinated Notes (the “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 the Company’s former senior credit facility.  The remaining proceeds were used for working capital and other general corporate purposes.

On July 14, 2005, Carter’s, Inc., through TWCC, acquired all of the outstanding common stock of OshKosh for a purchase price of $312.1 million, which included payment for vested stock options (the “Acquisition”).  As part of financing the Acquisition, the Company refinanced its existing debt (the “Refinancing”), comprised of its former senior credit facility and its Notes due 2011 (together with the Acquisition, the “Transaction”).

Financing for the Transaction was provided by a new $500 million Term Loan (the “Term Loan”) 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 proceeds from 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 Notes ($113.8 million), pay a redemption premium on the Company’s 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.

On June 6, 2006, the Company effected a two-for-one stock split through a stock dividend to stockholders of record as of May 23, 2006 of one share of our common stock for each share of common stock outstanding.  Earnings per share for all prior periods presented have been adjusted to reflect the stock split.

The selected financial data for the five fiscal years ended December 29, 2007 were derived from our audited consolidated financial statements.  Our fiscal year ends on the Saturday, in December or January, nearest the last day of December.  Consistent with this policy, fiscal 2007 ended on December 29, 2007, fiscal 2006 ended on December 30, 2006, fiscal 2005 ended on December 31, 2005, fiscal 2004 ended on January 1, 2005, and fiscal 2003 ended on January 3, 2004.  Fiscal 2007, fiscal 2006, fiscal 2005, and fiscal 2004 each contained 52 weeks of financial results.  Fiscal 2003 contained 53 weeks of financial results.


 
14

 

The following table should be read in conjunction with ITEM 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and ITEM 8 "Financial Statements and Supplementary Data."

   
Fiscal Years
 
                               
(dollars in thousands, except per share data)
 
2007
   
2006
   
2005
   
2004
   
2003
 
OPERATING DATA:
                             
Wholesale sales                                                           
  $ 568,905     $ 560,987     $ 486,750     $ 385,810     $ 356,888  
Retail sales                                                           
    600,072       562,153       456,581       291,362       263,206  
Mass channel sales                                                           
    243,269       220,327       178,027       145,949       83,732  
Total net sales                                                       
    1,412,246       1,343,467       1,121,358       823,121       703,826  
Cost of goods sold                                                           
    928,996       854,970       725,086       525,082       448,540  
Gross profit                                                           
    483,250       488,497       396,272       298,039       255,286  
Selling, general, and administrative expenses
    359,826       352,459       288,624       208,756       188,028  
Intangible asset impairment (a)                                                           
    154,886       --       --       --       --  
Closure costs (b)                                                           
    5,285       91       6,828       620       1,041  
Management fee termination (c)                                                           
    --       --       --       --       2,602  
Royalty income                                                           
    (30,738 )     (29,164 )     (20,426 )     (12,362 )     (11,025 )
Operating (loss) income                                                           
    (6,009 )     165,111       121,246       101,025       74,640  
Interest income                                                           
    (1,386 )     (1,914 )     (1,322 )     (335 )     (387 )
Loss on extinguishment of debt (d)                                                           
    --       --       20,137       --       9,455  
Interest expense                                                          
    24,465       28,837       24,564       18,852       26,646  
(Loss) income before income taxes
    (29,088 )     138,188       77,867       82,508       38,926  
Provision for income taxes                                                       
    41,530       50,968       30,665       32,850       15,648  
Net (loss) income                                                           
  $ (70,618 )   $ 87,220     $ 47,202     $ 49,658     $ 23,278  
PER COMMON SHARE DATA:
                                       
Basic net (loss) income                                                           
  $ (1.22 )   $ 1.50     $ 0.82     $ 0.88     $ 0.49  
Diluted net (loss) income                                                           
  $ (1.22 )   $ 1.42     $ 0.78     $ 0.83     $ 0.46  
Dividends                                                           
    --       --       --       --     $ 0.55  
Basic weighted-average shares                                                           
    57,871,235       57,996,241       57,280,504       56,251,168       47,222,744  
Diluted weighted-average shares                                                           
    57,871,235       61,247,122       60,753,384       59,855,914       50,374,984  
BALANCE SHEET DATA (end of period):
                                       
Working capital (e)                                                           
  $ 326,891     $ 265,904     $ 242,442     $ 185,968     $ 150,632  
Total assets                                                           
    974,668       1,123,191       1,116,727       672,965       646,102  
Total debt, including current maturities
    341,529       345,032       430,032       184,502       212,713  
Stockholders’ equity                                                           
    382,129       495,491       386,644       327,933       272,536  
CASH FLOW DATA:
                                       
Net cash provided by operating activities
  $ 51,987     $ 88,224     $ 137,267     $ 42,676     $ 40,506  
Net cash used in investing activities
    (21,819 )     (30,500 )     (308,403 )     (18,577 )     (16,472 )
Net cash (used in) provided by financing activities                                                        
    (49,701 )     (73,455 )     222,147       (26,895 )     (23,535 )
OTHER DATA:
                                       
Gross margin                                                           
    34.2 %     36.4 %     35.3 %     36.2 %     36.3 %
Depreciation and amortization                                                           
  $ 29,919     $ 26,489     $ 21,912     $ 19,536     $ 22,216  
Capital expenditures                                                           
    21,876       30,848       22,588       20,481       17,347  

See Notes to Selected Financial Data.

 
15

 

NOTES TO SELECTED FINANCIAL DATA

(a) Intangible asset impairment charges of $154.9 million in fiscal 2007 reflect the impairment of the OshKosh cost in excess of fair value of net assets acquired asset (OshKosh wholesale segment of $36.0 million and OshKosh retail segment of $106.9 million) and the impairment of the value ascribed to the OshKosh tradename of $12.0 million.

(b) The $1.0 million in closure costs in fiscal 2003 relate to the closure of our two sewing facilities located in Costa Rica.  The $0.6 million in closure costs in fiscal 2004 relate to costs associated with the closure of our Costa Rican facilities and our distribution facility in Leola, Pennsylvania.  The $6.8 million and $0.1 million in closure costs in fiscal 2005 and fiscal 2006 relate to the closure of our Mexican sewing facilities.  The $5.3 million in closure costs in fiscal 2007 relate to the closure of our White House, Tennessee distribution facility.

(c) The $2.6 million in fiscal 2003 reflects the payment to terminate the Berkshire Partners LLC management agreement upon completion of our initial public offering of our common stock on October 29, 2003.

(d) Debt extinguishment charges in fiscal 2003 reflect the write-off of $2.4 million of debt issuance costs resulting from the redemption of $61.3 million of our Notes and the prepayment of $11.3 million on our former senior credit facility, a debt redemption premium of approximately $6.7 million, and a $0.4 million write-off of the related Note discount.  Debt extinguishment charges in fiscal 2005 reflect the payment of a $14.0 million redemption premium on our Notes, the write-off of $4.5 million in unamortized debt issuance costs related to the former senior credit facility and Notes, and $0.5 million of the related Note discount.  Additionally, we expensed approximately $1.1 million of debt issuance costs associated with our 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” (“EITF 96-19”).

(e) Represents total current assets less total current liabilities.

 
16

 

 ITEM 7. 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 condition.  You should read this discussion in conjunction with our consolidated historical financial statements and notes included elsewhere in this Annual Report on Form 10-K.  Our discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products and services, and our future results.  We based these statements on assumptions that we consider reasonable.  Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed in the “Risk Factors” in ITEM 1A of this Annual Report on Form 10-K.  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 Annual Report on Form 10-K.

OVERVIEW

For more than 140 years, Carter’s has become one of the most highly recognized and most trusted brand names in the children’s apparel industry and with the Acquisition of OshKosh on July 14, 2005, we now own the highly recognized and trusted OshKosh brand.  Results of operations for fiscal 2007 and 2006 include the operations of OshKosh for the entire period.  Results of operations for fiscal 2005 include the operations of OshKosh for the period from July 14, 2005 through December 31, 2005.

We sell our products under our Carter’s and OshKosh brands in the wholesale channel, which includes nearly 450 department store, national chain, and specialty store accounts.  Additionally, as of December 29, 2007, we operated 228 Carter’s and 163 OshKosh retail stores located primarily in outlet and strip centers throughout the United States and sold our products in the mass channel under our Child of Mine brand to approximately 3,500 Wal-Mart stores nationwide and under our Just One Year brand to approximately 1,600 Target stores.  We also extend our brand reach by licensing our Carter’s, Child of Mine, Just One Year, OshKosh, and related brand names through domestic licensing arrangements, including licensing of our Genuine Kids from OshKosh brand to Target stores nationwide.  Our OshKosh B’Gosh brand name is also licensed through international licensing arrangements.  During fiscal 2007, we earned approximately $30.7 million in royalty income from these arrangements, including $15.4 million from our OshKosh and Genuine Kids from OshKosh brands.

While we have made significant progress integrating the OshKosh business, our plans to grow the OshKosh brand in the wholesale and retail store channels have not met our expectations to date.  We continue to focus on our core product development and marketing disciplines, leveraging our relationships with major wholesale accounts, leveraging our infrastructure and supply chain, and improving the productivity of our OshKosh retail stores.

Since the Acquisition, we have reduced the number of OshKosh sub-brands and have simplified the number of product offerings under our OshKosh brand.  This has allowed us to reduce product complexity, focus our efforts on essential, core products, and streamline operations.

In connection with the Acquisition of OshKosh, we recorded cost in excess of fair value of net assets acquired of $142.9 million and an OshKosh brand tradename asset of $102.0 million.  During the second quarter of fiscal 2007, as a result of the continued negative trends in sales and profitability of the Company’s OshKosh B’Gosh wholesale and retail segments and re-forecasted projections for such segments for the balance of fiscal 2007, the Company conducted an interim impairment assessment on the value of the intangible assets that the Company recorded in connection with the Acquisition.  Based on this assessment, charges of approximately $36.0 million for the OshKosh wholesale segment and $106.9 million for the OshKosh retail segment were recorded for the impairment of the cost in excess of fair value of net assets acquired asset.  In addition, an impairment charge of $12.0 million was recorded to reflect the impairment of the value ascribed to the OshKosh tradename.  The carrying value of the OshKosh tradename asset is subject to annual impairment reviews as of the last day of each fiscal year or more frequently if deemed necessary due to any significant events or changes in circumstances.  Estimated future cash flows used in such impairment reviews could be negatively impacted if we do not achieve our sales plans, planned cost savings, and other assumptions that support the carrying value of these intangible assets, which could result in potential impairment of such assets.

We have also acquired certain definite-lived intangible assets in connection with the Acquisition of OshKosh comprised of licensing agreements and leasehold interests which resulted in annual amortization expense of $4.7 million in fiscal 2006 and $4.5 million in fiscal 2007.  Amortization expense related to these intangible assets will be $4.1 million in fiscal 2008, $3.7 million in fiscal 2009, and $1.8 million in fiscal 2010.

 
17

 

During fiscal 2007, the Board of Directors approved a stock repurchase program, pursuant to which the Company is authorized to purchase up to $100 million of its outstanding common shares.  Such repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise.  This program has no time limit.  The timing and amount of any repurchases will be determined by management, based on its evaluation of market conditions, share price, and other factors.  During fiscal 2007, the Company repurchased and retired 2,473,219 shares, or approximately $57.5 million, of its common stock at an average price of $23.24 per share.

Our fiscal year ends on the Saturday, in December or January, nearest the last day of December.  Consistent with this policy, fiscal 2007 ended on December 29, 2007, fiscal 2006 ended on December 30, 2006, and fiscal 2005 ended on December 31, 2005.  Each of these periods contained 52 weeks of financial results.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated (i) selected statement of operations data expressed as a percentage of net sales and (ii) the number of retail stores open at the end of each period:
   
Fiscal Years
 
   
2007
   
2006
   
2005
 
                   
Wholesale sales:
                 
Carter’s
    34.2 %     34.6 %     38.1 %
OshKosh
    6.1       7.2       5.3  
    Total wholesale sales
    40.3       41.8       43.4  
                         
Retail store sales:
                       
Carter’s
    25.9       24.8       28.2  
OshKosh
    16.6       17.0       12.5  
    Total retail store sales
    42.5       41.8       40.7  
                         
Mass channel sales
    17.2       16.4       15.9  
                         
Consolidated net sales
    100.0       100.0       100.0  
Cost of goods sold
    65.8       63.6       64.7  
Gross profit
    34.2       36.4       35.3  
Selling, general, and administrative expenses
    25.5       26.2       25.7  
Intangible asset impairment
    11.0       --       --  
Closure costs
    0.3       --       0.6  
Royalty income
    (2.2 )     (2.1 )     (1.8 )
                         
Operating (loss) income
    (0.4 )     12.3       10.8  
Loss on extinguishment of debt
    --       --       1.8  
Interest expense, net
    1.7       2.0       2.1  
                         
(Loss) income before income taxes
    (2.1 )     10.3       6.9  
Provision for income taxes
    2.9       3.8       2.7  
                         
Net (loss) income
    (5.0 )%     6.5 %     4.2 %
Number of retail stores at end of period:
                       
Carter’s
    228       219       193  
OshKosh
    163       157       142  
Total
    391       376       335  


 
18

 

FISCAL YEAR ENDED DECEMBER 29, 2007 COMPARED WITH FISCAL YEAR ENDED DECEMBER 30, 2006

CONSOLIDATED NET SALES

Consolidated net sales for fiscal 2007 were $1.4 billion, an increase of $68.8 million, or 5.1%, compared to $1.3 billion in fiscal 2006.  This increase reflects growth in all three of our Carter’s brand distribution channels and our OshKosh brand retail store segment.

   
For the fiscal years ended
 
(dollars in thousands)
 
December 29,
2007
   
% of
Total
   
December 30,
2006
   
% of
Total
 
                         
Net sales:
                       
Wholesale-Carter’s                                        
  $ 482,350       34.2 %   $ 464,636       34.6 %
Wholesale-OshKosh                                        
    86,555       6.1 %     96,351       7.2 %
Retail-Carter’s                                        
    366,296       25.9 %     333,050       24.8 %
Retail-OshKosh                                        
    233,776       16.6 %     229,103       17.0 %
Mass Channel-Carter’s                                        
    243,269       17.2 %     220,327       16.4 %
Total net sales                                   
  $ 1,412,246       100.0 %   $ 1,343,467       100.0 %

CARTER’S WHOLESALE SALES

Carter’s brand wholesale sales increased $17.7 million, or 3.8%, in fiscal 2007, to $482.4 million.  The increase in Carter’s brand wholesale sales was driven by a 4% increase in units shipped.  Average price per unit, was comparable to fiscal 2006.

The growth in units shipped was driven primarily by our baby and playwear product categories, which accounted for approximately 47% and 33% of total Carter’s brand wholesale sales, respectively, partially offset by a decrease in sleepwear units shipped.  The growth in baby and playwear units shipped was driven by increased demand.

OSHKOSH WHOLESALE SALES

OshKosh brand wholesale sales decreased $9.8 million, or 10.2%, in fiscal 2007 to $86.6 million.  The decrease in OshKosh brand wholesale sales, was impacted by a 19% decrease in average price per unit, partially offset by an 11% increase in units shipped as compared to fiscal 2006.  The decrease in average prices reflects changes in product mix and higher levels of customer accommodations as compared to the prior year.

CARTER’S RETAIL STORES

Carter’s retail stores sales increased $33.2 million, or 10.0%, in fiscal 2007 to $366.3 million.  The increase was driven by incremental sales of $22.8 million generated by new store openings and a comparable store sales increase of $13.3 million, or 4.1%, based on 206 locations, partially offset by the impact of store closures of $2.8 million.  During fiscal 2007, units per transaction increased 5.3% and average prices decreased 3.0% as compared to fiscal 2006.  Average prices decreased due to increased promotional pricing on spring sleepwear and fall playclothes products.  We believe increased promotional pricing drove the increase in unit volume.  Average inventory levels, on a comparable store basis, were up 10.9% as compared to fiscal 2006.  We believe these higher average inventory levels helped drive our comparable store sales increases.

The Company's comparable store sales calculations include sales for all stores that were open during the comparable fiscal period, including remodeled stores and certain relocated stores.  If a store relocates within the same center with no business interruption or material change in square footage, the sales for such store will continue to be included in the comparable store calculation.  If a store relocates to another center or there is a material change in square footage, such store is treated as a new store.  Stores that are closed during the period are included in the comparable store sales calculation up to the date of closing.

There were a total of 228 Carter’s retail stores as of December 29, 2007.  During fiscal 2007, we opened ten stores and closed one store.  We plan to open 25 and close five Carter’s retail stores during fiscal 2008.


 
19

 

OSHKOSH RETAIL STORES

OshKosh retail store sales increased $4.7 million, or 2.0%, in fiscal 2007 to $233.8 million.  The increase was due to incremental sales of $15.2 million generated by new store openings, partially offset by a comparable store sales decrease of $9.8 million, or 4.3%, based on 146 locations, and the impact of store closings of $0.8 million.  Average prices decreased 6.0% and units per transaction increased 4.4%.  Average prices decreased due to increased promotional activity across all major product categories.  Average inventory levels, on a comparable store basis, were up 22.5% as compared to fiscal 2006.

There were a total of 163 OshKosh retail stores as of December 29, 2007.  During fiscal 2007, we opened nine stores and closed three stores.  We plan to open five and close three OshKosh retail stores during fiscal 2008.

MASS CHANNEL SALES

Mass channel sales increased $22.9 million, or 10.4%, in fiscal 2007 to $243.3 million.  The increase was driven by increased sales of $11.9 million, or 8.8%, of our Child of Mine brand to Wal-Mart and increased sales of $11.0 million, or 12.9%, of our Just One Year brand to Target.  The growth in sales of our Child of Mine brand was driven by gaining additional floor space for fall sleepwear and fall playwear products.  Growth in sales of our Just One Year brand was driven by new door growth and better product performance.

GROSS PROFIT

Our gross profit decreased $5.2 million, or 1.1%, to $483.3 million in fiscal 2007.  Gross profit as a percentage of net sales was 34.2% in fiscal 2007 as compared to 36.4% in fiscal 2006.

The decrease in gross profit as a percentage of net sales reflects:
 
(i)  
a decrease in gross profit in our consolidated retail segments, primarily OshKosh, due to increased promotional pricing (consolidated retail gross margin decreased from 51.1% in fiscal 2006 to 47.8% in fiscal 2007 despite an increase in consolidated retail net sales of 6.7% in fiscal 2007);

(ii)  
the impact of OshKosh brand wholesale product performance, which led to higher levels of customer accommodations in fiscal 2007; and

(iii)  
the impact of $4.9 million in higher losses associated with excess inventory.
 
The Company includes distribution costs in its selling, general, and administrative expenses.  Accordingly, the Company’s gross profit may not be comparable to other companies that include such distribution costs in their cost of goods sold.


 
20

 

SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES

Selling, general, and administrative expenses in fiscal 2007 increased $7.4 million, or 2.1%, to $359.8 million.  As a percentage of net sales, selling, general, and administrative expenses in fiscal 2007 were 25.5% as compared to 26.2% in fiscal 2006.

The decrease in selling, general, and administrative expenses as a percentage of net sales reflects:

(i)  
a reduction in incentive compensation expense of $10.2 million as compared to fiscal 2006;

(ii)  
controlling growth in spending to a rate lower than the growth in net sales for fiscal 2007; and

(iii)  
the reversal in fiscal 2007 of approximately $1.5 million of previously recorded stock-based compensation expense and the reduction in fiscal 2007 of $1.2 million of stock-based compensation expense on performance-based stock awards (see Note 6).

Partially offsetting these decreases were:

(i)  
accelerated depreciation charges of $2.1 million in fiscal 2007 related to the closure of our White House, Tennessee distribution facility; and

(ii)  
increased severance, recruiting, and relocation expenses of $1.9 million as compared to fiscal 2006.  The increase was driven primarily by restructuring our retail store management team. 

INTANGIBLE ASSET IMPAIRMENT

During the second quarter of fiscal 2007, as a result of negative trends in sales and profitability of the OshKosh wholesale and retail segments and revised projections for such segments, the Company conducted an interim impairment assessment on the value of the intangible assets that the Company recorded in connection with the Acquisition of OshKosh.  This assessment was performed in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Intangible Assets.”  Based on this assessment, charges of approximately $36.0 million and $106.9 million were recorded for the impairment of the cost in excess of fair value of net assets acquired for the wholesale and retail segments, respectively.  In addition, an impairment charge of $12.0 million was recorded to reflect the impairment of the value ascribed to the OshKosh tradename.

CLOSURE COSTS

On February 15, 2007, the Board of Directors approved management’s plan to close the Company’s White House, Tennessee distribution facility, which was utilized to distribute the Company’s OshKosh brand products.  In connection with this closure we recorded costs of $7.4 million, consisting of asset impairment charges of $2.4 million related to a write-down of the related land, building, and equipment, $2.0 million of severance charges, $2.1 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.9 million in other closure costs during fiscal 2007.

In May 2005, we decided to exit two Carter’s brand sewing facilities in Mexico.  During fiscal 2006, in connection with these closures, we recorded costs of $91,000, including $74,000 of severance and $17,000 of other exit costs.

ROYALTY INCOME

Our royalty income increased $1.6 million, or 5.4%, to $30.7 million in fiscal 2007.

We license the use of our Carter’s, Just One Year, and Child of Mine brands.  Royalty income from these brands was approximately $15.3 million, an increase of 2.1%, or $0.3 million, as compared to fiscal 2006 due to increased sales by our Carter’s brand and Child of Mine brand licensees.

We license the use of our OshKosh and Genuine Kids from OshKosh brand names.  Royalty income from these brands increased approximately $1.3 million, or 8.9%, to $15.4 million in fiscal 2007 and includes $6.5 million of international royalty.  This increase was driven primarily by increased sales by our OshKosh brand domestic licensees.


 
21

 

OPERATING (LOSS) INCOME

Our operating loss was $6.0 million in fiscal 2007 as compared to operating income of $165.1 million in fiscal 2006.  The decrease in operating results was due to the factors described above including the charges incurred in fiscal 2007 related to the impairment of OshKosh’s intangible assets and the closure of our White House, Tennessee distribution facility, partially offset by the reversal of stock-based compensation expense associated with performance stock awards.

INTEREST EXPENSE, NET

Interest expense in fiscal 2007 decreased $3.8 million, or 14.3%, to $23.1 million.  This decrease is attributable to accelerated debt reduction in fiscal 2006 and a lower effective interest rate.  In fiscal 2007, weighted-average borrowings were $349.2 million at an effective interest rate of 7.01% as compared to weighted-average borrowings of $397.9 million at an effective interest rate of 7.25% in fiscal 2006.  In fiscal 2007 and 2006, our interest rate swap agreement reduced our interest expense under the Term Loan by approximately $1.6 million and $1.3 million, respectively.

INCOME TAXES

Our effective tax rate was approximately (142.8%) in fiscal 2007 as compared to approximately 36.9% in fiscal 2006.  This change in our effective tax rate is a result of the impairment of our OshKosh cost in excess of fair value of net assets acquired asset, which is not deductible for income tax purposes.  See Note 8 to the accompanying audited consolidated financial statements for a reconciliation of the statutory rate to our effective tax rate.

NET (LOSS) INCOME

As a result of the factors above, we recorded a net loss for fiscal 2007 of $70.6 million as compared to net income of $87.2 million in fiscal 2006.

FISCAL YEAR ENDED DECEMBER 30, 2006 COMPARED WITH FISCAL YEAR ENDED DECEMBER 31, 2005

CONSOLIDATED NET SALES

Consolidated net sales for fiscal 2006 were $1.3 billion, an increase of $222.1 million, or 19.8%, compared to $1.1 billion in fiscal 2005.  This increase reflects growth in all channels of distribution and includes $325.5 million in net sales from our OshKosh brand in fiscal 2006 and $199.8 million in net sales from our OshKosh brand during the period from July 14, 2005 through December 31, 2005.

   
For the fiscal years ended
 
(dollars in thousands)
 
December 30,
2006
   
% of
Total
   
December 31,
2005
   
% of
Total
 
                         
Net sales:
                       
Wholesale-Carter’s                                        
  $ 464,636       34.6 %   $ 427,043       38.1 %
Wholesale-OshKosh                                        
    96,351       7.2 %     59,707       5.3 %
Retail-Carter’s                                        
    333,050       24.8 %     316,477       28.2 %
Retail-OshKosh                                        
    229,103       17.0 %     140,104       12.5 %
Mass Channel-Carter’s                                        
    220,327       16.4 %     178,027       15.9 %
Total net sales                                   
  $ 1,343,467       100.0 %   $ 1,121,358       100.0 %

CARTER’S WHOLESALE SALES

Carter’s brand wholesale sales increased $37.6 million in fiscal 2006, or 8.8%, to $464.6 million.  The increase in Carter’s brand wholesale sales was driven by a 10% increase in units shipped, offset by a 1% decrease in average price per unit as compared to fiscal 2005.

The growth in units shipped was driven primarily by our baby product category, which accounted for approximately 56% of total Carter’s brand wholesale units shipped in fiscal 2006.  The growth in baby units shipped was driven by our focus on high-volume, essential core products.


 
22

 

The decrease in average price per unit as compared to fiscal 2005 was due primarily to our playclothes product category which accounted for 27% of our Carter’s brand wholesale units shipped.  Playclothes average prices were down 4% as compared to fiscal 2005 due to product mix.  Favorable product mix in our sleepwear category, with average prices up 2% and which accounted for 17% of our Carter’s brand wholesale units shipped in fiscal 2006, partially offset the decline in average price per unit in playclothes.  Average price per unit in our baby product category increased 2% as compared to fiscal 2005.

OSHKOSH WHOLESALE SALES

Results for fiscal 2006 include OshKosh brand wholesale sales for the entire year and are not comparable to results for fiscal 2005 which include OshKosh brand wholesale sales from the Acquisition date of July 14, 2005 through December 31, 2005.

OshKosh brand wholesale sales were $96.4 million in fiscal 2006, including $7.5 million in off-price sales, and $59.7 million for the period from July 14, 2005 through December 31, 2005, including $10.5 million in off-price sales.  Since the Acquisition, we have reduced the number of OshKosh wholesale brands from three brands to one brand (OshKosh) and significantly reduced the number of styles in order to improve productivity.

CARTER’S RETAIL STORES

Carter’s retail stores sales increased $16.6 million in fiscal 2006, or 5.2%, to $333.1 million.  Such growth was driven by incremental sales of $23.1 million generated by new store openings offset by the impact of store closures of $6.3 million and a comparable store sales decrease of $0.2 million, or (0.1%), based on 180 locations.  On a comparable store basis, transactions and units per transaction were flat and average prices decreased 0.4% as compared to fiscal 2005.  Average prices decreased due to increased promotional pricing on spring and fall playclothes.  In fiscal 2006, the Company significantly changed the mix of and reduced the levels of inventory in its retail stores, which negatively impacted retail store performance.  Average inventory levels, on a comparable store basis, were down 10.1% as compared to fiscal 2005.  The Company believes it is taking the steps necessary to improve the level and mix of inventory in its retail stores.

The Company's comparable store sales calculations include sales for all stores that were open during the comparable fiscal period, including remodeled stores and certain relocated stores.  If a store relocates within the same center with no business interruption or material change in square footage, the sales for such store will continue to be included in the comparable store calculation.  If a store relocates to another center or there is a material change in square footage, such store is treated as a new store.  Stores that are closed are included in the comparable store sales calculation up to the date of closing.

There were a total of 219 Carter’s retail stores as of December 30, 2006.  During fiscal 2006, we opened 31 stores and closed five stores.

OSHKOSH RETAIL STORES

Results for fiscal 2006 include OshKosh retail store sales for the entire year and are not comparable to results for fiscal 2005 which include OshKosh retail store sales from the Acquisition date of July 14, 2005 through December 31, 2005.

OshKosh retail store sales contributed $229.1 million in fiscal 2006 and $140.1 million in net sales for the period from July 14, 2005 through December 31, 2005.  During fiscal 2006 we opened 17 stores and closed two stores.  During the period from July 14, 2005 through December 31, 2005, we closed 29 OshKosh retail stores, including 15 OshKosh lifestyle stores.

There were a total of 157 OshKosh retail stores as of December 30, 2006.

MASS CHANNEL SALES

Mass channel sales increased $42.3 million in fiscal 2006, or 23.8%, to $220.3 million.  The increase was driven by increased sales of $23.6 million, or 21.2%, of our Child of Mine brand to Wal-Mart and increased sales of $18.7 million, or 28.1%, of our Just One Year brand to Target.  The growth in sales resulted from increased productivity, additional floor space in existing stores, and new door growth.

 
23

 

GROSS PROFIT

Our gross profit increased $92.2 million, or 23.3%, to $488.5 million in fiscal 2006.  Gross profit as a percentage of net sales was 36.4% in fiscal 2006 as compared to 35.3% in fiscal 2005.

The increase in gross profit as a percentage of net sales reflects:

 
(i)
an amortization charge in fiscal 2005 of $13.9 million related to a fair value step-up of inventory acquired from OshKosh and sold during the period; and

 
(ii)
$1.6 million of accelerated depreciation recorded in fiscal 2005 in connection with the closure of two Carter's brand sewing facilities in Mexico.

Partially offsetting this increase was:

 
(i)
growth in our lower margin mass channel business, sales from which increased 23.8% in fiscal 2006;

 
(ii)
a reduction in our consolidated retail store gross margin due to increased promotional activity (consolidated retail gross margin decreased from 52.0% of consolidated retail store sales in fiscal 2005 to 51.1% of consolidated retail store sales in fiscal 2006); and

 
(iii)
a greater mix of OshKosh brand wholesale sales which generally have lower margins relative to Carter’s brand wholesale sales.

The Company includes distribution costs in its selling, general, and administrative expenses.  Accordingly, the Company’s gross margin may not be comparable to other companies that include such distribution costs in their cost of goods sold.

SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES

Selling, general, and administrative expenses in fiscal 2006 increased $63.8 million, or 22.1%, to $352.5 million.  As a percentage of net sales, selling, general, and administrative expenses in fiscal 2006 increased to 26.2% as compared to 25.7% in fiscal 2005.

The increase in selling, general, and administrative expenses as a percentage of net sales was led primarily by:

 
(i)
retail store sales increasing to 41.8% of our consolidated sales mix from 40.7% last year due to the Acquisition of OshKosh.  Our retail stores have a higher selling, general, and administrative cost structure than other components of our business and our OshKosh retail stores generally have a higher cost structure than our Carter’s retail stores.  Additionally, in fiscal 2006, we opened 29 brand stores which have a higher cost structure and lower sales volume than our outlet stores.  As a result, our retail store selling, general, and administrative expenses increased to 26.7% of consolidated retail store sales compared to 23.5% last year;

 
(ii)
growth in our retail store administration expenses from 3.4% of retail store sales in fiscal 2005 to 4.1% in fiscal 2006 due to expansion of the retail management team;

 
(iii)
incremental stock-based compensation expense of $3.9 million resulting from the adoption of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) as further discussed in Note 6 to the accompanying audited consolidated financial statements; and

 
(iv)
incremental amortization of OshKosh intangible assets related to OshKosh licensing agreements and leasehold interests capitalized in connection with the Acquisition, ($4.7 million in fiscal 2006 as compared to $2.2 million in fiscal 2005).

Partially offsetting these increases were:

 
(i)
a reduction in incentive compensation of $3.0 million as compared to fiscal 2005; and

 
(ii)
a decline in distribution and freight costs as a percentage of sales from 5.6% in fiscal 2005 to 5.3% in fiscal 2006.
 
CLOSURE COSTS

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 the Far East at lower costs.  As a result of these closures, we recorded total costs of $8.4 million, including $4.6 million of severance charges, $1.3 million of lease termination costs, $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 fiscal 2005.

During fiscal 2006, we recorded $91,000 in closure costs which included $74,000 in severance charges and $17,000 in other exit costs related to the closures.

ROYALTY INCOME

Our royalty income increased $8.7 million, or 42.8%, to $29.2 million in fiscal 2006.

We license the use of our Carter’s, Just One Year, and Child of Mine brands.  Royalty income from these brands was approximately $15.1 million in fiscal 2006, an increase of 8.9% or $1.3 million as compared to fiscal 2005 due to increased sales by our Carter’s and Child of Mine brand licensees.

We license the use of our OshKosh and Genuine Kids from OshKosh brand names.  Results for fiscal 2006 include a full year of royalty income from these brands and are not comparable to results for fiscal 2005 which include licensee sales from the Acquisition date of July 14, 2005 through December 31, 2005.  Royalty income from these brands was approximately $14.1 million in fiscal 2006, including $6.8 million in international royalty income, and $6.6 million for the period from July 14, 2005 through December 31, 2005, including $2.6 million in international royalty income.

OPERATING INCOME

Operating income increased $43.9 million, or 36.2%, to $165.1 million in fiscal 2006.  The increase in operating income was due to the factors described above.

LOSS ON EXTINGUISHMENT OF DEBT

As a result of the Refinancing in fiscal 2005, we incurred a $14.0 million redemption premium in connection with the repurchase of our Notes, expensed $4.5 million in debt issuance costs associated with our former senior credit facility and Notes, expensed $0.5 million related to the debt discount on the Notes, and wrote off $1.1 million in debt issuance costs associated with our new Senior Credit Facility in accordance with EITF 96-19.

INTEREST EXPENSE, NET

Interest expense in fiscal 2006 increased $3.7 million, or 15.8%, to $26.9 million.  This increase is attributable to the impact of additional borrowings associated with the Transaction.  In fiscal 2006, weighted-average borrowings were $397.9 million at an effective interest rate of 7.25% as compared to weighted-average borrowings of $320.6 million at an effective interest rate of 7.66% in fiscal 2005.  In fiscal 2006, we reclassified approximately $1.3 million related to our interest rate swap agreement into earnings, which effectively reduced our interest expense under the Term Loan.
24

INCOME TAXES

Our effective tax rate was approximately 36.9% in fiscal 2006 as compared to approximately 39.4% in fiscal 2005.  Our effective tax rate decreased in fiscal 2006 due primarily to lower state taxable income.  See Note 8 to the accompanying audited consolidated financial statements for a reconciliation of the statutory rate to our effective tax rate.

NET INCOME

Our fiscal 2006 net income increased $40.0 million to $87.2 million as compared to $47.2 million in fiscal 2005 as a result of the factors described above.
 
LIQUIDITY AND CAPITAL RESOURCES

Our primary cash needs are working capital and capital expenditures.  Our primary source of liquidity will continue to be cash flow from operations and borrowings under our Revolver, and we expect that these sources will fund our ongoing requirements for working capital and capital expenditures.  These sources of liquidity may be impacted by continued demand for our products and our ability to meet debt covenants under our Senior Credit Facility, described below.

Net accounts receivable at December 29, 2007 were $119.7 million compared to $110.6 million at December 30, 2006.  This increase reflects higher levels of wholesale and mass channel revenue in the latter part of fiscal 2007 as compared to the latter part of fiscal 2006.

Net inventories at December 29, 2007 were $225.5 million compared to $193.6 million at December 30, 2006.  This increase was driven by higher levels of inventory in our retail stores to better support demand, an increase in finished goods inventory to support demand, particularly in baby products, and slightly higher levels of excess inventory as compared to the prior year.

Net cash provided by operating activities for fiscal 2007 was $52.0 million compared to $88.2 million in fiscal 2006.  This change is primarily attributable to increased inventory levels as discussed above.  Net cash provided by our operating activities in fiscal 2005 was approximately $137.3 million.  Cash flow in fiscal 2006 is not comparable to fiscal 2005 due to the timing of the Acquisition on July 14, 2005, a point in the year when OshKosh’s working capital was at its peak.  Additionally, in fiscal 2006, the Company had significant reductions in current liabilities resulting from the payment of Acquisition-related liabilities and a change in classification of the income tax benefit from the exercise of stock options resulting from the adoption of SFAS 123R, as described in Note 6 to the accompanying audited consolidated financial statements.

We invested $21.9 million in capital expenditures during fiscal 2007 compared to $30.8 million in fiscal 2006.  Major investments include retail store openings and remodelings and investments in information technology.  We plan to invest approximately $50 million in capital expenditures in fiscal 2008 primarily for retail store openings and includes a new point of sale system for our retail stores.

On February 16, 2007, the Board of Directors approved a stock repurchase program, pursuant to which the Company is authorized to purchase up to $100 million of its outstanding common shares.  Such repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise.  This program has no time limit.  The timing and amount of any repurchases will be determined by management, based on its evaluation of market conditions, share price, and other factors.  During fiscal 2007, the company repurchased and retired 2,473,219 shares, or approximately $57.5 million, of its common stock at an average price of $23.24 per share.

Weighted-average borrowings for fiscal 2007 were $349.2 million at an effective rate of 7.01% as compared to weighted-average borrowings of $397.9 million at an effective interest rate of 7.25% in fiscal 2006.

At December 29, 2007, we had approximately $341.5 million in Term Loan borrowings and no borrowings under our Revolver, exclusive of $16.3 million of outstanding letters of credit.  At December 30, 2006, we had approximately $345.0 million in Term Loan borrowings and no borrowings under our Revolver, exclusive of approximately $14.5 million of outstanding letters of credit.

The term of the Revolver expires July 14, 2011 and the term of the Term Loan expires July 14, 2012.  Principal borrowings under the Term Loan are due and payable in quarterly installments of $0.9 million from March 31, 2008 through June 30, 2012 with the remaining balance of $325.8 million due on July 14, 2012.

In March 2006, we made a $9.0 million prepayment on our Term Loan; in May 2006, we made a $15.0 million prepayment on our Term Loan; in June 2006, we made a $10.0 million prepayment on our Term Loan; in November 2006, we made a $35.0 million prepayment on our Term Loan, and in December 2006, we made an $11.9 million prepayment on our Term Loan.  In fiscal 2006, we also made scheduled amortization payments of $4.1 million.  In fiscal 2007, we made scheduled amortization payments of $3.5 million.

On April 28, 2006, the Company entered into Amendment No. 1 to the Senior Credit Facility.  Amendment No. 1 reduced the Company’s interest rate by refinancing the existing Term Loan (initially priced at LIBOR + 1.75% with a leverage-based pricing grid ranging from LIBOR + 1.50% to LIBOR + 1.75%) with a new Term Loan having an applicable rate of LIBOR + 1.50% with no leverage-based pricing grid.  Interest is payable at the end of interest rate reset periods, which vary in length, but in no case exceed 12 months for LIBOR rate loans and quarterly for prime rate loans.  The effective interest rate on variable rate Term Loan borrowings as of December 29, 2007 and December 30, 2006 was 6.4% and 6.9%.  The Senior Credit Facility contains financial covenants, including a minimum interest coverage ratio, maximum leverage ratio, and fixed charge coverage ratio.  The Senior Credit Facility also sets forth mandatory and optional prepayment conditions, including an annual excess cash flow requirement, as defined, that may result in our use of cash to reduce our debt obligations.  There was no excess cash flow payment required for fiscal 2007 or 2006.  Our obligations under the Senior Credit Facility are collateralized by a first priority lien on substantially all of our assets, including the assets of our domestic subsidiaries.

Our operating results are subject to risk from interest rate fluctuations on our Senior Credit Facility, which carries variable interest rates.  As of December 29, 2007, our outstanding debt aggregated approximately $341.5 million, of which $93.4 million bore interest at a variable rate.  An increase or decrease of 1% in the applicable rate would increase or decrease our annual interest cost by $0.9 million, exclusive of variable rate debt subject to our swap and collar agreements (see Note 2), and could have an adverse effect on our net (loss) income and cash flow.

During fiscal 2007, the Company closed its White House, Tennessee distribution center, which was utilized to distribute the Company’s OshKosh brand products.  As a result of this closure, we recorded costs in fiscal 2007 of $7.4 million, consisting of asset impairment charges of $2.4 million related to a write-down of the related land, building and equipment, $2.0 million of severance charges, $2.1 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.9 million of other closure costs.  The estimated annual savings resulting from the closure of this facility are approximately $4.0 million.  As of December 29, 2007, there are no significant remaining cash payments to be made as a result of this closure.

The estimated value of the White House assets as of December 29, 2007 was $6.1 million.  These assets are classified as assets held for sale on the accompanying audited consolidated balance sheet.

In connection with the Acquisition, management developed an integration plan that includes severance, certain facility and store closures, and contract terminations.  The following liabilities, included in other current liabilities in the accompanying audited consolidated balance sheets, were established at the closing of the Acquisition, will be funded by cash flows from operations and borrowings under our Revolver, and are expected to be paid in fiscal 2008:

(dollars in thousands)
 
Severance
   
Other
exit
costs
   
Lease
termination
costs
   
Contract
termination
costs
   
Total
 
                               
Balance at December 31, 2005
  $ 8,209     $ 1,926     $ 6,552     $ 898     $ 17,585  
Payments
    (5,294 )     (1,377 )     (4,999 )     (399 )     (12,069 )
Adjustments to cost in excess of fair value of net assets acquired
    (780 )     170       180       (299 )     (729 )
Balance at December 30, 2006
    2,135       719       1,733       200       4,787  
Payments
    (1,624 )     (641 )     (1,059 )     --       (3,324 )
Adjustments to cost in excess of fair value of net assets acquired
    (100 )     --       --       (200 )     (300 )
Balance at December 29, 2007
  $ 411     $ 78     $ 674     $ --     $ 1,163  

 
25

 

The following table summarizes as of December 29, 2007, the maturity or expiration dates of mandatory contractual obligations and commitments for the following fiscal years:

(dollars in thousands)
 
2008
   
2009
   
2010
   
2011
   
2012
   
Thereafter
   
Total
 
Long-term debt                                    
  $ 3,503     $ 3,503     $ 3,503     $ 3,503     $ 327,517     $ --     $ 341,529  
Interest on debt:
                                                       
Variable rate (a)
    21,429       21,429       21,429       21,429       10,715       --       96,431  
Operating leases (see Note 9 to the Consolidated Financial Statements)
    49,029       42,130       35,202       26,279       17,852       41,683       212,175  
Total financial obligations
    73,961       67,062       60,134       51,211       356,084       41,683       650,135  
                                                         
Letters of credit                                    
    16,268       --       --       --       --       --       16,268  
Purchase obligations (b)
    194,453       --       --       --       --       --       194,453  
Total financial obligations and commitments
  $ 284,682     $ 67,062     $ 60,134     $ 51,211     $ 356,084     $ 41,683     $ 860,856  

(a)
Reflects estimated variable rate interest on obligations outstanding on our Term Loan as of December 29, 2007 using an interest rate of 6.4% (rate in effect at December 29, 2007).

(b)
Unconditional purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms, including fixed or minimum
quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction.  The purchase obligations category above relates to commitments for inventory
purchases.  Amounts reflected on the accompanying audited consolidated balance sheets in accounts payable or other current liabilities are excluded from the table above.

In addition to the total contractual obligations and commitments in the table above, we have post-retirement benefit obligations and reserves for uncertain tax positions, included in other current and other long-term liabilities as further described in Note 7 and Note 8, respectively, to the accompanying audited consolidated financial statements.

Based on our current level of operations, we believe that cash generated from operations and available cash, together with amounts available under our Revolver, will be adequate to meet our debt service requirements, capital expenditures, and working capital needs for the foreseeable future, although no assurance can be given in this regard.  We may, however, need to refinance all or a portion of the principal amount of amounts outstanding under our Revolver on or before July 14, 2011 and amounts outstanding under our Term Loan on or before July 14, 2012.

EFFECTS OF INFLATION AND DEFLATION

We are affected by inflation and changing prices primarily through purchasing product from our global suppliers, increased operating costs and expenses, and fluctuations in interest rates.  The effects of inflation on our net sales and operations have not been material.  In recent years, there has been deflationary pressure on selling prices.  While we have been successful in offsetting such deflationary pressures through product improvements and lower costs with the expansion of our global sourcing network, if deflationary price trends outpace our ability to obtain further price reductions from our global suppliers, our profitability may be affected.

SEASONALITY

We experience seasonal fluctuations in our sales and profitability, with generally lower sales and gross profit in the first and second quarters of our fiscal year.  Over the past five fiscal years, excluding the impact of the Acquisition in fiscal 2005, approximately 57% of our consolidated net sales were generated in the second half of our fiscal year.  Accordingly, our results of operations for the first and second quarters of any year are not indicative of the results we expect for the full year.

As a result of this seasonality, our inventory levels and other working capital requirements generally begin to increase during the second quarter and into the third quarter of each fiscal year.  During these peak periods we have historically borrowed under our Revolver.  In fiscal 2007, we had $41.6 million in peak borrowings under our Revolver.


 
26

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities.  We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 to the accompanying audited consolidated financial statements.  The following discussion addresses our critical accounting policies and estimates, which are those policies that require management’s most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Revenue recognition: We recognize wholesale and mass channel revenue after shipment of products to customers, when title passes, when all risks and rewards of ownership have transferred, the sales price is fixed or determinable, and collectibility is reasonably assured.  In certain cases, in which we retain the risk of loss during shipment, revenue recognition does not occur until the goods have reached the specified customer.  In the normal course of business, we grant certain accommodations and allowances to our wholesale and mass channel customers in order to assist these customers with inventory clearance or promotions.  Such amounts are reflected as a reduction of net sales and are recorded based upon historical trends and annual forecasts.  Retail store revenues are recognized at the point of sale.  We reduce revenue for customer returns and deductions.  We also maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make payments and other actual and estimated deductions.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional allowance could be required.  Past due balances over 90 days are reviewed individually for collectibility.  Our credit and collections department reviews all other balances regularly.  Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered.

We contract with a third-party service to provide us with the fair value of cooperative 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 EITF Issue No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer/Reseller,” we have included the fair value of these arrangements of approximately $2.5 million in fiscal 2007, $3.3 million in fiscal 2006, and $4.8 million in fiscal 2005 as a component of selling, general, and administrative expenses on the accompanying audited consolidated statement of operations rather than as a reduction of revenue.  Amounts determined to be in excess of the fair value of these arrangements are recorded as a reduction of net sales.

Inventory:  We provide reserves for slow-moving inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.  If actual market conditions are less favorable than those we project, additional write-downs may be required.

Cost in excess of fair value of net assets acquired and tradename:  As of December 29, 2007, we had approximately $444.8 million in Carter’s cost in excess of fair value of net assets acquired and Carter’s and OshKosh tradename assets.  The fair value of the Carter’s tradename was estimated at the 2001 acquisition to be approximately $220.2 million using a discounted cash flow analysis, which examined the hypothetical cost savings that accrue as a result of our ownership of the tradename.  The fair value of the OshKosh tradename was recently estimated to be approximately $88.0 million, also using a discounted cash flow analysis.  The cash flows, which incorporated both historical and projected financial performance, were discounted using a discount rate of 10% for Carter’s and 12% for OshKosh.  The tradenames were determined to have indefinite lives.  The carrying value of these assets is subject to annual impairment reviews as of the last day of each fiscal year.  Factors affecting such impairment reviews include the continued market acceptance of our offered products and the development of new products.  Impairment reviews may also be triggered by any significant events or changes in circumstances.

Accrued expenses:  Accrued expenses for workers’ compensation, incentive compensation, health insurance, and other outstanding obligations are assessed based on actual commitments, statistical trends, and estimates based on projections and current expectations, and these estimates are updated periodically as additional information becomes available.


 
27

 

 
Accounting for income taxes:  As part of the process of preparing the accompanying audited consolidated financial statements, we are required to estimate our actual current tax exposure (state, federal, and foreign).  We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting dates.  For those uncertain tax positions where it is “more likely than not” that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information.  For those income tax positions where it is not “more likely than not” that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements.  Where applicable, associated interest is also recognized.  We also assess permanent and temporary differences resulting from differing bases and treatment of items for tax and accounting purposes, such as the carrying value of intangibles, deductibility of expenses, depreciation of property, plant, and equipment, and valuation of inventories.  Temporary differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets.  We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income.  Actual results could differ from this assessment if sufficient taxable income is not generated in future periods.  To the extent we determine the need to establish a valuation allowance or increase such allowance in a period, we must include an expense within the tax provision in the accompanying audited consolidated statement of operations.

Stock-based compensation arrangements:  The Company accounts for stock-based compensation in accordance with the fair value recognition provisions of SFAS 123R.  The Company adopted SFAS 123R using the modified prospective application method of transition.  The Company uses the Black-Scholes option pricing model, which requires the use of subjective assumptions.  These assumptions include the following:

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.

Forfeitures – The Company estimates forfeitures of stock-based awards based on historical experience and expected future activity.

Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized in the accompanying audited consolidated statement of operations.

The Company accounts for its performance-based awards in accordance with SFAS 123R and records stock-based compensation expense over the vesting term of the awards that are expected to vest based on whether it is probable that the performance criteria will be achieved.  The Company reassesses the probability of vesting at each reporting period for awards with performance criteria and adjusts stock-based compensation expense based on its probability assessment.

 
28

 

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  The provisions of SFAS 157 are effective as of the beginning of our 2008 fiscal year.  In February 2008, the FASB issued FSP No. FAS 157-2, which delays the effective date of SFAS 157, "Fair Value Measurements," for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  Nonfinancial assets and nonfinancial liabilities would include all assets and liabilities other than those meeting the definition of a financial asset or financial liability as defined in paragraph 6 of SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (“SFAS 159”).  This FASB Staff Position defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of FSP No. FAS 157-2.  We have evaluated the impact that SFAS 157 will have on our consolidated financial statements and have determined that it will not have a significant impact on our consolidated financial statements.

In February 2007, the FASB issued SFAS 159, which provides entities with an option to report selected financial assets and liabilities at fair value.  SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities.  This statement is effective as of the beginning of the first fiscal year that begins after November 15, 2007.  The Company has evaluated the impact that SFAS 159 will have on its consolidated financial statements and have determined that it will not have a significant impact on our consolidated financial statements.
 
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS No. 141, “Business Combinations” (“SFAS 141”).  SFAS 141(R) retains the underlying concepts of SFAS 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting but SFAS 141(R) changed the method of applying the acquisition method in a number of significant aspects.  Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.  SFAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies.  SFAS 141(R) amends SFAS No. 109, “Accounting for Income Taxes,” such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) would also apply the provisions of SFAS 141(R).  Early adoption is not permitted.  We are currently evaluating the effects, if any, that SFAS 141(R) may have on our consolidated financial statements.

FORWARD-LOOKING STATEMENTS

Statements contained herein that relate to our future performance, including, without limitation, statements with respect to our anticipated results of operations or level of business for fiscal 2008 or any other future period, are forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Such statements are based on current expectations only and are subject to certain risks, uncertainties, and assumptions.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected.  These risks are described herein under the heading “Risk Factors” on page 7.  We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.


 
29

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

CURRENCY AND INTEREST RATE RISKS

In the operation of our business, we have market risk exposures, including those related to foreign currency risk and interest rates.  These risks and our strategies to manage our exposure to them are discussed below.

We contract for production with third parties primarily in the Far East and South and Central America.  While these contracts are stated in United States dollars, there can be no assurance that the cost for the future production of our products will not be affected by exchange rate fluctuations between the United States dollar and the local currencies of these contractors.  Due to the number of currencies involved, we cannot quantify the potential impact of future currency fluctuations on net (loss) income in future years.  In order to manage this risk, we source products from approximately 130 vendors worldwide, providing us with flexibility in our production should significant fluctuations occur between the United States dollar and various local currencies.  To date, such exchange fluctuations have not had a material impact on our financial condition or results of operations.  We do not hedge foreign currency exchange rate risk.

Our operating results are subject to risk from interest rate fluctuations on our Senior Credit Facility, which carries variable interest rates.  As of December 29, 2007, our outstanding debt aggregated approximately $341.5 million, of which $93.4 million bore interest at a variable rate.  An increase or decrease of 1% in the applicable rate would increase or decrease our annual interest cost by $0.9 million, exclusive of variable rate debt subject to our swap and collar agreements, and could have an adverse effect on our net (loss) income and cash flow.

OTHER RISKS

We enter into various purchase order commitments with full-package suppliers.  We can cancel these arrangements, although in some instances, we may be subject to a termination charge reflecting a percentage of work performed prior to cancellation.  As we rely exclusively on our full-package global sourcing network, we could incur more of these termination charges, which could increase our cost of goods sold and have a material impact on our business.


 
30

 

 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



 
CARTER’S, INC.
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


 
Page
   
 
32
 
33
 
34
 
35
 
36
37


 
31

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders of Carter's, Inc.:


In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Carter's, Inc. and its subsidiaries at December 29, 2007 and December 30, 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 2007 in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A.  Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinions.

As discussed in Note 6 to the consolidated financial statements, the Company changed the manner in which it accounts for stock-based compensation in 2006.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.


/s/ PricewaterhouseCoopers LLP

Stamford, Connecticut
February 27, 2008

 
32

 

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

   
December 29,
2007
   
December 30,
2006
 
ASSETS
           
             
Current assets:
           
  Cash and cash equivalents                                                                                                        
  $ 49,012     $ 68,545  
  Accounts receivable, net of reserve for doubtful accounts of $4,743 in fiscal 2007 and $3,316 in fiscal 2006
    119,707       110,615  
  Finished goods inventories, net                                                                                                        
    225,494       193,588  
  Prepaid expenses and other current assets                                                                                                        
    9,093       7,296  
  Assets held for sale                                                                                                        
    6,109       --  
  Deferred income taxes                                                                                                        
    24,234       22,377  
Total current assets                                                                                                  
    433,649       402,421  
Property, plant, and equipment, net                                                                                                        
    75,053       87,940  
Tradenames                                                                                                        
    308,233       322,233  
Cost in excess of fair value of net assets acquired                                                                                                        
    136,570       279,756  
Licensing agreements, net of accumulated amortization of $10,185 in fiscal 2007 and $6,205 in fiscal 2006
    8,915       12,895  
Deferred debt issuance costs, net                                                                                                        
    4,743       5,903  
Leasehold interests, net of accumulated amortization of $1,149 in fiscal 2007 and $682 in fiscal 2006
    684       1,151  
Other assets                                                                                                        
    6,821       10,892  
Total assets                                                                                             
  $ 974,668     $ 1,123,191  
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities:
               
  Current maturities of long-term debt                                                                                                        
  $ 3,503     $ 2,627  
  Accounts payable                                                                                                        
    56,589       70,310  
  Other current liabilities                                                                                                        
    46,666       63,580  
         Total current liabilities                                                                                                        
    106,758       136,517  
Long-term debt                                                                                                        
    338,026       342,405  
Deferred income taxes                                                                                                        
    113,706       125,784  
Other long-term liabilities                                                                                                        
    34,049       22,994  
        Total liabilities                                                                                                        
    592,539       627,700  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock; par value $.01 per share; 100,000 shares authorized; none issued or outstanding at December 29, 2007 and December 30, 2006
    --       --  
Common stock, voting; par value $.01 per share; 150,000,000 shares authorized; 57,663,315 and 58,927,280 shares issued and outstanding at December 29, 2007 and December 30, 2006, respectively
    576       589  
  Additional paid-in capital                                                                                                         
    232,356       275,045  
  Accumulated other comprehensive income                                                                                                         
    2,671       5,301  
  Retained earnings                                                                                                         
    146,526       214,556  
        Total stockholders’ equity                                                                                                         
    382,129       495,491  
Total liabilities and stockholders’ equity                                                                                              
  $ 974,668     $ 1,123,191  

The accompanying notes are an integral part of the consolidated financial statements
 
33

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

   
For the fiscal years ended
 
   
December 29,
2007
   
December 30,
2006
   
December 31,
2005
 
                   
Net sales
  $ 1,412,246     $ 1,343,467     $ 1,121,358  
Cost of goods sold
    928,996       854,970       725,086  
                         
Gross profit
    483,250       488,497       396,272  
Selling, general, and administrative expenses
    359,826       352,459       288,624  
Intangible asset impairment (Note 2)
    154,886       --       --  
Closure costs
    5,285       91       6,828  
Royalty income
    (30,738 )      (29,164 )      (20,426 )
                         
Operating (loss) income
    (6,009 )     165,111       121,246  
Interest income
    (1,386 )     (1,914 )     (1,322 )
Loss on extinguishment of debt
    --       --       20,137  
Interest expense
    24,465       28,837       24,564  
                         
(Loss) income before income taxes
    (29,088 )     138,188       77,867  
Provision for income taxes
    41,530       50,968       30,665  
                         
Net (loss) income
  $ (70,618 )   $ 87,220     $ 47,202  
                         
Basic net (loss) income per common share
  $ (1.22 )   $ 1.50     $ 0.82  
Diluted net (loss) income per common share
  $ (1.22 )   $ 1.42     $ 0.78  
Basic weighted-average number of shares outstanding
    57,871,235       57,996,241       57,280,504  
Diluted weighted-average number of shares outstanding
    57,871,235       61,247,122       60,753,384  

The accompanying notes are an integral part of the consolidated financial statements

 
34

 

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

   
For the fiscal years ended
 
   
December 29,
2007
   
December 30,
2006
   
December 31,
2005
 
Cash flows from operating activities:
                 
  Net (loss) income
  $ (70,618 )   $ 87,220     $ 47,202  
  Adjustments to reconcile net (loss) income to net cash provided by operating activities:
                       
Depreciation and amortization
    29,919       26,489       21,912  
Non-cash intangible asset impairment charges
    154,886       --       --  
Loss on extinguishment of debt
    --       --       20,137  
Amortization of debt issuance costs
    1,160       2,354       2,802  
Amortization of inventory step-up
    --       --       13,900  
Accretion of debt discount
    --       --       40  
Non-cash stock-based compensation expense
    3,601       5,942       1,824  
Non-cash closure costs
    2,450       --       113  
Loss (gain) on sale of property, plant, and equipment
    690       118       (64 )
Income tax benefit from exercised stock options
    (8,230 )     (9,155 )     6,590  
Deferred income taxes
    (9,630 )     502       380  
Effect of changes in operating assets and liabilities (net of assets acquired and liabilities assumed):
                       
         Accounts receivable
    (9,092 )     (14,471 )     275  
         Inventories
    (31,906 )     (5,134 )     4,639  
         Prepaid expenses and other assets
    (1,404 )     (886 )     543  
         Accounts payable
    (13,721 )     7,181       18,561  
         Other liabilities
    3,882       (11,936 )     (1,587 )
Net cash provided by operating activities
    51,987       88,224       137,267  
Cash flows from investing activities:
                       
  Acquisition of OshKosh B’Gosh, Inc., net of cash acquired
    --       --       (309,984 )
  Capital expenditures
    (21,876 )     (30,848 )     (22,588 )
  Proceeds from sale of property, plant, and equipment
    57       348       2,860  
  Sale of investments
    --       --       229,180  
  Purchase of investments
    --       --       (210,825 )
  Collections on loan
    --       --       2,954  
Net cash used in investing activities
    (21,819 )     (30,500 )     (308,403 )
Cash flows from financing activities:
                       
  Payments on term loan
    (3,503 )     (85,000 )     (69,968 )
  Proceeds from term loan
    --       --       500,000  
  Proceeds from revolving loan facility
    121,400       5,000       --  
  Payments on revolving loan facility
    (121,400 )     (5,000 )     --  
  Payments on former term loan
    --       --       (71,326 )
  Payment of 10.875% Senior Subordinated Notes
    --       --       (113,750 )
  Payment of debt redemption premium
    --       --       (14,015 )
  Payments of debt issuance costs
    --       --       (10,780 )
  Share repurchase
    (57,467 )     --       --  
  Income tax benefit from exercised stock options
    8,230