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. Established in 1865, our Carter’s brand is recognized and trusted by consumers for high-quality apparel for children sizes newborn to seven. In fiscal 2005, we acquired OshKosh B’Gosh, Inc. Established in 1895, OshKosh is recognized as a well-known brand that is trusted by consumers for its line of apparel for children sizes newborn to 12. 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 use a business model that we believe has multiple platforms for growth and is focused on high volume and productivity. Our Carter’s, OshKosh, and related brands are sold to national department stores, chain and specialty stores, discount retailers, and, as of January 1, 2011, through our 306 Carter’s and 180 OshKosh outlet and brand retail stores. We believe each of our brands has its own unique positioning in the marketplace. Our brands compete in the $22 billion children’s apparel market, for children sizes newborn to seven, with our Carter’s brand achieving the #1 branded position with a 10.9% market share and our OshKosh brand has a 3.2% 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 across various channels, socio-economic groups, and geographic regions.
Since fiscal 2006, we have increased consolidated net sales at a compound annual growth rate of 7.0%. Our pre-tax results have ranged from income of $128.6 million in fiscal 2006 to $233.4 million in fiscal 2010, with the exception of fiscal 2007 in which we had a pre-tax loss of $37.3 million. In fiscal 2007, our pre-tax results were impacted 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. In fiscal 2008, our pre-tax results were decreased by executive retirement charges of $5.3 million and a write-down of $2.6 million on our White House, Tennessee distribution facility. In fiscal 2009, our pre-tax results were decreased by $5.7 million related to professional service fees incurred in connection with the customer margin support investigation, $5.5 million related to the reduction in the Company’s corporate workforce, $4.3 million of expenses associated with the closure of our Barnesville, Georgia distribution facility (including accelerated depreciation), $1.2 million of asset impairment charges net of gain associated with the closure and sale of our Company’s Oshkosh, Wisconsin facility, and a $0.7 million related to the write-down of the carrying value of our White House, Tennessee distribution facility.
The Company is a Delaware corporation. The Company and its predecessors have been doing business since 1865. 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 through the mass channel our Just One You and Precious Firsts brands at Target and our Child of Mine brand at Walmart. In fiscal 2010, we sold over 256 million units of Carter’s, Child of Mine, Just One You, and Precious Firsts products to our wholesale customers, mass channel customers, and through our Carter’s retail stores, an increase of approximately 12% from fiscal 2009. Under our Carter’s and Just One You 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 approximately 67% of our baby and sleepwear net sales in fiscal 2010, including mass channel. We believe our core apparel products are essential consumer staples, less dependent on changes in fashion trends, and supported by a strong birth rate and other favorable demographic trends.
We have four cross-functional product teams focused on the development of our Carter’s 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, shoes, room décor, furniture, gear, 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 our susceptibility to fashion risk and supports efficient operations. We conduct consumer research as part of our product development process and engage in product testing in our own stores. 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 is to drive our brand image as the leader in baby and young children’s apparel and to consistently provide high-quality products at a great value to consumers. We employ a disciplined merchandising strategy that 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 fixturing and branding packages and advertising with our wholesale and mass channel customers. We have invested in display units for our major wholesale customers that more 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 a consistent, high-level of service, including delivering and replenishing products on time to fulfill customer needs.
CARTER’S PRODUCTS
Baby
Carter’s brand baby products include bodysuits, pants, undershirts, towels, washcloths, receiving blankets, layette gowns, bibs, caps, and booties. In fiscal 2010, excluding mass channel sales, we generated $458.7 million in net sales of these products, representing 26.2% of our consolidated net sales.
Our Carter’s brand is the leading brand in the baby category. In fiscal 2010, in the department store, national chain, outlet, specialty store, and off-price sales channels, our aggregate Carter’s brand market share was approximately 29.8% for baby (sizes newborn to twenty-four months), which represents greater than six 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 Little Layette product line, the largest component of our baby business, provides parents with essential core products and accessories, including value-focused multi-packs. Our Little Collections 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 seven. In fiscal 2010, we generated $402.9 million in net sales of these products, excluding the mass channel, or 23.0%, of our consolidated net sales. We continue to focus 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 aggregate 2010 Carter’s brand playclothes market share was approximately 11.9% in the $9.5 billion department store, national chain, outlet, specialty store, and off-price sales channels.
Sleepwear
Carter’s brand sleepwear products include pajamas and blanket sleepers in sizes 12 months to seven. In fiscal 2010, we generated $215.0 million in net sales of these products, excluding the mass channel, or 12.3%, of our consolidated net sales. 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 2010, in these channels, our Carter’s brand market share was approximately 30.5%, which represents approximately two times the market share of the next largest brand. As in our baby product line, we differentiate our sleepwear products by offering high-volume, high quality core products with distinctive print designs and artistic applications.
Mass Channel Products
Our mass channel product team focuses on baby, sleepwear, and playclothes products produced specifically for the mass channel. Such products are differentiated through fabrications, artwork, and packaging. Our 2010 market share was 8.0% in the $8.5 billion mass channel babies and young children’s apparel market. Our Child of Mine product line, which is sold in substantially all Walmart stores nationwide, includes layette, sleepwear, and playclothes along with a range of licensed products, such as hosiery, bedding, toys, furniture, and gifts. We also sell our Just One You and Precious Firsts brands to Target, which include baby, sleepwear, and baby playclothes along with a range of licensed products, such as hosiery, bedding, toys, furniture, gear, and gifts. In fiscal 2010, we generated $254.8 million in net sales of our Child of Mine, Just One You, and Precious Firsts products, or 14.6%, of our consolidated net sales.
Other Products
Our other product offerings include bedding, outerwear, swimwear, shoes, socks, diaper bags, gift sets, toys, and hair accessories. In fiscal 2010, we generated $71.2 million in net sales of these other products in our Carter’s retail stores, or 4.1%, of our consolidated net sales.
Royalty Income
We currently extend our Carter’s, Child of Mine, and Just One You product offerings by licensing these brands to 15 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 lifestyle 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 provide for 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 brand 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 2010, our Carter’s brand and mass channel licensees generated wholesale and mass channel net sales of $203.4 million on which we earned $18.4 million in royalty income.
We currently extend our Carter’s brand internationally with five licensees in approximately five countries. In connection with these arrangements, our international licensees generated Carter’s brand retail sales of $32.0 million on which we earned $1.9 million in royalty income in fiscal 2010.
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 2010, sales of our Carter’s brand products through the wholesale channel, including off-price sales, accounted for 34.4% of our consolidated net sales (32.8% in fiscal 2009), sales through our retail stores, including eCommerce, accounted for 31.2% of our consolidated net sales (30.8% in fiscal 2009), and sales through the mass channel accounted for 14.6% of our consolidated net sales (15.1% in fiscal 2009).
Business segment financial information for our Carter’s brand wholesale, retail, and mass channel segments is contained in Item 8 - “Financial Statements and Supplementary Data,” Note 14 - “Segment Information” to the accompanying audited consolidated financial statements.
Our Carter’s brand wholesale customers include major retailers, such as Kohl’s, Costco, Toys “R” Us, JCPenney, Macy’s, Sam’s Club, and Bon-Ton. Our mass channel customers are Target and Walmart. 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 replenishment 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, advertising, and frequent meetings with the senior management of our major wholesale and mass channel customers.
As of January 1, 2011, we operated 306 Carter’s retail stores, of which 180 were outlet stores and 126 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 4,600 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 have 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 use 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 brand store 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 12. 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 2010, we sold over 49 million units of OshKosh products through our retail stores and to our wholesale customers, an increase of approximately 5% over fiscal 2009. 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 represents a significant long-term growth opportunity for us, especially in the $15.6 billion young children’s playclothes market. While 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, improving the productivity of our OshKosh retail stores, investing in new employees and talent development, leveraging our relationships with major wholesale accounts, and leveraging our infrastructure and supply chain.
OSHKOSH BRAND POSITIONING
We believe our OshKosh brand stands for high-quality, authentic playclothes products for children sizes newborn to 12. Our core OshKosh brand products include denim, overalls, t-shirts, fleece, and other playclothes for children. Our OshKosh brand is generally positioned towards an older segment (sizes two to seven) and at slightly 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 2010, we generated $256.2 million in net sales of OshKosh brand playclothes products, which accounted for approximately 14.6% of our consolidated net sales. OshKosh brand playclothes products include denim apparel products with multiple wash treatments and coordinating garments, overalls, woven bottoms, knit tops, and playclothes products for everyday use in sizes newborn to 12. We plan to grow this business by strengthening our product offerings, improving product value, reducing product complexity, and leveraging our strong customer relationships and global supply chain expertise. We believe our OshKosh brand represents a significant opportunity for us to increase our share in the playclothes category as the $15.6 billion young children’s playclothes market, including the mass channel, is highly fragmented. In fiscal 2010, this market was more than five times the size of the baby and sleepwear markets combined.
Other Products
The remainder of our OshKosh brand product offering includes baby, sleepwear, outerwear, shoes, hosiery, and accessories. In fiscal 2010, we generated $90.4 million in net sales of these other products in our OshKosh retail stores, which accounted for 5.2% 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 six domestic licensees, as well as 30 international licensees selling apparel and accessories in approximately 37 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, and accessories. In fiscal 2010, our domestic licensees generated wholesale and mass channel net sales of approximately $184.5 million on which we earned approximately $9.8 million in royalty income. In fiscal 2010, our international licensees generated retail sales of approximately $124.8 million, on which we earned approximately $7.5 million in royalty income.
OSHKOSH DISTRIBUTION CHANNELS
In fiscal 2010, sales of our OshKosh brand products through our OshKosh retail stores, including eCommerce, accounted for 15.1% of our consolidated net sales (16.2% in fiscal 2009) and sales through the wholesale channel, including off-price sales, accounted for 4.7% of our consolidated net sales (5.1% in fiscal 2009).
Business segment financial information for our OshKosh brand retail and wholesale segments is contained in Item 8 - “Financial Statements and Supplementary Data,” Note 14 - “Segment Information” to the accompanying audited consolidated financial statements.
As of January 1, 2011, we operated 180 OshKosh retail stores, of which 161 were outlet stores and 19 were brand stores. These stores carry a wide assortment of young children’s apparel, accessories, and gift items and average approximately 4,700 square feet per location.
Our OshKosh brand wholesale customers include major retailers, such as Kohl’s, Bon-Ton, Fred Meyer, JCPenney, Belk, and Ross Stores. 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 AND PRODUCT COSTS
We have significant experience in sourcing products internationally, primarily from Asia, with expertise that includes the ability to evaluate vendors, familiarity with foreign supply sources, and experience with sourcing logistics particular to Asia. We also have relationships with both leading and certain specialized sourcing agents in Asia. One sourcing agent manages approximately 90% of our inventory purchases. Our product costs can vary depending on the underlying cost of raw materials, such as cotton and polyester, and the level of labor and transportation costs. The availability of raw materials impacts the cost of our products. Our sourcing network consists of over 100 vendors located in over 15 countries. We believe that our sourcing arrangements are sufficient to meet our current operating requirements and provide capacity for growth.
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, 77kids, and Disney. Most retailers, including our customers, have significant private label product offerings that compete with our products. 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, OshKosh, and related 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®, Celebrating Childhood™, Little Collections™, Little Layette™, Child of Mine®, Just One Year®, Just One You™, Precious Firsts™, OshKosh®, OshKosh B’gosh®, At Play Since 1895™, OshKosh Est. 1895®, Genuine Kids®, The Genuine Article®, and The Genuine Deal™, 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 You, Precious Firsts, 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, shoes, boots, slippers, diaper bags, furniture, room décor, bedding, giftwrap, baby books, party goods, and toys.
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. On our website, we make available, free of charge, our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, director and officer reports on Forms 3, 4, and 5, and any 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 January 1, 2011, we had 8,673 employees, 2,486 of whom were employed on a full-time basis and 6,187 of whom were employed on a part-time basis. We have no unionized employees. We have had no labor-related work stoppages and believe that our labor relations are good.
ITEM 1A.
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 SEC 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 2010, we derived approximately 41% of our consolidated net sales from our top eight customers, including mass channel customers. Kohl’s accounted for approximately 10% of our consolidated net sales in fiscal 2010. Both the Carter’s and OshKosh wholesale segments include sales to Kohl’s. We do not enter into long-term sales contracts with our major customers, relying instead on long-standing relationships 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 their business with us or terminate 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 and timely evaluate and adapt our products to changes in consumers’ tastes and preferences or 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 effect 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.
In addition, 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 generate royalty income from the sale of licensed products that bear its Carter’s, Just One Year, Just One You, Precious Firsts, Child of Mine, OshKosh, OshKosh Est. 1895, Genuine Kids, 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.
We may incur substantial costs as a result of litigation, investigations or other proceedings, including those related to our previously filed restatements.
We are currently involved in litigation matters and investigations and may be subject to additional actions in the future. As disclosed in the Company’s amended and restated Annual Report on Form 10-K for fiscal 2008, we announced on November 10, 2009, that our Audit Committee, with the assistance of outside counsel, had commenced a review of customer margin support provided by the Company and an investigation into undisclosed margin support commitments and related matters. The Company self-reported information concerning this investigation to the SEC in the fourth quarter of fiscal 2009 and has also been informed that the United States Attorney’s Office is conducting an investigation into this matter. In December 2010, the Company and the SEC entered into a non-prosecution agreement pursuant to which the SEC agreed not to charge the Company with any violations of the federal securities laws, commence any enforcement action against the Company, or require the Company to pay any financial penalties in connection with the SEC’s investigation of customer margin support provided by the Company, conditioned upon the Company’s continued cooperation with the SEC’s investigation and with any related enforcement proceedings. The Company has incurred, and expects to continue to incur, substantial expenses for legal and accounting services due to the SEC and United States Attorney’s Office investigations and any resulting litigation. These matters have diverted in the past, and may continue to divert in the future, management’s time and attention away from operations and cause the Company to continue to incur substantial costs. The Company also may bear additional costs to the extent it is required, under the terms of organizational documents or under Delaware law, to indemnify former officers of the Company in respect of costs they incur in connection with any proceedings related to these matters. At this point, the Company is unable to predict the duration, costs, scope or result of these matters.
As described in more detail in Part I - Item 3 of this filing, the Company is also currently subject to two class action lawsuits and a derivative shareholder action lawsuit, as well as various other claims and pending or threatened lawsuits in the normal course of our business. We have only limited amounts of insurance, which may not provide coverage to offset a negative judgment or a settlement payment, which could be substantial. We may be unable to obtain additional insurance in the future, or we may be unable to do so on favorable terms. Our insurers may also dispute our claims for coverage. Further, these lawsuits may result in diversion of management's time and attention, the expenditure of large amounts of cash on legal fees and other expenses, and injury to our reputation, all of which may adversely affect our operations and financial condition.
The Company’s databases containing 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 banks and payment 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 payment card industry, we may be subject to fines, restrictions, and expulsion from card acceptance programs, which could adversely affect our retail operations.
Increased production costs and deflationary pressures on our selling prices may adversely affect our results.
The Company’s product costs, driven by inflation in significant component costs such as cotton, polyester, labor, and transportation, have increased and are expected to continue to increase for the foreseeable future. Our product costs have also been adversely impacted by the devaluation of the U.S. dollar relative to foreign currencies. These inflationary and currency risk factors have begun to result in higher costs of goods sold and inventory levels. Although we plan to raise our selling prices on some of our products, we do not expect in the near term to be able to fully absorb these cost increases and our profitability will be adversely impacted. In recent years, the Company has also experienced deflationary pressure on its selling prices, in part driven by intense price competition in the young children’s apparel industry. In this environment there is a risk that customers will not accept our price increases. If the Company is unable to effectively raise selling prices to help offset higher production costs, the adverse effect on our profitability may be even greater than anticipated.
Our business is sensitive to overall levels of consumer spending, particularly in the young children’s apparel segment.
Consumers’ demand for young children’s apparel, specifically brand name apparel products, is impacted by the overall level of consumer spending. Discretionary consumer spending is impacted by employment levels, gasoline and utility costs, business conditions, availability of consumer credit, tax rates, interest rates, levels of consumer indebtedness, and overall levels of consumer confidence. Recent and further reductions in the level of discretionary spending may have a material adverse effect 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, unfavorable economic conditions, 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 Asia, coordinated by our sourcing 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:
· financial instability of one or more of our major vendors;
· political instability or other international events resulting in the disruption of trade in foreign countries from which we source our products;
· increases in transportation costs as a result of increased fuel prices or significant changes in the relationship between carrier capacity and shipper demand;
· interruptions in the supply, or increases in the cost of raw materials, including cotton, fabric, and trim items;
· significant changes in the cost of labor in our sourcing locations;
· the imposition of new regulations relating to imports, duties, taxes, and other charges on imports;
· 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 the 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 application of foreign intellectual property laws;
· the ability of our vendors to secure sufficient credit to finance the manufacturing process including the acquisition of raw materials; and
· exchange rate fluctuations between the United States dollar and the local currencies of foreign contractors.
These and other events beyond our control could interrupt our supply chain and delay receipt of our products into the United States.
We source all of our products through a network of vendors. We have limited control over these vendors and we may experience delays, product recalls or loss of revenues if our products do not meet our quality standards or regulatory requirements.
Our vendors, independent manufacturers, and licensees may not continue to provide products that are consistent with our standards. We have occasionally received, and may in the future continue to receive, shipments of product that fail to conform to our quality control standards. A failure in our quality control program may result in diminished product quality, which may result in increased order cancellations and returns, decreased consumer demand for our products, or product recalls, any of which may have a material adverse affect on our results of operations and financial condition. In addition, notwithstanding our strict quality control procedures, because we do not control our vendors, products that fail to meet our standards, or other unauthorized products, could end up in the marketplace without our knowledge. This could materially harm our brand and our reputation in the marketplace.
Our products are subject to regulation of and regulatory standards set by various governmental authorities including the Consumer Product Safety Commission, with respect to quality and safety. Regulations and standards in this area are currently in place. These regulations and standards may change from time to time. Our inability, or that of our vendors, to comply on a timely basis with regulatory requirements could result in significant fines or penalties, which could adversely affect our reputation and sales. Issues with the quality and safety of merchandise we sell in our stores, regardless of our culpability, or customer concerns about such issues, could result in damage to our reputation, lost sales, uninsured product liability claims or losses, merchandise recalls, and increased costs.
The loss of a sourcing agent could negatively impact our ability to timely deliver our inventory supply and disrupt our business, which may adversely affect our operating results.
One sourcing agent manages approximately 90% of our inventory purchases. Although we believe that other buying agents could be retained, the loss of this buying agent could delay our ability to timely receive inventory supply and disrupt our business, which could result in a material adverse effect on our operating results.
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 revenue 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, 77kids, 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 brand stores do not maintain a sufficient customer base that provides a reasonable sales volume or the Company is unable to negotiate appropriate lease terms for the retail stores, there could be a material adverse impact on the Company’s sales, gross margin, and results of operations.
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.
As of January 1, 2011, the Company had Carter’s goodwill of $136.6 million, a $220.2 million Carter’s brand tradename asset, and an $85.5 million OshKosh brand tradename asset on its consolidated balance sheet. 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. 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.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2. PROPERTIES
As of January 1, 2011, we operated 486 leased retail stores located primarily in outlet and strip centers across the United States, having an average size of approximately 4,600 square feet. Generally, the majority of our leases have an average term of ten years.
Aggregate lease commitments as of January 1, 2011 for the above leased properties are as follows: fiscal 2011-$66.0 million; fiscal 2012-$60.2 million; fiscal 2013-$55.5 million; fiscal 2014-$48.2 million; fiscal 2015-$35.9 million, and $111.6 million for the balance of these commitments beyond fiscal 2015.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
A shareholder class action lawsuit was filed on September 19, 2008 in the United States District Court for the Northern District of Georgia entitled Plymouth County Retirement System v. Carter’s, Inc., No. 1:08-CV-02940-JOF (the “Plymouth Action”). The Amended Complaint filed on May 12, 2009 in the Plymouth Action asserted claims under Sections 10(b), 20(a), and 20A of the 1934 Securities Exchange Act, and alleged that between February 1, 2006 and July 24, 2007, the Company and certain current and former executives made misrepresentations to investors regarding the successful integration of OshKosh into the Company’s business, and that the share price of the Company’s stock later fell when the market learned that the integration had not been as successful as represented. Defendants in the Plymouth Action filed a motion to dismiss the Amended Complaint for failure to state a claim under the federal securities laws on July 17, 2009, and briefing of that motion was complete on October 22, 2009.
A separate shareholder class action lawsuit was filed on November 17, 2009 in the United States District Court for the Northern District of Georgia entitled Mylroie v. Carter’s, Inc., No. 1:09-CV-3196-JOF (the “Mylroie Action”). The initial Complaint in the Mylroie Action asserted claims under Sections 10(b) and 20(a) of the 1934 Securities Exchange Act, and alleged that between April 27, 2004 and November 10, 2009, the Company and certain current and former executives made misstatements to investors regarding the Company’s accounting for discounts offered to some wholesale customers. The Court consolidated the Plymouth Action and the Mylroie Action on November 24, 2009 (the “Consolidated Action”). On March 15, 2010, the plaintiffs in the Consolidated Action filed their amended and consolidated complaint. The Company filed a motion to dismiss on April 30, 2010, and briefing of the motion was complete on July 23, 2010. The parties are awaiting an oral argument date and/or a decision from the Court. The Company intends to vigorously defend against the claims in the Consolidated Action.
A shareholder derivative lawsuit was filed on May 25, 2010 in the Superior Court of Fulton County, Georgia, entitled Alvarado v. Bloom, No. 2010-cv-186118 (the “Alvarado Action”). The Complaint in the Alvarado Action alleges, among other things, that certain current and former directors and executives of the Company breached their fiduciary duties to the Company in connection with the Company’s accounting for discounts offered to some wholesale customers. The Company is named solely as a nominal defendant against whom the plaintiff seeks no recovery. Pursuant to a series of stipulations among the parties, the Court has temporarily deferred the defendants’ obligation to respond to the Complaint pending timely resolution of the motions to dismiss filed in the Consolidated Action referenced above.
The Company is subject to various other claims and pending or threatened lawsuits in the normal course of our business. The Company is not currently party to any other legal proceedings that it believes would have a material adverse effect on its financial position, results of operations or cash flows.
ITEM 4.
ITEM 4. REMOVED AND RESERVED
Not applicable
PART II
ITEM 5.
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 25, 2011 was $29.13. On that date there were approximately 33,257 holders of record of our common stock.
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:
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 2010 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
(1)
Represents repurchased shares which were retired.
(2)
On February 16, 2007, our Board of Directors approved a share repurchase authorization, pursuant to which the Company was authorized to purchase up to $100 million of its outstanding common shares. This program was announced in the Company’s report on Form 8-K, which was filed on February 21, 2007. As of August 13, 2010, the Company had repurchased outstanding shares in the amount totaling the entire $100 million authorized by the Board of Directors on February 16, 2007. On June 15, 2010, the Company’s Board of Directors approved another share repurchase authorization, pursuant to which the Company is authorized to purchase up to an additional $100 million of its outstanding common shares. This program was announced in the Company’s report on Form 8-K, which was filed on July 29, 2010. Repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise. The timing and amount of any repurchases will be determined by the Company’s management, based on its evaluation of market conditions, share price, other investment priorities, and other factors. The total remaining capacity under this authorization was approximately $58.9 million as of January 1, 2011. This authorization has no expiration date.
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 unless TWCC and its consolidated subsidiaries meet certain leverage ratio and minimum availability requirements under the credit facility, 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
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and other data as of and for the five fiscal years ended January 1, 2011 (fiscal 2010).
On June 6, 2006, the Company affected 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. Earnings per share for fiscal 2006 has been adjusted to reflect the stock split.
On October 15, 2010, the Company entered into a new $375 million ($130 million sub-limit for letters of credit and a swing line sub-limit of $40 million) revolving credit facility with Bank of America as sole lead arranger and administrative agent, JP Morgan Chase Bank as syndication agent, and other financial institutions. The new revolving credit facility was immediately drawn upon to pay off the Company’s former term loan of $232.2 million and pay transaction fees and expenses of $3.8 million, leaving approximately $130 million available under the revolver for future borrowings (net of letters of credit of approximately $8.6 million). In connection with the repayment of the Company’s former term loan, in the fourth quarter of fiscal 2010 the Company wrote off approximately $1.2 million in unamortized debt issuance costs. In addition, in connection with the new revolving credit facility, the Company recorded $3.5 million of debt issuance costs to be amortized over the term of the new revolving credit facility (five years).
The selected financial data for the five fiscal years ended January 1, 2011 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 2010 ended on January 1, 2011, fiscal 2009 ended on January 2, 2010, fiscal 2008 ended on January 3, 2009, fiscal 2007 ended on December 29, 2007, and fiscal 2006 ended on December 30, 2006. Fiscal 2010, fiscal 2009, fiscal 2007, and fiscal 2006 each contained 52 weeks of financial results. Fiscal 2008 contained 53 weeks of financial results.
The following table should be read in conjunction with Item 7
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 145 years, Carter’s has been one of the most recognized and trusted brand names in the children’s apparel industry. We also own the OshKosh B’gosh brand, which has over 110 years and also earned the position of a highly trusted and well-known brand.
We sell our products under our Carter’s and OshKosh brands in the wholesale channel, which includes over 340 department store, national chain, specialty store, and discount retailer accounts. We also sell our products in the mass channel under our Child of Mine brand to over 3,600 Walmart stores nationwide and under our Just One You brand to over 1,800 Target stores. Additionally, as of January 1, 2011, we operated 306 Carter’s and 180 OshKosh retail stores located primarily in outlet and strip centers throughout the United States. In March 2010, we launched our eCommerce business. We also extend our brand reach by licensing our Carter’s, Child of Mine, Just One You, 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 and Carter’s brand names are also licensed through international licensing arrangements. During fiscal 2010, we earned approximately $37.6 million in royalty income from these arrangements.
We source substantially all of our products through a network of vendors primarily in Asia. Various sourcing agents coordinate this process, with one sourcing agent managing approximately 90% of our inventory purchases. Our product costs, driven by inflation in significant component costs such as cotton, polyester, labor, and transportation have increased and are expected to continue to increase for the foreseeable future. These cost increases have begun to result in higher cost of goods sold and inventory levels. Although we plan to raise our selling prices on some of our products, we do not expect in the near term to be able to fully absorb these cost increases and our profitability will be adversely impacted. If the Company is unable to effectively raise selling prices to help offset higher production costs, the adverse effect on our profitability may be greater than anticipated.
In connection with the acquisition of OshKosh, we acquired certain definite-lived intangible assets comprised of licensing agreements and leasehold interests which resulted in annual amortization expense of $1.8 million in fiscal 2010; $3.7 million in fiscal 2009; and $4.1 million in fiscal 2008.
On October 15, 2010, the Company entered into a new $375 million ($130 million sub-limit for letters of credit and a swing line sub-limit of $40 million) revolving credit facility with Bank of America as sole lead arranger and administrative agent, JP Morgan Chase Bank as syndication agent, and other financial institutions. The new revolving credit facility was immediately drawn upon to pay off the Company’s former term loan of $232.2 million and pay transaction fees and expenses of $3.8 million, leaving approximately $130 million available under the revolver for future borrowings (net of letters of credit of approximately $8.6 million). In connection with the repayment of the Company’s former term loan, in the fourth quarter of fiscal 2010 the Company wrote off approximately $1.2 million in unamortized debt issuance costs. In addition, in connection with the new revolving credit facility, the Company recorded $3.5 million of debt issuance costs to be amortized over the term of the new revolving credit facility (five years).
During fiscal 2007, the Company’s Board of Directors approved a share repurchase authorization, pursuant to which the Company was authorized to purchase up to $100 million of its outstanding common shares. During fiscal 2010, the Company’s Board of Directors approved a share repurchase authorization, pursuant to which the Company is authorized to purchase up to an additional $100 million of its outstanding common shares. As of August 13, 2010, the Company had repurchased outstanding shares in the amount totaling the entire $100 million authorized by the Board of Directors on February 16, 2007. The timing and amount of any future share repurchases will be determined by the Company’s management, based upon its evaluation of market conditions, share price, other investment priorities, and other factors. During fiscal 2010, the Company repurchased and retired 2,058,830 shares, or approximately $50.0 million, of its common stock at an average price of $24.29 per share. Since inception of the repurchase program and through fiscal 2010, the Company repurchased and retired 6,658,410 shares, or approximately $141.1 million, of its common stock at an average price of $21.19 per share. The total remaining capacity under this authorization was approximately $58.9 million as of January 1, 2011. This authorization has no expiration date.
Our fiscal year ends on the Saturday, in December or January, nearest the last day of December. Consistent with this policy, fiscal 2010 ended on January 1, 2011, fiscal 2009 ended on January 2, 2010, and fiscal 2008 ended on January 3, 2009. Fiscal 2010 and 2009 each contained 52 weeks of financial results while fiscal 2008 contained 53 weeks.
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 YEAR ENDED JANUARY 1, 2011 COMPARED WITH FISCAL YEAR ENDED JANUARY 2, 2010
CONSOLIDATED NET SALES
Consolidated net sales for fiscal 2010 were $1.7 billion, an increase of $159.6 million, or 10.0%, compared to $1.6 billion in fiscal 2009 and reflects growth in all of our segments.
CARTER’S WHOLESALE SALES
Carter’s brand wholesale sales increased $80.3 million, or 15.4%, in fiscal 2010 to $601.6 million. The increase in Carter’s brand wholesale sales was driven by a 14% increase in units shipped and a 1% increase in average price per unit, as compared to fiscal 2009. The increase in units shipped was primarily driven by strong over-the-counter performance at our wholesale customers, and the increase in average price per unit primarily reflects higher average selling prices on off-price sales.
OSHKOSH WHOLESALE SALES
OshKosh brand wholesale sales increased $1.2 million, or 1.5%, in fiscal 2010 to $81.7 million. The increase in OshKosh brand wholesale sales was driven by a 3% increase in units shipped, partially offset by a 1% decrease in average price per unit, as compared to fiscal 2009. The increase in units shipped was primarily driven by over-the-counter performance at our wholesale customers. The decrease in average price per unit primarily reflects lower average selling prices on wholesale sales.
CARTER’S RETAIL STORES
Carter’s retail stores sales increased $56.5 million, or 11.5%, in fiscal 2010 to $546.2 million. The increase was driven by incremental sales of $45.3 million generated by new store openings and eCommerce sales, and a comparable store sales increase of $11.9 million, or 2.5% (based on 271 locations), partially offset by the impact of store closures of $0.7 million. During fiscal 2010, on a comparable store basis, units per transaction increased 2.8%, average transaction value increased 2.2%, and average prices decreased 0.6% as compared to fiscal 2009. We attribute the increases in units per transaction and average transaction value to strong product performance in our playwear product category, improved in-store product presentation, and increased merchandising and marketing efforts. The decrease in average prices resulted from increased promotional activity given the current competitive environment.
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 306 Carter’s retail stores open as of January 1, 2011. During fiscal 2010, we opened 30 Carter’s retail stores. We plan to open approximately 55 and close four Carter’s retail stores during fiscal 2011.
OSHKOSH RETAIL STORES
OshKosh retail store sales increased $7.6 million, or 3.0%, in fiscal 2010 to $264.9 million. The increase was due to incremental sales of $13.7 million generated by new store openings and eCommerce sales, partially offset by the impact of a comparable store sales decline of $4.8 million, or 1.9% (based on 162 locations), and store closures of $1.2 million. On a comparable store basis, units per transaction increased 2.6%, transactions decreased 1.9%, and average prices decreased 2.6%. We attribute the increase in units per transaction to strong in-store product presentation and direct-to-consumer marketing efforts, partially offset by a decrease in transactions attributable to reduced traffic at our stores. The decrease in average prices resulted from increased promotional activity given the current competitive environment.
There were a total of 180 OshKosh retail stores open as of January 1, 2011. During fiscal 2010, we opened 12 OshKosh retail stores and closed two. We plan to open approximately four and close three OshKosh retail stores during fiscal 2011.
MASS CHANNEL SALES
Mass channel sales increased $14.0 million, or 5.8%, in fiscal 2010 to $254.8 million. The increase was due to increased sales of $22.9 million, or 19.1%, of our Just One You and Precious Firsts brands to Target, partially offset by an $8.9 million, or 7.3%, decrease in sales of our Child of Mine brand to Walmart. The increase in Just One You brand sales was largely driven by the addition of new programs and improved product performance. The decrease in Child of Mine brand sales resulted from merchandising assortment changes made by Walmart and a related reduction in floor space during the first nine months of the year.
GROSS PROFIT
Our gross profit increased $69.5 million, or 11.5%, to $673.9 million in fiscal 2010. Gross margin increased 50 basis points from 38.0% in fiscal 2009 to 38.5% in fiscal 2010.
The increase in gross margin as a percentage of net sales reflects:
(i) $18.6 million of higher consolidated retail and eCommerce gross margins driven by new store and comp store sales growth; and
(ii) $4.2 million related to growth in Carter’s wholesale margins due to increased volume and improved product performance, partially offset by
higher product costs, air freight and excess inventory charges.
Partially offsetting these increases were:
(i) $5.9 million related to the mass channel segment resulting from higher air freight and excess inventory charges, and the absence of a vendor
recovery that occured in fiscal 2009; and
(ii) $4.7 million related to the OshKosh wholesale segment, reflecting higher levels of customer support, air freight, and excess inventory charges.
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.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses in fiscal 2010 increased $39.5 million, or 9.2%, to $468.2 million. As a percentage of net sales, selling, general, and administrative expenses was 26.8% in fiscal 2010 as compared to 27.0% in fiscal 2009.
The decrease in selling, general, and administrative expenses as a percentage of net sales reflects:
(i) controlling growth in spending to a lower rate than growth in net sales for fiscal 2010;
(ii) $1.9 million reduction in amortization expense; and
(iii) $1.0 million in accelerated depreciation related to a facility closure.
Partially offsetting these decreases were:
(i) $22.9 million, or 10.2%, increase in consolidated retail expenses primarily due to new store growth; and
(ii) $8.7 million of incremental expenses associated with eCommerce.
INVESTIGATION EXPENSES
In connection with the investigation of customer margin support, the Company recorded pre-tax charges in the fourth quarter of fiscal 2009 of approximately $5.7 million related to professional service fees.
WORKFORCE REDUCTION, FACILITY WRITE-DOWN, AND CLOSURE COSTS
During fiscal 2009, as a result of the corporate workforce reduction, the Company recorded charges of $6.7 million consisting of $5.5 million in severance charges and other benefits, and approximately $1.2 million in asset impairment charges net of a gain on the closure and sale of our Oshkosh, Wisconsin office.
In conjunction with the plan to close the Barnesville, Georgia distribution facility, the Company recorded closure costs of approximately $4.3 million during fiscal 2009, consisting of severance and other benefits of $1.7 million, asset impairment charges of $1.1 million related to the write-down of the related land, building, and equipment, $1.0 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.5 million of other closure costs.
During fiscal 2009, the Company also wrote down the carrying value of its White House, Tennessee distribution facility by approximately $0.7 million to $2.8 million to reflect the decrease in the fair market value of the facility at that time. During the third quarter of fiscal 2009, the Company sold this facility for net proceeds of approximately $2.8 million.
ROYALTY INCOME
Our royalty income increased $1.2 million, or 3.2%, to $37.6 million in fiscal 2010.
We license the use of our Carter’s, Just One You, and Child of Mine brands. Domestic royalty income from these brands was approximately $18.4 million, a decrease of 0.5%, or $0.1 million, as compared to fiscal 2009 due to increased sales by our Carter’s brand and Just One You brand licensees, partially offset by decreased sales from our Child of Mine brand licensees. The Carter’s brand internationally generated $1.9 million in royalty income in fiscal 2010 as compared to $0.7 million in fiscal 2009.
We also license the use of our OshKosh B’gosh, OshKosh, and Genuine Kids from OshKosh brands. Royalty income from these brands increased approximately $0.1 million, or 0.6%, to $17.3 million in fiscal 2010. This increase was driven by increased sales by our OshKosh brand domestic licensees. The OshKosh brand internationally generated $7.5 million in royalty income in fiscal 2010 as compared to $7.9 million in fiscal 2009.
OPERATING INCOME
Our operating income increased $47.6 million, or 24.4%, to $243.3 million in fiscal 2010. This increase in operating income is attributable to the factors described above.
INTEREST EXPENSE, NET
Interest expense, net, in fiscal 2010 decreased $1.9 million, or 16.2%, to $9.9 million. This decrease is attributable to $53.4 million in lower weighted-average borrowings. In fiscal 2010, weighted-average borrowings were $283.3 million at an effective interest rate of 3.72% as compared to weighted-average borrowings of $336.7 million at an effective interest rate of 3.57% in fiscal 2009. In fiscal 2010, we recorded $1.7 million in interest expense related to our interest rate swap agreements. In fiscal 2009, we recorded $2.5 million in interest expense related to our interest rate swap agreements and $0.5 million in interest expense related to our interest rate collar agreement.
INCOME TAXES
Our effective tax rate was approximately 37.2% in fiscal 2010 as compared to approximately 37.1% in fiscal 2009. The effective tax rate in both years was reduced by the reversal of reserves for uncertain tax positions.
NET INCOME
As a result of the factors described above, our net income for fiscal 2010 increased $30.8 million, or 26.7%, to $146.5 million as compared to $115.6 million in fiscal 2009.
FISCAL YEAR ENDED JANUARY 2, 2010 COMPARED WITH FISCAL YEAR ENDED JANUARY 3, 2009
CONSOLIDATED NET SALES
Consolidated net sales for fiscal 2009 were $1.6 billion, an increase of $95.2 million, or 6.4%, compared to $1.5 billion in fiscal 2008. This increase reflects growth in our Carter’s brand and OshKosh brand wholesale and retail store segments.
CARTER’S WHOLESALE SALES
Carter’s brand wholesale sales increased $32.7 million, or 6.7%, in fiscal 2009 to $521.3 million. The increase in Carter’s brand wholesale sales was driven by a 4% increase in units shipped and a 2% increase in average price per unit, as compared to fiscal 2008. The growth in units shipped was primarily driven by strong over-the-counter performance at our wholesale customers. The increase in average price per unit was due to more competitive pricing in certain product categories, particularly to our off-price customers.
OSHKOSH WHOLESALE SALES
OshKosh brand wholesale sales increased $0.5 million, or 0.6%, in fiscal 2009 to $80.5 million. The increase in OshKosh brand wholesale sales was driven by a 3% increase in average price per unit, partially offset by a 3% decrease in units shipped, as compared to fiscal 2008. The increase in average price per unit reflects higher average selling prices on off-price sales as compared to fiscal 2008. The decrease in units shipped relate primarily to a reduction in off-price shipments.
CARTER’S RETAIL STORES
Carter’s retail stores sales increased $67.3 million, or 15.9%, in fiscal 2009 to $489.7 million. The increase was driven by a comparable store sales increase of $26.5 million, or 6.4% (based on 240 locations), and incremental sales of $46.3 million generated by new store openings, partially offset by the impact of an additional week in fiscal 2008 of $5.2 million and store closures of $0.1 million. During fiscal 2009, on a comparable store basis, transactions increased 3.7%, units per transaction increased 2.8%, and average prices decreased 0.2% as compared to fiscal 2008. The increases in transactions and units per transaction were driven by strong product performance in all product categories, changes in our merchandising strategies which include a higher mix of opening price point items (high-volume, entry level basic products), a better assortment of in-season merchandise on the floor, in-store product presentation, and direct to consumer marketing efforts.
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 276 Carter’s retail stores open as of January 2, 2010. During fiscal 2009, we opened 24 stores and closed one store.
OSHKOSH RETAIL STORES
OshKosh retail store sales increased $8.2 million, or 3.3%, in fiscal 2009 to $257.3 million. The increase was due to incremental sales of $6.9 million generated by new store openings and a comparable store sales increase of $4.7 million, or 1.9% (based on 161 locations), partially offset by the impact of an additional week in fiscal 2008 of $2.6 million and store closings of $1.0 million. On a comparable store basis, transactions increased 1.9%, units per transaction increased 2.1%, and average prices decreased 2.1%.
We attribute the increases in transactions and units per transaction to strong product performance in most product categories, changes in our merchandising strategies which include a higher mix of opening price point items (high-volume, entry level basic products), a better assortment of in-season merchandise on the floor, in-store product presentation, and direct to consumer marketing efforts. The decrease in average prices during fiscal 2009 were due to increased promotional activity and a greater mix of opening price point items such as t-shirts and knit pants.
There were a total of 170 OshKosh retail stores open as of January 2, 2010. During fiscal 2009, we opened six stores and closed one store.
MASS CHANNEL SALES
Mass channel sales decreased $13.5 million, or 5.3%, in fiscal 2009 to $240.8 million. The decrease was due to decreased sales of $22.2 million, or 15.5%, of our Child of Mine brand to Walmart partially offset by an $8.7 million, or 7.9%, increase in sales of our Just One Year brand to Target. The decrease in Child of Mine brand sales resulted from merchandising assortment changes made by Walmart and a related reduction in floor space. The timing of product shipments also contributed to the decline in Child of Mine sales in fiscal 2009. The increase in Just One Year brand sales was driven largely by improved product performance and the addition of new programs.
GROSS PROFIT
Our gross profit increased $85.8 million, or 16.6%, to $604.4 million in fiscal 2009. Gross profit as a percentage of net sales was 38.0% in fiscal 2009 as compared to 34.7% in fiscal 2008.
The increase in gross profit as a percentage of net sales reflects:
(i) $18.2 million related to lower levels of excess and obsolete inventory charges, more favorable loss rates on off-price sales, and improved
inventory management;
(ii) $17.9 million related to higher consolidated retail gross margins as a percentage of consolidated retail sales; and
(iii) $12.4 million related to a greater mix of consolidated retail sales which, on average, have a higher gross margin than sales in our wholesale and
mass channel segments.
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.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses in fiscal 2009 increased $24.4 million, or 6.0%, to $428.7 million. As a percentage of net sales, selling, general, and administrative expenses in fiscal 2009 and 2008 were 27.0%.
The changes in selling, general, and administrative expenses as a percentage of net sales reflects:
(i) $13.6 million in higher provisions for bonuses and incentive compensation; and
(ii) $14.0 million, or 7.7%, increase in consolidated retail store expenses. This increase is due primarily to new store growth.
Partially offsetting these increases were:
(i) a decline in distribution costs as a percentage of sales from 3.7% in fiscal 2008 to 3.3% in fiscal 2009 resulting from supply chain efficiencies and
the closure of our Barnesville, Georgia distribution facility; and
(ii) reduced discretionary spending and increased overall focus on our corporate cost structure.
INVESTIGATION EXPENSES
In connection with the investigation of customer margin support, the Company recorded pre-tax charges in the fourth quarter of fiscal 2009 of approximately $5.7 million related to professional service fees.
EXECUTIVE RETIREMENT CHARGES
In fiscal 2008, the Company announced the retirement of an executive officer. In connection with this retirement, the Company recorded charges during fiscal 2008 of $5.3 million, $3.1 million of which related to the present value of severance and benefit obligations, and $2.2 million of which related to the accelerated vesting of stock options.
WORKFORCE REDUCTION, FACILITY WRITE-DOWN, AND CLOSURE COSTS
As a result of the corporate workforce reduction announced in the first quarter of fiscal 2009, we recorded charges of $6.7 million consisting of $5.5 million in severance charges and other benefits, and approximately $1.2 million in asset impairment charges net of a gain on the closure and sale of our Oshkosh, Wisconsin office during fiscal 2009.
In conjunction with the plan to close the Barnesville, Georgia distribution facility, the Company recorded closure costs of approximately $4.3 million during fiscal 2009, consisting of severance and other benefits of $1.7 million, asset impairment charges of $1.1 million related to the write-down of the related land, building, and equipment, $1.0 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.5 million of other closure costs.
During fiscal 2009, the Company wrote down the carrying value of its White House, Tennessee distribution facility by approximately $0.7 million to $2.8 million to reflect the decrease in the fair market value. During the third quarter of fiscal 2009, the Company sold this facility for net proceeds of approximately $2.8 million.
In fiscal 2008, the Company wrote down the carrying value of the White House, Tennessee distribution facility by approximately $2.6 million to $3.5 million to reflect the anticipated selling price of the property at that time.
ROYALTY INCOME
Our royalty income increased $2.7 million, or 8.1%, to $36.4 million in fiscal 2009.
We license the use of our Carter’s, Just One Year, and Child of Mine brands. Royalty income from these brands was approximately $19.2 million, an increase of 12.8%, or $2.2 million, as compared to fiscal 2008 due to increased sales by our Carter’s brand and Child of Mine brand licensees. The Carter’s brand internationally generated $0.7 million in royalty income in fiscal 2009 as compared to $0.3 million in fiscal 2008.
We also license the use of our OshKosh B’gosh, OshKosh, and Genuine Kids from OshKosh brand names. Royalty income from these brands increased approximately $0.6 million, or 3.3%, to $17.2 million in fiscal 2009. This increase was driven by increased sales by our OshKosh brand international licensees, which generated $7.9 million in royalty income in fiscal 2009 as compared to $7.1 million in fiscal 2008, partially offset by lower domestic licensing income.
OPERATING INCOME
Our operating income increased $55.6 million, or 39.7%, to $195.6 million in fiscal 2009. This increase in operating income was due to the factors described above.
INTEREST EXPENSE, NET
Interest expense, net, in fiscal 2009 decreased $6.3 million, or 34.8%, to $11.8 million. This decrease is attributable to a lower effective interest rate on lower weighted-average borrowings. In fiscal 2009, weighted-average borrowings were $336.7 million at an effective interest rate of 3.57% as compared to weighted-average borrowings of $340.2 million at an effective interest rate of 5.75% in fiscal 2008. In fiscal 2009, we recorded $2.5 million in interest expense related to our interest rate swap agreements and $0.5 million in interest expense related to our interest rate collar agreement. In fiscal 2008, we recorded $1.1 million in interest expense related to our interest rate swap agreement and $1.2 million in interest expense related to our interest rate collar agreement.
INCOME TAXES
Our effective tax rate was approximately 37.1% in fiscal 2009 as compared to approximately 36.1% in fiscal 2008. This change was a result of the reversal of $1.5 million of uncertain tax positions related to the completion of an Internal Revenue Service examination for fiscal 2006 and 2007 and the closing of the statute of limitations recorded in fiscal 2009 as compared to the reversal of $1.9 million of uncertain tax positions related to the completion of an Internal Revenue Service examination for fiscal 2004 and 2005 and the closing of the statute of limitations recorded in fiscal 2008.
NET INCOME
As a result of the factors described above, our net income for fiscal 2009 increased $37.7 million, or 48.4%, to $115.6 million as compared to $77.9 million in fiscal 2008.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash needs are working capital and capital expenditures. Our primary source of liquidity will continue to be cash and cash equivalents on hand, cash flow from operations, and borrowings under our revolving credit facility, 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 events described in our risk factors, as further discussed in Item 1A of this filing.
Net accounts receivable at January 1, 2011 were $121.5 million compared to $82.1 million at January 2, 2010 and reflects higher levels of wholesale and mass channel sales in the latter part of fiscal 2010 as compared to the latter part of fiscal 2009.
Net inventories at January 1, 2011 were $298.5 million compared to $214.0 million at January 2, 2010. This increase primarily reflects growth in all of our businesses, increased product costs, and longer lead times.
Net cash provided by operating activities for fiscal 2010 was $85.8 million compared to $188.9 million in fiscal 2009. The decrease in operating cash flow primarily reflects changes in net working capital, partially offset by increased earnings. Net cash provided by our operating activities in fiscal 2008 was approximately $181.0 million.
We invested approximately $39.8 million in capital expenditures during fiscal 2010, $33.6 million in fiscal 2009, and $34.9 million in fiscal 2008. Major investments included retail store openings and remodelings, fixtures for our wholesale customers, and investments in information technology. We plan to invest approximately $50 million in capital expenditures in fiscal 2011 primarily for retail store openings and remodelings and investments in information technology.
Product costs can vary depending on the underlying cost of raw materials, such as cotton and polyester, and the level of labor and transportation costs. A substantial portion of the Company’s products utilize cotton based fabrics, the cost of which has recently reached historically high levels. Additionally, labor costs have increased across Asia, particularly in China, where the Company currently sources more than 50% of its products. Furthermore, transportation costs to bring product to the United States have risen due to higher fuel costs and limited capacity in the marketplace. The Company purchases finished goods largely from foreign suppliers and pays its suppliers in U.S. currency. Consequently, the Company’s product costs have been adversely impacted by the devaluation of the U.S. dollar relative to foreign currencies. These inflationary and currency risk factors have begun to result in higher costs of goods sold and inventory levels, and have adversely impacted our profitability and cash flows from operations. We expect that higher product costs will continue to adversely impact our profitability and cash flow through at least fiscal 2011.
On February 16, 2007, the Company’s Board of Directors approved a share repurchase authorization, pursuant to which the Company was authorized to purchase up to $100 million of its outstanding common shares. On June 15, 2010, the Company’s Board of Directors approved a new share repurchase authorization, pursuant to which the Company is authorized to purchase up to an additional $100 million of its outstanding common shares. As of August 13, 2010, the Company had repurchased outstanding shares in the amount totaling the entire $100 million authorized by the Board of Directors on February 16, 2007.
During fiscal 2010, the Company repurchased and retired 2,058,830 shares, or approximately $50.0 million, of its common stock at an average price of $24.29 per share. Since inception of the authorization and through fiscal 2010, the Company repurchased and retired 6,658,410 shares, or approximately $141.1 million, of its common stock at an average price of $21.19 per share. We have reduced common stock by the par value of such shares repurchased and have deducted the remaining excess repurchase price over par value from additional paid-in capital. Future repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise. The timing and amount of any repurchases will be determined by the Company’s management, based on its evaluation of market conditions, share price, other investment priorities, and other factors. The total remaining capacity under this authorization was approximately $58.9 million as of January 1, 2011. This authorization has no expiration date.
On October 15, 2010, the Company entered into a new $375 million ($130 million sub-limit for letters of credit and a swing line sub-limit of $40 million) revolving credit facility with Bank of America as sole lead arranger and administrative agent, JP Morgan Chase Bank as syndication agent, and other financial institutions. The new revolving credit facility was immediately drawn upon to pay off the Company’s former term loan of $232.2 million and pay transaction fees and expenses of $3.8 million, leaving approximately $130 million available under the revolver for future borrowings (net of letters of credit of approximately $8.6 million). In connection with the repayment of the Company’s former term loan, in the fourth quarter of fiscal 2010 the Company wrote off approximately $1.2 million in unamortized debt issuance costs. In addition, in connection with the new revolving credit facility, the Company recorded $3.5 million of debt issuance costs to be amortized over the term of the new revolving credit facility (five years).
The term of the new revolving credit facility expires October 15, 2015. This revolving credit facility provides for two pricing options for revolving loans: (i) revolving loans on which interest is payable quarterly at a base rate equal to the highest of (x) the Federal Funds Rate plus ½ of 1%, (y) the rate of interest in effect for such day as publicly announced from time to time by Bank of America, N.A. as its prime rate, or (z) the Eurodollar Rate plus 1%, plus, in each case, an applicable margin initially equal to 1.25%, which may be adjusted based upon a leverage-based pricing grid ranging from 1.00% to 1.50% and (ii) revolving loans on which interest accrues for one, two, three, six or if, generally available, nine or twelve month interest periods (but is payable not less frequently than every three months) at a rate of interest per annum equal to an adjusted British Bankers Association LIBOR rate, plus an applicable margin initially equal to 2.25%, which may be adjusted based upon a leverage-based pricing grid ranging from 2.00% to 2.50%. Amounts currently outstanding under the revolving credit facility initially accrue interest at a LIBOR rate plus 2.25%.
The new revolving credit facility contains and defines financial covenants, including a lease adjusted leverage ratio (defined as, with certain adjustments, the ratio of the Company’s consolidated indebtedness plus six times rent expense to consolidated net income before interest, taxes, depreciation, amortization, and rent expense (“EBITDAR”)) to exceed (x) if such period ends on or before December 31, 2014, 3.75:1.00 and (y) if such period ends after December 31, 2014, 3.50:1.00; and consolidated fixed charge coverage ratio (defined as, with certain adjustments, the ratio of consolidated EBITDAR to consolidated fixed charges (defined as interest plus rent expense)), for any such period to be less than 2.75:1.00. As of January 1, 2011, the Company believes it was in compliance with its debt covenants.
At January 1, 2011, we had approximately $236.0 million in revolver borrowings, exclusive of $8.6 million of outstanding letters of credit. At January 2, 2010, we had approximately $334.5 million in former term loan borrowings and no borrowings under our former revolver, exclusive of approximately $8.6 million of outstanding letters of credit. Weighted-average borrowings for fiscal 2010 were $283.3 million at an effective rate of 3.72% as compared to weighted-average borrowings of $336.7 million at an effective rate of 3.57% in fiscal 2009.
Our operating results are subject to risk from interest rate fluctuations on our revolving credit facility, which carries variable interest rates. As of January 1, 2011, our outstanding variable rate debt aggregated approximately $236.0 million. An increase or decrease of 1% in the applicable rate would increase or decrease our annual interest cost by approximately $2.4 million and could have an adverse effect on our earnings and cash flow.
The following table summarizes as of January 1, 2011, the maturity or expiration dates of mandatory contractual obligations and commitments for the following fiscal years:
(a)
Reflects estimated variable rate interest on obligations outstanding on our revolving credit facility as of January 1, 2011 using an interest rate of 2.51% (rate in effect at January 1, 2011).
(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 outlook, we believe that cash generated from operations and available cash, together with amounts available under our revolving credit facility, will be adequate to meet our working capital needs and capital expenditure requirements 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, if any, outstanding under our revolving credit facility on or before October 15, 2015.
EFFECTS OF INFLATION AND DEFLATION; OPERATING COSTS
The Company is subject to both inflationary and deflationary risks. With respect to inflation, the Company is experiencing, and expects to continue to experience for the foreseeable future, increases in the cost of its products, driven by increases in underlying component costs, such as cotton, polyester, labor rates, and transportation costs. The Company’s product costs have also been adversely impacted by the devaluation of the U.S. dollar relative to foreign currencies. These inflationary and currency risk factors have begun to result in higher costs of goods sold and inventory levels. Although we plan to raise our selling prices on some of our products, we do not expect in the near term to be able to fully absorb these cost increases and our profitability will be adversely impacted.
In recent years, the Company has also experienced deflationary pressure on its selling prices, in part driven by intense price competition in the young children’s apparel industry. In this environment there is a risk that customers will not accept our price increases. If the Company is unable to effectively raise selling prices to help offset higher production costs, the adverse effect on our profitability may be even greater than anticipated.
SEASONALITY
We experience seasonal fluctuations in our sales and profitability due to the timing of certain holidays and key retail shopping periods, generally resulting in lower sales and gross profit in the first half of our fiscal year. Our consolidated net sales over the past five fiscal years have typically been generated in the second half of our fiscal year (approximately 57%). Accordingly, our results of operations during the first half of the year may not be indicative of the results we expect for the full year.
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, mass channel, and eCommerce 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 collectability 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 to assist these customers with inventory clearance or promotions. Such amounts are reflected as a reduction of net sales and are recorded based upon agreements with customers, historical trends, and annual forecasts. Retail store revenues are recognized at the point of sale. We reduce revenue for estimated 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 collectability. 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 accounting guidance on consideration given by a vendor to a customer/reseller, we have included the fair value of these arrangements of approximately $4.0 million in fiscal 2010, $3.3 million in fiscal 2009, and $2.5 million in fiscal 2008 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 we project, additional write-downs may be required.
Goodwill and tradename: As of January 1, 2011, we had approximately $136.6 million in Carter’s goodwill and $305.7 million of aggregate value related to the Carter’s and OshKosh tradename assets. The fair value of the Carter’s tradename was estimated using a discounted cash flow analysis at the time of the acquisition of Carter’s, Inc. which was consummated on August 15, 2001. The particular discounted cash flow approach utilized the hypothetical cost savings that accrue as a result of our ownership of the tradename. The fair value of the OshKosh tradename was also estimated at its acquisition date using an identical discounted cash flow analysis. The Carter’s and OshKosh tradenames were determined to have indefinite lives.
The carrying values of the goodwill and tradename assets are subject to annual impairment reviews in accordance with accounting guidance on goodwill and other intangible assets, as of the last day of each fiscal year. Impairment reviews may also be triggered by any significant events or changes in circumstances affecting our business. Factors affecting such impairment reviews include the continued market acceptance of our offered products and the development of new products. We use discounted cash flow models to determine the fair value of these assets, using assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, if the carrying amount exceeds the fair value, an impairment charge is recognized in the amount equal to that excess.
We perform impairment tests of our goodwill at our reporting unit level, which is consistent with our operating segments. The goodwill impairment test consists of a two-step process, if necessary. The first step is to compare the fair value of a reporting unit to its carrying value, including goodwill. We use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe hypothetical marketplace participants would use. If the fair value of a reporting unit is less than its carrying value, the second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill.
A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models, but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with accounting guidance, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our actual cost of capital has changed. Therefore, we may recognize an impairment of an intangible asset or assets even though realized actual cash flows are approximately equal to or greater than our previously forecasted amounts.
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.
Loss contingencies: We record accruals for various contingencies including legal exposures as they arise in the normal course of business. In accordance with accounting guidance on contingencies, we determine whether to disclose and accrue for loss contingencies based on an assessment of whether the risk of loss is remote, reasonably possible or probable. Our assessment is developed in consultation with our internal and external counsel and other advisors and is based on an analysis of possible outcomes under various strategies. Loss contingency assumptions involve judgments that are inherently subjective and can involve matters that are in litigation, which, by its nature is unpredictable. We believe that our assessment of the probability of loss contingencies is reasonable, but because of the subjectivity involved and the unpredictable nature of the subject matter at issue, our assessment may prove ultimately to be incorrect, which could materially impact our consolidated financial statements.
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, stock-based compensation expense, 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.
Employee benefit plans: We sponsor a defined contribution plan, a frozen defined benefit pension plan and other unfunded post-retirement plans. The defined benefit pension and post-retirement plans require an actuarial valuation to determine plan obligations and related periodic costs. We use independent actuaries to assist with these calculations. Plan valuations require economic assumptions, including expected rates of return on plan assets, discount rates to value plan obligations, employee demographic assumptions including mortality rates, and changes in health care costs. The actuarial assumptions used may differ materially from actual results due to changing market and economic conditions. Actual results that differ from the actuarial assumptions are reflected as unrecognized gains and losses. Unrecognized gains and losses that exceed 10% of the greater of the plan’s projected benefit obligations or market value of assets are amortized to earnings over the estimated service life of the remaining plan participants.
Significant assumptions used in valuing the Company’s net obligation under its Oshkosh B’Gosh pension plan under which retirement benefits were frozen as of December 31, 2005 are expected long-term rates of return on plans assets and the discount rate used to determine the plan’s projected benefit obligation. Expected long-term rates of return on plan assets were estimated to be 7.5% for the fiscal year ended January 1, 2011. Our strategy with regards to the investments in the pension plan is to earn a rate of return sufficient to fund all pension obligations as they arise. The long-term rate of return assumption considers current market trends, historical investment performance, and the portfolio mix of investments and has been set at 7.5% for fiscal 2011. The discount rate used to determine the plan’s projected benefit obligation was 5.5% for the year ended January 1, 2011. This discount rate was used to calculate the present value of expected future cash flows for benefit payments. The rate used reflects the comparable long-term rate of return on a pool of high quality fixed income investments.
Any future obligations under our plan not funded from investment returns on plan assets will be funded from cash flows from operations. The assumptions used in computing our net pension expense and projected benefit obligations have a significant impact on the amounts recorded. A 0.25% change in the assumptions identified below would have had the following effects on the net pension expense and projected benefit obligation as of and for the year ended January 1, 2011.
The most significant assumption used to determine the Company’s projected benefit obligation under its post-retirement life and medical plan under which retirement benefits were frozen in 1991 is the discount rate used to determine the plan’s projected benefit obligation. A 0.25% change in the assumed discount rate would result in an increase or decrease, as applicable, in plan’s projected benefit obligation of approximately $0.2 million.
See Note 7, “Employee Benefits Plans,” to the accompanying audited consolidated financial statements for further details on rates and assumptions.
Stock-based compensation arrangements: The Company accounts for stock-based compensation in accordance with the fair value recognition provisions of accounting guidance on share-based payments. The Company adopted this guidance 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 covering the expected life of stock 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 stock option. An increase in the risk-free interest rate will increase compensation expense.
Expected term - This is the period of time over which the stock 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 accounting guidance on share-based payments 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.
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 2011 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.
ITEM 7A.
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 Asia 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 income (loss) in future years. In order to manage this risk, we source products from over 100 vendors in over 15 countries, 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 revolving credit facility, which carries variable interest rates. As of January 1, 2011, our outstanding variable rate debt aggregated approximately $236.0 million. An increase or decrease of 1% in the applicable rate would increase or decrease our annual interest cost by $2.4 million and could have an adverse effect on our net income (loss) and cash flow.
OTHER RISKS
We enter into various purchase order commitments with our 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.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CARTER’S, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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. at January 1, 2011 and January 2, 2010, and the results of their operations and their cash flows for each of the three years in the period ended January 1, 2011 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 January 1, 2011, 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.
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
March 2, 2011
CARTER’S, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except for share data)
The accompanying notes are an integral part of the consolidated financial statements
CARTER’S, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
The accompanying notes are an integral part of the consolidated financial statements
CARTER’S, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements
CARTER’S, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(dollars in thousands, except for share data)
The accompanying notes are an integral part of the consolidated financial statements
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-THE COMPANY:
Carter’s, Inc. and its wholly owned subsidiaries (collectively, the “Company,” “we,” “us,” “its,” and “our”) design, source, and market branded childrenswear under the Carter’s, Child of Mine, Just One You, Precious Firsts, OshKosh, and related brands. Our products are sourced through contractual arrangements with manufacturers worldwide for wholesale distribution to major domestic retailers, including the mass channel, our 306 Carter’s and 180 OshKosh retail stores, and our eCommerce business that market our brand name merchandise and other licensed products manufactured by other companies.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION:
The accompanying audited consolidated financial statements include the accounts of Carter’s, Inc. and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
RECLASSIFICATIONS:
Certain prior year amounts have been reclassified for comparative purposes.
FISCAL YEAR:
Our fiscal year ends on the Saturday, in December or January, nearest the last day of December. The accompanying audited consolidated financial statements reflect our financial position as of January 1, 2011 and January 2, 2010 and results of operations for the fiscal years ended January 1, 2011, January 2, 2010, and January 3, 2009. The fiscal years ended January 1, 2011 (fiscal 2010) and January 2, 2010 (fiscal 2009), each contain 52 weeks. The fiscal year ended January 3, 2009 (fiscal 2008) contains 53 weeks.
USE OF ESTIMATES IN THE PREPARATION OF THE CONSOLIDATED FINANCIAL STATEMENTS:
The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS:
We consider all highly liquid investments that have original maturities of three months or less to be cash equivalents. Our cash and cash equivalents consist of deposit accounts, cash management funds invested in U.S. Treasury securities, and municipal obligations that provide income exempt from federal income taxes. We had cash deposits, in excess of deposit insurance limits, in three banks at January 1, 2011.
ACCOUNTS RECEIVABLE:
Approximately 82.9% of our gross accounts receivable at January 1, 2011 and 86.2% at January 2, 2010 were from our ten largest wholesale and mass channel customers. Of these customers, four had individual receivable balances in excess of 10% of our gross accounts receivable (but not more than 17%) at January 1, 2011. At January 2, 2010, three customers had individual receivable balances in excess of 10% of our gross accounts receivable (but not more than 27%). Sales to these customers represent 80.8% and 81.1% of total wholesale and mass channel net sales for fiscal 2010 and fiscal 2009, respectively. In fiscal 2010 and 2009, one customer accounted for approximately 10% of our consolidated net sales.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
Components of accounts receivable as of January 1, 2011 and January 2, 2010 are as follows:
INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out basis for wholesale and mass channel inventory and average cost for retail inventories) or market. 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.
PROPERTY, PLANT, AND EQUIPMENT:
Property, plant, and equipment are stated at cost, less accumulated depreciation and amortization. When fixed assets are sold or otherwise disposed of, the accounts are relieved of the original cost of the assets, and the related accumulated depreciation and any resulting profit or loss is credited or charged to income. For financial reporting purposes, depreciation and amortization are computed on the straight-line method over the estimated useful lives of the assets as follows: buildings from 15 to 26 years and retail store fixtures, equipment, and computers from 3 to 10 years. Leasehold improvements and fixed assets purchased under capital leases, if any, are amortized over the lesser of the asset life or related lease term. We capitalize the cost of our fixtures designed and purchased for use at major wholesale and mass channel accounts. The cost of these fixtures is amortized over a three-year period.
GOODWILL AND OTHER INTANGIBILE ASSETS:
Goodwill as of January 1, 2011, represents the excess of the cost of the acquisition of Carter’s, Inc. by Berkshire Partners LLC which was consummated on August 15, 2001 (the “2001 Acquisition”) over the fair value of the net assets acquired. Our goodwill is not deductible for tax purposes. Our Carter’s goodwill and Carter’s and OshKosh tradenames are deemed to have indefinite lives and are not being amortized.
In connection with the acquisition of OshKosh on July 14, 2005 (the “Acquisition”), the Company recorded goodwill, tradename, licensing, and leasehold interest assets. During fiscal 2007, the Company recorded impairment charges of approximately $36.0 million and $106.9 million on the goodwill for the OshKosh 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 asset.
The carrying values of the goodwill and tradename assets are subject to annual impairment reviews in accordance with accounting guidance on goodwill and other intangible assets, as of the last day of each fiscal year. Impairment reviews may also be triggered by any significant events or changes in circumstances affecting our business. Factors affecting such impairment reviews include the continued market acceptance of our offered products and the development of new products. Based upon our most recent assessment performed as of January 1, 2011, we determined that there is no impairment of our goodwill or tradename assets. We use discounted cash flow models to determine the fair value of these assets, using assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, if the carrying amount exceeds the fair value, an impairment charge is recognized in the amount equal to that excess.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
We perform impairment tests of our goodwill at our reporting unit level, which is consistent with our operating segments. The goodwill impairment test consists of a two-step process, if necessary. The first step is to compare the fair value of a reporting unit to its carrying value, including goodwill. We use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe hypothetical marketplace participants would use. If the fair value of a reporting unit is less than its carrying value, the second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill.
A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models, but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with accounting guidance, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company’s actual cost of capital has changed. Therefore, our Company may recognize an impairment of an intangible asset or assets even though realized actual cash flows are approximately equal to or greater than our previously forecasted amounts.
The Company’s intangible assets were as follows:
(1) $51.8 million of which relates to Carter’s wholesale segment, $82.0 million of which relates to Carter’s retail segment, and $2.7 million of which relates to Carter’s mass
channel segment.
Amortization expense for intangible assets subject to amortization was approximately $1.8 million for the fiscal year ended January 1, 2011, $3.7 million for the fiscal year ended January 2, 2010, and $4.1 million for the fiscal year ended January 3, 2009. All intangible assets subject to amortization were fully amortized as of January 1, 2011.
IMPAIRMENT OF OTHER LONG-LIVED ASSETS:
We review other long-lived assets, including property, plant, and equipment, and licensing agreements, for impairment whenever events or changes in circumstances indicate that the carrying amount of such an asset may not be recoverable. Management will determine whether there has been a permanent impairment on such assets held for use in the business by comparing anticipated undiscounted future cash flows from the use and eventual disposition of the asset or asset group to the carrying value of the asset. The amount of any resulting impairment will be calculated by comparing the carrying value to fair value, which may be estimated using the present value of the same cash flows. Long-lived assets that meet the definition of held for sale will be valued at the lower of carrying amount or fair value.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
DEFERRED DEBT ISSUANCE COSTS:
Debt issuance costs are deferred and amortized to interest expense using the straight-line method, which approximates the effective interest method, over the life of the related debt. During the second quarter of fiscal 2010, the Company wrote off approximately $0.5 million of unamortized debt issuance costs related to the $100 million prepayment of a portion of its former term loan debt. On October 15, 2010, the Company entered into a new $375 million ($130 million sub-limit for letters of credit and a swing line sub-limit of $40 million) revolving credit facility with Bank of America as sole lead arranger and administrative agent, JP Morgan Chase Bank as syndication agent, and other financial institutions. The new revolving credit facility was immediately drawn upon to pay off the Company’s former term loan of $232.2 million and pay transaction fees and expenses of $3.8 million, leaving approximately $130 million available under the revolver for future borrowings (net of letters of credit of approximately $8.6 million). In connection with the repayment of the Company’s former term loan, in the fourth quarter of fiscal 2010 the Company wrote off approximately $1.2 million in unamortized debt issuance costs. In addition, in connection with the new revolving credit facility, the Company recorded $3.5 million of debt issuance costs to be amortized over the term of the new revolving credit facility (five years). Amortization approximated $0.9 million (exclusive of $1.7 million related to prepayments) for the fiscal year ended January 1, 2011 and $1.1 million for fiscal years ended January 2, 2010 and January 3, 2009.
CASH FLOW HEDGES:
Our former senior credit facility required us to hedge at least 25% of our variable rate debt under this facility. The Company entered into interest rate swap agreements in order to hedge the risk of interest rate fluctuations. These interest rate swap agreements were designated as cash flow hedges of the variable interest payments on a portion of our variable rate former term loan debt. Our interest rate swap agreements were traded in the over-the-counter market. Fair values were based on quoted market prices for similar assets or liabilities or determined using inputs that use as their basis readily observable market data that are actively quoted and can be validated through external sources, including third-party pricing services, brokers, and market transactions.
In connection with the repayment of the Company’s former term loan, the Company terminated its two remaining interest rate swap agreements totaling $100.0 million originally scheduled to mature in January 2011.
The unrealized gain related to the swap agreements, net of tax, was approximately $0.7 million for the fiscal year ended January 1, 2011 and $0.4 million for the fiscal year ended January 2, 2010. The unrealized loss related to the swap agreement, net of tax benefit, was approximately $1.0 million for the fiscal year ended January 3, 2009. The realized gain related to the swap agreements, net of tax, was approximately $0.2 million for the fiscal year ended January 1, 2011. These unrealized gains and losses and realized gain, net of tax, are included within accumulated other comprehensive (loss) income on the accompanying audited consolidated balance sheets. In fiscal 2010, 2009, and 2008, we recorded $1.7 million, $2.5 million, and $1.1 million, respectively, in interest expense related to the swap agreements.
On May 25, 2006, we entered into an interest rate collar agreement (the “collar”) with a LIBOR floor of 4.3% and a ceiling of 5.5%. The collar covered $100 million of our variable rate former term loan debt and was designated as a cash flow hedge of the variable interest payments on such debt. The collar matured on January 31, 2009. For the fiscal year ended January 2, 2010, the Company realized a gain of approximately $0.4 million, net of taxes, related to the collar. The unrealized gain, net of taxes, related to the collar was approximately $0.2 million for the fiscal year ended January 3, 2009. These realized and unrealized gains related to the collar, net of tax, are included within accumulated other comprehensive (loss) income on the accompanying audited consolidated balance sheets. In fiscal 2009, we recorded $0.5 million in interest expense related to the collar.
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME:
Accumulated other comprehensive (loss) income, shown as a component of stockholders’ equity on the accompanying audited consolidated balance sheets, reflects realized gains and unrealized gains or losses on the Company’s interest rate swap and collar agreements, net of taxes, which are not included in the determination of net income. These realized gains and unrealized gains and losses are recorded directly into accumulated other comprehensive (loss) income and are referred to as comprehensive (loss) income items. Accumulated other comprehensive (loss) income also reflects adjustments to the Company’s defined benefit and post-retirement plan assets and liabilities as of the end of the year, and the gains and losses and prior service costs or credits, net of tax, that arise during the period but that are not recognized as components of net periodic benefit cost pursuant to accounting guidance on pensions and post-retirement benefits.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
Accumulated other comprehensive income is summarized as follows:
As of January 1, 2011, other accumulated comprehensive income for the pension/post-retirement liability adjustment are net of tax benefit of $1.1 million.
REVENUE RECOGNITION:
Revenues consist of sales to customers, net of returns, accommodations, allowances, deductions, and cooperative advertising. We consider revenue realized or realizable and earned when the product has been shipped, when title passes, when all risks and rewards of ownership have transferred, the sales price is fixed or determinable, and collectability 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. We provide accommodations and allowances to our major wholesale and mass channel customers in order to assist these customers with inventory clearance and promotions. Such amounts are reflected as a reduction of net sales and are recorded based on agreements with customers, 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 collectability. Our credit and collections department reviews all other balances regularly. Account balances are charged off against the allowance when we feel 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 accounting guidance on consideration given by a vendor to a customer/reseller, we have included the fair value of these arrangements of approximately $4.0 million in fiscal 2010, $3.3 million in fiscal 2009, and $2.5 million in fiscal 2008 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.
ACCOUNTING FOR SHIPPING AND HANDLING FEES AND COSTS:
Shipping and handling costs include related labor costs, third-party shipping costs, shipping supplies, and certain distribution overhead. Such costs are generally absorbed by us and are included in selling, general, and administrative expenses. These costs amounted to approximately $33,285,000 for fiscal 2010, $31,914,000 for fiscal 2009, and $36,727,000 for fiscal 2008.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
With respect to the freight component of our shipping and handling costs, certain customers arrange for shipping and pay the related freight costs directly to third parties. However, in the event that we arrange and pay the freight for these customers and bill them for this service, such amounts billed are included in revenue and the related cost is charged to cost of goods sold. In addition, shipping and handling costs billed to our eCommerce customers are included in revenue and the related cost is charged to cost of goods sold. For fiscal years 2010, 2009, and 2008, the Company billed customers approximately $1,521,000, $133,000, and $185,000, respectively.
ROYALTIES AND LICENSE FEES:
We license the Carter’s, Just One You, Precious Firsts, Child of Mine, OshKosh B’gosh, OshKosh, and Genuine Kids from OshKosh trademarks to other companies for use on baby and young children’s products, including bedding, outerwear, sleepwear, shoes, underwear, socks, room décor, toys, stationery, hair accessories, furniture, gear and related products. These royalties are recorded as earned, based upon the sales of licensed products by our licensees.
STOCK-BASED COMPENSATION ARRANGEMENTS:
In accordance with the fair value recognition provisions of accounting guidance on share-based payments, the Company recognizes stock-based compensation expense for its share-based payments based on the fair value of the awards at the grant date.
We determine the fair value of stock options using the Black-Scholes option pricing model, which requires the use of the following subjective assumptions:
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 covering the expected life of options being valued. An increase in the expected volatility will increase stock-based 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 stock-based 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 stock-based 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 stock-based 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 statements of operations.
The Company accounts for its performance-based awards in accordance with accounting guidance on share-based payments 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.
The fair value of restricted stock is determined based on the quoted closing price of our common stock on the date of grant.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
INCOME TAXES:
The accompanying audited consolidated financial statements reflect current and deferred tax provisions. The deferred tax provision is determined under the liability method. Deferred tax assets and liabilities are recognized based on differences between the book and tax bases of assets and liabilities using presently enacted tax rates. Valuation allowances are established when it is “more likely than not” that a deferred tax asset will not be recovered. The provision for income taxes is generally the sum of the amount of income taxes paid or payable for the year as determined by applying the provisions of enacted tax laws to the taxable income for that year, the net change during the year in our deferred tax assets and liabilities, and the net change during the year in any valuation allowances.
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 consolidated financial statements. Where applicable, associated interest is also recognized.
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid in cash approximated $7,787,000 for the fiscal year ended January 1, 2011, $10,515,000 for the fiscal year ended January 2, 2010, and $19,074,000 for the fiscal year ended January 3, 2009. Income taxes paid in cash approximated $71,745,000 for the fiscal year ended January 1, 2011, $54,580,000 for the fiscal year ended January 2, 2010, and $44,157,000 for the fiscal year ended January 3, 2009.
EARNINGS PER SHARE:
The Company calculates basic and diluted net income per common share in accordance with accounting guidance which requires earnings per share to be calculated pursuant to the two-class method for unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid).
Basic net income per share is calculated by dividing net income for the period by the weighted-average common shares outstanding for the period. Diluted net income per share includes the effect of dilutive instruments, such as stock options and restricted stock, and uses the average share price for the period in determining the number of shares that are to be added to the weighted-average number of shares outstanding.
For the fiscal years ended January 1, 2011 and January 2, 2010, antidilutive shares of 599,000 and 1,035,500, respectively, were excluded from the computations of diluted earnings per share. For the fiscal year ended January 3, 2009, antidilutive shares of 1,539,650 and performance-based stock options of 220,000 were excluded from the computations of diluted earnings per share.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
The following is a reconciliation of basic common shares outstanding to diluted common and common equivalent shares outstanding:
EMPLOYEE BENEFIT PLANS:
The Company accounts for its employee benefit plans in accordance with accounting guidance on defined benefit pension and other post-retirement plans which requires an employer to recognize the over-funded or under-funded status of a defined benefit post-retirement plan (other than a multi-employer plan) as an asset or liability on its balance sheet. It also requires an employer to recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 715-30. These costs are then subsequently recognized as components of net periodic benefit cost in the consolidated statement of operations.
We adjusted accumulated other comprehensive (loss) income related to the Company’s post-retirement benefit obligations by approximately $0.3 million, or $0.2 million, net of tax, in fiscal 2010, $0.2 million, or $0.1 million, net of tax, in fiscal 2009, and $1.3 million, or $0.8 million, net of tax, in fiscal 2008 to reflect changes in underlying assumptions including projected claims and population. In addition, the Company recorded an unrealized gain of $1.8 million, or $1.1 million, net of tax, in fiscal 2010, an unrealized gain of $3.7 million, or $2.3 million, net of tax, during fiscal 2009, and an unrealized loss of $15.8 million, or $10.0 million, net of tax, during fiscal 2008 to the OshKosh pension plan asset and accumulated other comprehensive (loss) income to reflect changes in the funded status of this plan.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
RECENT ACCOUNTING PRONOUNCEMENTS:
In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance became effective for the Company with the reporting period beginning January 3, 2010 (the first day of fiscal 2010), except for the disclosure on the roll forward activities for Level 3 fair value measurements, which will become effective for the Company with the reporting period beginning January 2, 2011 (the first day of fiscal 2011). The Company has included the required disclosures in Note 9.
In February 2010, new accounting guidance was issued related to subsequent events. This guidance amended guidance previously issued in May 2009 regarding subsequent events and states that an entity that is a Securities and Exchange Commission (“SEC”) filer is no longer required to disclose the date through which subsequent events have been evaluated. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
NOTE 3-PROPERTY, PLANT, AND EQUIPMENT:
Property, plant, and equipment consisted of the following:
Depreciation and amortization expense was approximately $29,950,000 for the fiscal year ended January 1, 2011, $28,557,000 for the fiscal year ended January 2, 2010, and $26,053,000 for the fiscal year ended January 3, 2009.
NOTE 4-LONG-TERM DEBT:
Long-term debt consisted of the following:
On October 15, 2010, the Company entered into a new $375 million ($130 million sub-limit for letters of credit and a swing line sub-limit of $40 million) revolving credit facility with Bank of America as sole lead arranger and administrative agent, JP Morgan Chase Bank as syndication agent, and other financial institutions. The new revolving credit facility was immediately drawn upon to pay off the Company’s former term loan of $232.2 million and pay transaction fees and expenses of $3.8 million, leaving approximately $130 million available under the revolver for future borrowings (net of letters of credit of approximately $8.6 million). In connection with the repayment of the Company’s former term loan, in the fourth quarter of fiscal 2010 the Company wrote off approximately $1.2 million in unamortized debt issuance costs. In addition, in connection with the new revolving credit facility, the Company recorded $3.5 million of debt issuance costs to be amortized over the term of the new revolving credit facility (five years). At January 1, 2011, we had approximately $236.0 million in revolver borrowings, exclusive of $8.6 million of outstanding letters of credit, at an effective interest rate of 2.51%.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4-LONG-TERM DEBT: (Continued)
The term of the new revolving credit facility expires October 15, 2015. This revolving credit facility provides for two pricing options for revolving loans: (i) revolving loans on which interest is payable quarterly at a base rate equal to the highest of (x) the Federal Funds Rate plus ½ of 1%, (y) the rate of interest in effect for such day as publicly announced from time to time by Bank of America, N.A. as its prime rate, or (z) the Eurodollar Rate plus 1%, plus, in each case, an applicable margin initially equal to 1.25%, which may be adjusted based upon a leverage-based pricing grid ranging from 1.00% to 1.50% and (ii) revolving loans on which interest accrues for one, two, three, six or if, generally available, nine or twelve month interest periods (but is payable not less frequently than every three months) at a rate of interest per annum equal to an adjusted British Bankers Association LIBOR rate, plus an applicable margin initially equal to 2.25%, which may be adjusted based upon a leverage-based pricing grid ranging from 2.00% to 2.50%. Amounts currently outstanding under the revolving credit facility initially accrue interest at a LIBOR rate plus 2.25%.
The new revolving credit facility contains and defines financial covenants, including a lease adjusted leverage ratio (defined as, with certain adjustments, the ratio of the Company’s consolidated indebtedness plus six times rent expense to consolidated net income before interest, taxes, depreciation, amortization, and rent expense (“EBITDAR”)) to exceed (x) if such period ends on or before December 31, 2014, 3.75:1.00 and (y) if such period ends after December 31, 2014, 3.50:1.00; and consolidated fixed charge coverage ratio (defined as, with certain adjustments, the ratio of consolidated EBITDAR to consolidated fixed charges (defined as interest plus rent expense)), for any such period to be less than 2.75:1.00.
Provisions in our new 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 unless TWCC and its consolidated subsidiaries meet certain leverage ratio and minimum availability requirements under the credit facility, 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.
The Company’s former senior credit facility was comprised of a $500 million term loan and a $125 million revolving credit facility (including a sub-limit for letters of credit of $80 million). The revolver was scheduled to expire on July 14, 2011 and the term loan was scheduled to expire July 14, 2012. As of January 2, 2010, principal borrowings under the term loan were due and payable in quarterly installments of $0.9 million with the remaining balance of $325.8 million due on July 14, 2012.
Amounts borrowed under the former term loan had an applicable rate of LIBOR + 1.50%, regardless of the Company’s overall leverage level. Interest was payable at the end of interest rate reset periods, which vary in length but in no case exceeded 12 months for LIBOR rate loans and quarterly for prime rate loans. The effective interest rates on former term loan borrowings as of January 2, 2010 and January 3, 2009 were 1.7% and 3.3%, respectively.
Amounts borrowed under the former revolver accrued interest at a prime rate or, at our option, a LIBOR rate plus 1.00% which is based upon a leverage-based pricing grid ranging from Prime or LIBOR plus 1.00% to Prime plus 1.00% or LIBOR plus 2.00%. There were no borrowings outstanding under the former revolver at January 2, 2010.
The former senior credit facility contained and defined financial covenants, including a minimum interest coverage ratio, maximum leverage ratio, and a minimum fixed charge coverage ratio. The former senior credit facility also set forth mandatory and optional prepayment conditions, including an annual excess cash flow requirement, as defined, that could have resulted in our use of cash to reduce our debt obligations. There was no excess cash flow payment required for fiscal 2009 or 2008. Our obligations under the former senior credit facility were collateralized by a first priority lien on substantially all of our assets, including the assets of our domestic subsidiaries.
On November 17, 2009, the Company obtained a waiver to its former senior credit facility which waived defaults resulting from the untimely filing of the Company’s third quarter of fiscal 2009 financial statements and the restatement of prior period financial statements. The waiver resulted in a fee of approximately $450,000 and required the Company to deliver to the lenders the restatement of prior period financial statements and the third quarter of fiscal 2009 financial statements by January 15, 2010. The Company complied with the terms of the waiver. The Company’s third quarter of fiscal 2009 financial statements and the prior period restated financial statements were filed with the SEC on January 15, 2010. The Company complied with the terms of the waiver and was in compliance with its debt covenants as of January 15, 2010.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4-LONG-TERM DEBT: (Continued)
The former senior credit facility required us to hedge at least 25% of our variable rate debt under the former term loan. The Company historically entered into interest rate swap agreements to hedge the risk of interest rate fluctuations. These interest rate swap agreements were designated as cash flow hedges of the variable interest payments on a portion of our variable rate former term loan debt. As of January 2, 2010, approximately $238.9 million of our $334.5 million of outstanding debt was hedged under interest rate swap agreements. In connection with the repayment of the Company’s former term loan, the Company terminated its two remaining interest rate swap agreements totaling $100.0 million originally scheduled to mature in January 2011. During fiscal 2010, 2009, and 2008, we recorded approximately $1.7 million, $2.5 million, and $1.1 million, respectively, in interest expense related to our swap agreements.
On May 25, 2006, we entered into an interest rate collar agreement with a floor of 4.3% and a ceiling of 5.5%. The collar covered $100 million of our variable rate former term loan debt and was designated as a cash flow hedge of the variable interest payments on such debt. The collar matured on January 31, 2009. In fiscal 2009 and 2008, we recorded $0.5 million and $1.2 million, respectively, in interest expense related to the collar.
NOTE 5-COMMON STOCK:
As of January 1, 2011, the total amount of Carter’s, Inc.’s authorized capital stock consisted of 150,000,000 shares of common stock, $0.01 par value per share, and 100,000 shares of preferred stock, $0.01 par value per share. As of January 1, 2011, 57,493,567 shares of common stock and no shares of preferred stock were outstanding.
During fiscal 2010, the Company issued 24,032 and 2,115 shares of common stock at a fair market value of $33.29 and $23.65, respectively, to its non-management board members and recognized approximately $850,000 in stock-based compensation expense. During fiscal 2009, we issued 33,656 and 748 shares of common stock at a fair market value of $20.80 and $22.29, respectively, to its non-management board members and recognized $720,000 in stock-based compensation expense. During fiscal 2008, we issued 43,386 shares of our common stock at a fair market value of $14.52 to our non-management board members and recognized approximately $630,000 in compensation expense. We received no proceeds from the issuance of these shares.
On February 16, 2007, the Company’s Board of Directors approved a share repurchase authorization, pursuant to which the Company was authorized to purchase up to $100 million of its outstanding common shares. On June 15, 2010, the Company’s Board of Directors approved a new share repurchase authorization, pursuant to which the Company is authorized to purchase up to an additional $100 million of its outstanding common shares. As of August 13, 2010, the Company had repurchased outstanding shares in the amount totaling the entire $100 million authorized by the Board of Directors on Februay 16, 2007.
During fiscal 2010, the Company repurchased and retired 2,058,830 shares, or approximately $50.0 million, of its common stock at an average price of $24.29 per share. During fiscal 2009, the Company did not repurchase any shares of its common stock. Since inception of the repurchase program and through fiscal 2010, the Company repurchased and retired 6,658,410 shares, or approximately $141.1 million, of its common stock at an average price of $21.19 per share. We have reduced common stock by the par value of such shares repurchased and have deducted the remaining excess repurchase price over par value from additional paid-in capital. Future repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise. The timing and amount of any repurchases will be determined by the Company’s management, based on its evaluation of market conditions, share price, other investment priorities, and other factors. The total remaining capacity under this authorization was approximately $58.9 million as of January 1, 2011. This authorization has no expiration date.
The issued and outstanding shares of common stock are validly issued, fully paid, and nonassessable. Holders of our common stock are entitled to share equally, share for share, if dividends are declared on our common stock, whether payable in cash, property, or our securities. The shares of common stock are not convertible and the holders thereof have no preemptive or subscription rights to purchase any of our securities. Upon liquidation, dissolution, or winding up of our Company, the holders of common stock are entitled to share equally, share for share, in our assets which are legally available for distribution, after payment of all debts and other liabilities and subject to the prior rights of any holders of any series of preferred stock then outstanding. Each outstanding share of common stock is entitled to one vote on all matters submitted to a vote of stockholders. There is no cumulative voting. Except as otherwise required by law or the certificate of incorporation, the holders of common stock vote together as a single class on all matters submitted to a vote of stockholders.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6-STOCK-BASED COMPENSATION:
Our Board of Directors may issue preferred stock from time to time. Subject to the provisions of our certificate of incorporation and limitations prescribed by law, the Board of Directors is expressly authorized to adopt resolutions to issue the shares, to fix the number of shares, and to change the number of shares constituting any series and to provide for or change the voting powers, designations, preferences and relative participating, optional or other special rights, qualifications, limitations or restrictions thereof, including dividend rights (including whether dividends are cumulative), dividend rates, terms of redemption (including sinking fund provisions), redemption prices, conversion rights, and liquidation preferences of the shares constituting any series of the preferred stock, in each case without any further action or vote by the shareholders.
Under the Company’s Amended and Restated 2003 Equity Incentive Plan (the “Plan”), the compensation committee of our Board of Directors may award incentive stock options (ISOs and non-ISOs), stock appreciation rights (SARs), restricted stock, unrestricted stock, stock deliverable on a deferred basis, performance-based stock awards, and cash payments intended to help defray the cost of awards.
At the Company’s May 14, 2009 shareholders’ meeting, the shareholders approved a proposal to amend the Plan to (i) increase the maximum number of shares of stock available under the Existing Plan by 565,000 shares from 11,488,392 shares to 12,053,392 shares; (ii) remove the limitation on the number of shares that may be used for awards other than stock options and replace it with a provision requiring any awards, with the exception of options and stock appreciation rights, to reduce the shares of stock available for issuance under the Plan by 1.46 shares for each share subject to the award granted; (iii) prohibit the ability to provide dividend equivalents for stock options or stock appreciation rights; and (iv) require that the number of shares of common stock available for issuance under the Plan be reduced by the aggregate number of shares subject to a stock appreciation right upon the exercise of the stock appreciation right. Under the Plan, the maximum number of shares for which stock options may be granted to any individual or which can be subject to SARs granted to any individual in any calendar year is 2,000,000. As of January 1, 2011, there are 1,257,571 shares available for grant under the Plan. The Plan makes provision for the treatment of awards upon termination of service or in the case of a merger or similar corporate transaction. Participation in the Plan is limited to Directors and those key employees selected by the compensation committee.
The limit on shares available under the Plan, the individual limits, and other award terms are subject to adjustment to reflect stock splits or stock dividends, combinations, and certain other events. All stock options issued under the Plan subsequent to the 2001 Acquisition expire no later than ten years from the date of grant. The Company believes that the current level of authorized shares is sufficient to satisfy future option exercises.
Stock options outstanding under the Plan consist of basic options. Basic options issued prior to May 12, 2005 vested in equal annual installments over a five-year period. Basic options granted on and subsequent to May 12, 2005 vest in equal annual installments over a four-year period.
In accordance with accounting guidance on share-based payments, the Company has recorded stock-based compensation expense (as a component of selling, general, and administrative expenses) in the amount of approximately $7.3 million, $6.8 million, and $8.7 million (including $2.2 million of accelerated performance-based stock option expense, see Note 17) related to stock awards for the fiscal years ended January 1, 2011, January 2, 2010, and January 3, 2009, respectively.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6-STOCK-BASED COMPENSATION: (Continued)
Basic Options
A summary of stock option activity under the Plan (in number of shares that may be purchased) is as follows for the fiscal year ended January 1, 2011:
During fiscal 2010, the Company granted 417,500 basic stock options. In connection with these grants of basic stock options, the Company recognized approximately $954,000 in stock-based compensation expense during the fiscal year ended January 1, 2011.
A summary of basic stock options outstanding and exercisable at January 1, 2011 is as follows:
At January 1, 2011, the aggregate intrinsic value of all outstanding basic stock options was approximately $31.9 million and the aggregate intrinsic value of currently exercisable basic stock options was approximately $25.6 million. The intrinsic value of basic stock options exercised during the fiscal year ended January 1, 2011 was approximately $26.9 million. At January 1, 2011, the total estimated compensation cost related to non-vested basic stock options not yet recognized was approximately $6.3 million with a weighted-average expense recognition period of 2.59 years.
As a result of the retirement of an executive officer during fiscal 2008, the Company recognized approximately $2.2 million of stock-based compensation expense relating to the accelerated vesting of 400,000 performance-based stock options (see Note 17, “Executive Retirement Charges”).
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6-STOCK-BASED COMPENSATION: (Continued)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing method with the following weighted-average assumptions used for grants issued:
Restricted Stock
Restricted stock awards issued under the Plan vest based upon continued service or performance targets. Restricted stock awards vest in equal annual installments over a four-year period or cliff vest after a three- or four-year period. As noted above, the fair value of restricted stock is determined based on the quoted closing price of our common stock on the date of grant.
The following table summarizes our restricted stock award activity during the fiscal year ended January 1, 2011:
During the fiscal year ended January 1, 2011, the Company granted 192,233 shares of restricted stock to employees and Directors. Stock-based compensation expense recorded during the fiscal year ended January 1, 2011 for all restricted stock awards totaled approximately $3.4 million. The total amount of estimated compensation expense related to unvested restricted stock awards is approximately $7.1 million as of January 1, 2011.
During the fiscal year ended January 3, 2009, the Company granted our Chief Executive Officer 75,000 shares of restricted stock at a fair market value of $17.92. Vesting of these restricted shares is contingent upon meeting specific performance targets through fiscal 2010 as well as continued employment through fiscal 2012. Currently, the Company believes that these targets will be achieved and, accordingly, we will continue to record compensation expense until the restricted shares vest or the Company’s assessment of achievement of the performance criteria changes.
Unrecognized stock-based compensation expense related to outstanding unvested stock options and unvested restricted stock awards are expected to be recorded as follows:
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7-EMPLOYEE BENEFIT PLANS:
Under a defined benefit plan frozen in 1991, we offer a comprehensive post-retirement medical plan to current and certain future retirees and their spouses until they become eligible for Medicare or a Medicare Supplement Plan. We also offer life insurance to current and certain future retirees. Employee contributions are required as a condition of participation for both medical benefits and life insurance and our liabilities are net of these expected employee contributions.
The following is a reconciliation of the Accumulated Post-Retirement Benefit Obligation (“APBO”) under this plan:
In conjunction with the closure of our Barnesville, Georgia distribution facility (as discussed in Note 15), the Company experienced a partial plan curtailment in fiscal 2009 for its post retirement medical plan for future retirees working in the facility prior to the plan becoming frozen in 1991. In conjunction with this partial curtailment, a curtailment gain of $0.6 million has been recognized as income in the fiscal year ended January 2, 2010.
Our contribution for these post-retirement benefit obligations was $532,016 in fiscal 2010, $484,078 in fiscal 2009, and $570,231 in fiscal 2008. We expect that our contribution and benefit payments for post-retirement benefit obligations each year from fiscal 2011 through fiscal 2015 will be approximately $550,000. We do not pre-fund this plan and as a result there are no plan assets. The measurement date used to determine the post-retirement benefit obligations is as of the end of the fiscal year.
Post-retirement benefit obligations under the plan are measured on a discounted basis at an assumed discount rate. The discount rate used at January 1, 2011 was determined with consideration given to Moody’s Aa Corporate Bond rate, the Barclay Capital Aggregate Bond index, and the Citigroup Pension Discount and Liability index, adjusted for the timing of expected plan distributions. The discount rate used at January 2, 2010 was determined with consideration given to Moody’s Aa Corporate Bond rate, adjusted for the timing of expected plan distributions. We believe these indexes reflect a risk-free rate with maturities that are comparable to the timing of the expected payments under the plan. The discount rates used in determining the APBO were as follows:
The components of post-retirement benefit expense charged to operations are as follows:
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7-EMPLOYEE BENEFIT PLANS: (Continued)
The discount rates used in determining the net periodic post-retirement benefit costs were as follows:
The effects on our plan of all future increases in health care costs are borne primarily by employees; accordingly, increasing medical costs are not expected to have any material effect on our future financial results.
We have an obligation under a defined benefit plan covering certain former officers and their spouses. At January 1, 2011 and January 2, 2010, the present value of the estimated remaining payments under this plan was approximately $0.6 million and $0.9 million, respectively, and is included in other current and long-term liabilities in the accompanying audited consolidated balance sheets.
The retirement benefits under the OshKosh B’Gosh pension plan were frozen as of December 31, 2005. The Company’s investment strategy is to invest in a well diversified portfolio consisting of 12-14 mutual funds or group annuity contracts that minimize concentration of risks by utilizing a variety of asset types, fund strategies, and fund managers. The target allocation for plan assets is 50% equity securities, 42% intermediate term debt securities, and 8% real estate investments.
Equity securities primarily include funds invested in large-cap and mid-cap companies, primarily located in the United States, with up to 5% of the plan assets invested in international equities. Fixed income securities include funds holding corporate bonds of companies from diverse industries, and U.S. Treasuries. Real estate funds include investments in actively managed commercial real estate projects located in the United States.
The fair value hierarchy for disclosure of fair value measurements is as follows:
Level 1
- Quoted prices in active markets for identical assets or liabilities
Level 2
- Quoted prices for similar assets and liabilities in active markets or inputs that are observable
Level 3
- Inputs that are unobservable (for example, cash flow modeling inputs based on assumptions)
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7-EMPLOYEE BENEFIT PLANS: (Continued)
The fair value of the Company’s pension plan assets at January 1, 2011 and January 2, 2010 by asset category were as follows:
(a) This category comprises low-cost equity index funds not actively managed that track the S&P 500.
(b) This category invests in both U.S. Treasuries and mid-term corporate debt from U.S. issuers from diverse industries.
(c) This category invests in corporate debt from U.S. issuers in diverse industries and mortgage backed securities.
(d) This category invests in active management of U.S. commercial real estate projects.
During fiscal 2010, the Company reinvested approximately $10.2 million of Level 2 investments into Level 1 mutual funds to further diversify its investment portfolio and limit its investment in group annuity contracts.
Pension liabilities are measured on a discounted basis at an assumed discount rate. The discount rate used at January 1, 2011 was determined with consideration given to Moody’s Aa Corporate Bond rate, the Barclay Capital Aggregate Bond index, and the Citigroup Pension Discount and Liability index, adjusted for the timing of expected plan distributions. The discount rate used at January 2, 2010 was determined with consideration given to Moody’s Aa Corporate Bond rate, adjusted for the timing of expected plan distributions. We believe these indexes reflect a risk-free rate with maturities that are comparable to the timing of the expected payments under the plan. The expected long-term rate of return assumption considers historic returns adjusted for changes in overall economic conditions that may affect future returns and a weighting of each investment class. The actuarial computations utilized the following assumptions, using year-end measurement dates:
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7-EMPLOYEE BENEFIT PLANS: (Continued)
The net periodic pension (benefit) cost included in the statement of operations was comprised of:
A reconciliation of changes in the projected pension benefit obligation and plan assets is as follows:
A pension liability of approximately $2.2 million and $4.4 million is included in other long-term liabilities in the accompanying audited consolidated balance sheet for fiscal 2010 and 2009, respectively. We do not expect to make any contributions to the OshKosh defined benefit plan during fiscal 2011 as the plan's funding exceeds the minimum funding requirements.
The Company currently expects benefit payments for its defined benefit pension plans as follows for the next ten fiscal years.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7-EMPLOYEE BENEFIT PLANS: (Continued)
We also sponsor a defined contribution plan within the United States. This plan covers employees who are at least 21 years of age and have completed three months of service, during which at least 250 hours were served. The plan provides for a discretionary employer match. Prior to April 2009, the plan provided for an employer match amounting to 100% on the first 3% employee contribution and 50% on the next 2% employee contribution. The Company’s expense for the defined contribution plan totaled approximately $4.3 million for the fiscal year ended January 1, 2011, $1.8 million for the fiscal year ended January 2, 2010, and $3.0 million for the fiscal year ended January 3, 2009.
NOTE 8-INCOME TAXES:
The provision for income taxes consisted of the following:
The foreign portion of the current tax position relates primarily to foreign tax withholdings related to our foreign royalty income.
There was no income or (loss) before taxes attributable to foreign income for the fiscal years ended January 1, 2011, January 2, 2010, and January 3, 2009.
The difference between our effective income tax rate and the federal statutory tax rate is reconciled below:
The Company and its subsidiaries file income tax returns in the United States and in various states and local jurisdictions. During fiscal 2009, the Internal Revenue Service completed an income tax audit for fiscal 2006 and 2007. In most cases, the Company is no longer subject to state and local tax authority examinations for years prior to fiscal 2007.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8-INCOME TAXES: (Continued)
In accordance with accounting guidance on uncertain tax positions, the following is a reconciliation of the beginning and ending amount of unrecognized tax benefits:
During fiscal 2008, we recognized approximately $1.9 million in tax benefits consisting of $1.6 million due to the completion of an Internal Revenue Service audit for fiscal 2004 and 2005 and approximately $0.3 million due to various statute closures, primary state and local jurisdictions. In addition, we recognized approximately $1.5 million of pre-Acquisition uncertainties previously reserved for consisting of approximately $0.9 million related to the completion of the Internal Revenue Service audit and $0.6 million related to the closure of applicable statute of limitations. These pre-Acquisition uncertainties have been reflected as a reduction in the OshKosh tradename asset in accordance with ASC 105.
During fiscal 2009, we recognized approximately $1.5 million in tax benefits consisting of $1.1 million due to the completion of the Internal Revenue Service audit for fiscal 2006 and 2007 and approximately $0.4 million due to various statute closures. During fiscal 2010, we recognized approximately $1.2 million in tax benefits due to various statute closures.
All of the Company’s reserve for unrecognized tax benefits as of January 1, 2011, if ultimately recognized, will impact the Company’s effective tax rate in the period settled. The Company has recorded tax positions for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductions. Because of deferred tax accounting, changes in the timing of these deductions would not impact the annual effective tax rate, but would accelerate the payment of cash to the taxing authorities.
Included in the reserves for unrecognized tax benefits are approximately $2.0 million of reserves for which the statute of limitations is expected to expire within the next fiscal year. If these tax benefits are ultimately recognized, such recognition may impact our annual effective tax rate for fiscal 2011 and the effective tax rate in the quarter in which the benefits are recognized.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8-INCOME TAXES: (Continued)
We recognize interest related to unrecognized tax benefits as a component of interest expense and penalties related to unrecognized tax benefits as a component of income tax expense. During the fiscal year ended January 1, 2011, the Company recognized a nominal amount of interest expense consisting of interest expense on unrecognized positions offset by the expiration of various state statute of limitations. During the fiscal year ended January 2, 2010, the Company recognized a net reduction in interest expense of approximately $0.1 million, primarily related to the successful resolution of the Internal Revenue Service audit for 2006 and 2007 in addition to the settlement of tax positions due to the expiration of the applicable statute of limitations. During the fiscal year ended January 3, 2009, the Company recognized a net reduction in interest expense of approximately $0.7 million, primarily related to the successful resolution of the Internal Revenue Service audit for 2004 and 2005 in addition to the settlement of tax positions due to the expiration of the applicable statute of limitations. The Company had approximately $0.6 million of interest accrued as of January 1, 2011 and January 2, 2010.
Components of deferred tax assets and liabilities were as follows:
The net deferred tax liability is classified on our accompanying audited consolidated balance sheets as follows:
NOTE 9-FAIR VALUE MEASUREMENTS:
The Company accounts for its fair value measurements in accordance with accounting guidance which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The fair value hierarchy for disclosure of fair value measurements is as follows:
Level 1
- Quoted prices in active markets for identical assets or liabilities
Level 2
- Quoted prices for similar assets and liabilities in active markets or inputs that are observable
Level 3
- Inputs that are unobservable (for example, cash flow modeling inputs based on assumptions)
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9-FAIR VALUE MEASUREMENTS: (Continued)
The following table summarizes assets and liabilities measured at fair value on a recurring basis:
At January 1, 2011, we had approximately $151.5 million of cash invested in money market deposit accounts ($73.3 million in Bank of America and $78.2 million in JP Morgan) and $75.0 million in U.S. Treasury bills.
At January 2, 2010, we had approximately $130.0 million of cash invested in two Dreyfus Cash Management Funds. These funds consisted of the Dreyfus Treasury Prime Cash Management fund ($87.9 million) which invests only in U.S. Treasury Bills or U.S. Treasury Notes and the Dreyfus Tax Exempt Cash Management fund ($42.1 million) which invests in short-term, high quality municipal obligations that provide income exempt from federal taxes.
Our former senior credit facility required us to hedge at least 25% of our variable rate debt under this facility. The Company historically entered into interest rate swap agreements in order to hedge the risk of interest rate fluctuations. These interest rate swap agreements were designated as cash flow hedges of the variable interest payments on a portion of our variable rate former term loan debt. Our interest rate swap agreements were traded in the over-the-counter market. Fair values were based on quoted market prices for similar assets or liabilities or determined using inputs that use as their basis readily observable market data that are actively quoted and can be validated through external sources, including third-party pricing services, brokers, and market transactions. Our interest rate swap agreements were classified as current as their terms span less than one year.
In connection with the repayment of the Company’s former term loan, the Company terminated its two remaining interest rate swap agreements totaling $100.0 million originally scheduled to mature in January 2011.
As of January 2, 2010, approximately $238.9 million of our $334.5 million of outstanding debt was hedged under interest rate swap agreements.
In fiscal 2006, the Company entered into an interest rate collar agreement which covered $100 million of our variable rate former term loan debt and was designated as a cash flow hedge of the variable interest payments on such debt. The interest rate collar agreement matured on January 31, 2009.
The fair value of our derivative instruments in our accompanying audited consolidated balance sheets were as follows:
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9-FAIR VALUE MEASUREMENTS: (Continued)
The effect of derivative instruments designated as cash flow hedges on our accompanying consolidated financial statements were as follows:
NOTE 10-LEASE COMMITMENTS:
Rent expense under operating leases was approximately $70,080,000 for the fiscal year ended January 1, 2011, $65,239,000 for the fiscal year ended January 2, 2010, and $57,914,000 for the fiscal year ended January 3, 2009.
Minimum annual rental commitments under current noncancellable operating leases as of January 1, 2011 were as follows:
We currently operate 486 leased retail stores located primarily in outlet and strip centers across the United States, having an average size of approximately 4,600 square feet. Generally, the majority of our leases have an average term of approximately ten years.
In accordance with accounting guidance on leases, we review all of our leases to determine whether they qualify as operating or capital leases. As of January 1, 2011, all of our leases are classified as operating. Leasehold improvements are amortized over the lesser of the useful life of the asset or current lease term. We account for free rent periods and scheduled rent increases on a straight-line basis over the lease term. Landlord allowances and incentives are recorded as deferred rent and are amortized as a reduction to rent expense over the lease term.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11-COMMITMENTS AND CONTINGENCIES:
A shareholder class action lawsuit was filed on September 19, 2008 in the United States District Court for the Northern District of Georgia entitled Plymouth County Retirement System v. Carter’s, Inc., No. 1:08-CV-02940-JOF (the “Plymouth Action”). The Amended Complaint filed on May 12, 2009 in the Plymouth Action asserted claims under Sections 10(b), 20(a), and 20A of the 1934 Securities Exchange Act, and alleged that between February 1, 2006 and July 24, 2007, the Company and certain current and former executives made misrepresentations to investors regarding the successful integration of OshKosh into the Company’s business, and that the share price of the Company’s stock later fell when the market learned that the integration had not been as successful as represented. Defendants in the Plymouth Action filed a motion to dismiss the Amended Complaint for failure to state a claim under the federal securities laws on July 17, 2009, and briefing of that motion was complete on October 22, 2009.
A separate shareholder class action lawsuit was filed on November 17, 2009 in the United States District Court for the Northern District of Georgia entitled Mylroie v. Carter’s, Inc., No. 1:09-CV-3196-JOF (the “Mylroie Action”). The initial Complaint in the Mylroie Action asserted claims under Sections 10(b) and 20(a) of the 1934 Securities Exchange Act, and alleged that between April 27, 2004 and November 10, 2009, the Company and certain current and former executives made misstatements to investors regarding the Company’s accounting for discounts offered to some wholesale customers. The Court consolidated the Plymouth Action and the Mylroie Action on November 24, 2009 (the “Consolidated Action”). On March 15, 2010, the plaintiffs in the Consolidated Action filed their amended and consolidated complaint. The Company filed a motion to dismiss on April 30, 2010, and briefing of the motion was complete on July 23, 2010. The parties are awaiting an oral argument date and/or a decision from the Court. The Company intends to vigorously defend against the claims in the Consolidated Action.
A shareholder derivative lawsuit was filed on May 25, 2010 in the Superior Court of Fulton County, Georgia, entitled Alvarado v. Bloom, No. 2010-cv-186118 (the “Alvarado Action”). The Complaint in the Alvarado Action alleges, among other things, that certain current and former directors and executives of the Company breached their fiduciary duties to the Company in connection with the Company’s accounting for discounts offered to some wholesale customers. The Company is named solely as a nominal defendant against whom the plaintiff seeks no recovery. Pursuant to a series of stipulations among the parties, the Court has temporarily deferred the defendants’ obligation to respond to the Complaint pending timely resolution of the motions to dismiss filed in the Consolidated Action referenced above.
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. From time to time, our operations have resulted or may result in noncompliance with or liability pursuant to environmental laws. 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.
We also have other commitments and contingent liabilities related to legal proceedings, self-insurance programs, and matters arising out of the normal course of business. We accrue contingencies based upon a range of possible outcomes. If no amount within this range is a better estimate than any other, then we accrue the minimum amount. Management does not anticipate that in the aggregate such losses would have a material adverse effect on the Company’s consolidated financial position or liquidity; however, it is possible that the final outcomes could have a significant impact on the Company’s reported results of operations in any given period.
As of January 1, 2011, we have entered into various purchase order commitments with our suppliers for merchandise for resale that approximates $530.4 million. 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.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12-OTHER CURRENT LIABILITIES:
Other current liabilities consisted of the following:
NOTE 13-VALUATION AND QUALIFYING ACCOUNTS:
Information regarding accounts receivable reserves is as follows:
NOTE 14-SEGMENT INFORMATION:
We report segment information in accordance with accounting guidance on segment reporting which requires segment information to be disclosed based upon a “management approach.” The management approach refers to the internal reporting that is used by management for making operating decisions and assessing the performance of our reportable segments. We report our corporate expenses, workforce reduction, and facility write-down and closure costs separately as they are not included in the internal measures of segment operating performance used by the Company in order to measure the underlying performance of our reportable segments.
Segment results include the direct costs of each segment and all other costs are allocated based upon detailed estimates and analysis of actual time and expenses incurred to support the operations of each segment or units produced or sourced to support each segment’s revenue. Certain costs, including incentive compensation for certain employees, facility closure costs, and various other general corporate costs that are not specifically allocable to our segments, are included in other reconciling items below. Intersegment sales and transfers are recorded at cost and are treated as a transfer of inventory. The accounting policies of the segments are the same as those described in Note 2 to the consolidated financial statements.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14-SEGMENT INFORMATION: (Continued)
The table below presents certain segment information for the periods indicated:
(a)
Includes eCommerce results.
(b)
OshKosh mass channel consists of a licensing agreement with Target Stores. Operating income consists of royalty income, net of related expenses.
(c)
Corporate expenses generally include expenses related to incentive compensation, stock-based compensation, executive management, severance and relocation, finance, building occupancy, information technology, certain legal fees, consulting, and audit fees.
(d)
Includes closure costs associated with our Barnesville, Georgia distribution facility and our Oshkosh, Wisconsin facility, write-down of the White House, Tennessee facility, and severance and other benefits related to the corporate workforce reduction.
(e)
Professional service fees related to the investigation of margin support commitments.
(f)
Charges associated with an executive officer’s retirement.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14-SEGMENT INFORMATION: (Continued)
In fiscal 2010 and 2009, one customer accounted for approximately 10% of our consolidated net sales. In fiscal 2008, two customers accounted for approximately 10% of our consolidated net sales.
The table below represents inventory, net, by segment:
Wholesale inventories include inventory produced and warehoused for the retail segment.
All of our property, plant, and equipment, net, for the past three fiscal years have been located within the United States.
The following represents goodwill by segment:
NOTE 15-WORKFORCE REDUCTION, FACILITY WRITE-DOWN, AND CLOSURE COSTS:
Corporate Workforce Reduction
On April 21, 2009, the Company announced to affected employees a plan to reduce its corporate workforce (defined as excluding retail district managers, hourly retail store employees, and distribution center employees). Approximately 150 employees were affected under the plan. The plan included consolidating the majority of our operations performed in our Oshkosh, Wisconsin office into other Company locations. This consolidation has resulted in the addition of resources in our other locations.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15-WORKFORCE REDUCTION, FACILITY WRITE-DOWN, AND CLOSURE COSTS: (Continued)
As a result of this corporate workforce reduction, during fiscal 2009, we recorded net charges of $6.7 million consisting of $5.5 million in severance charges and other benefits ($3.3 million which related to corporate office positions in connection with our existing plan and $2.2 million of special one-time benefits provided to affected employees), and approximately $1.2 million in asset impairment charges net of a gain related to the closure and sale of our Oshkosh, Wisconsin office.
The following table summarizes restructuring reserves related to the corporate workforce reduction which are included in other current liabilities on the accompanying consolidated balance sheet:
Barnesville Distribution Facility Closure
On April 2, 2009, the Company announced to affected employees a plan to close its Barnesville, Georgia distribution facility. Approximately 210 employees were affected by this closure. Operations at the Barnesville facility ceased on June 1, 2009.
In accordance with accounting guidance on accounting for the impairment or disposal of long-lived assets, under a held and used model, it was determined that the distribution facility assets became impaired during March 2009, when it became “more likely than not” that the expected life of the Barnesville, Georgia distribution facility would be significantly shortened. Accordingly, we wrote down the assets to their estimated recoverable fair value in March 2009. The adjusted asset values were subject to accelerated depreciation over their remaining estimated useful life.
In conjunction with the plan to close the Barnesville, Georgia distribution facility, the Company recorded approximately $4.3 million during fiscal 2009, consisting of severance of $1.7 million, asset impairment charges of $1.1 million related to the write-down of the related land, building, and equipment, $1.0 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.5 million of other closure costs. On February 21, 2011, the Company sold the facility for zero net proceeds.
The following table summarizes restructuring reserves related to the closure of the Barnesville, Georgia distribution facility which are included in other current liabilities on the accompanying consolidated balance sheet:
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15-WORKFORCE REDUCTION, FACILITY WRITE-DOWN, AND CLOSURE COSTS: (Continued)
White House, Tennessee Distribution Facility
The Company continually evaluates opportunities to reduce its supply chain complexity and lower costs. In the first quarter of fiscal 2007, the Company determined that OshKosh brand products could be effectively distributed through its other distribution facilities and third-party logistics providers. On February 15, 2007, the Company’s Board of Directors approved management’s plan to close the Company’s OshKosh distribution facility, which was utilized to distribute the Company’s OshKosh brand products.
In accordance with accounting guidance on impairment or disposal of long-lived assets, under a held and used model, it was determined that the distribution facility assets were impaired as of the end of January 2007, as it became “more likely than not” that the expected life of the OshKosh distribution facility would be significantly shortened. Accordingly, we wrote down the assets to their estimated recoverable fair value as of the end of January 2007. The adjusted asset values were subject to accelerated depreciation over their remaining estimated useful life. Distribution operations at the OshKosh facility ceased as of April 5, 2007, at which point the land, building, and equipment assets of $6.1 million were reclassified as held for sale. For a majority of the affected employees, severance benefits were communicated on February 20, 2007. Approximately 215 employees were terminated. During fiscal 2007, 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 of other closure costs. As of January 2, 2010, there were no remaining liabilities associated with this facility closure.
Due to declines in the commercial real estate market in 2008, the Company lowered the selling price of the facility during the third quarter of fiscal 2008 and wrote down the carrying value of the facility by $2.6 million to $3.5 million (classified as an asset held for sale within prepaid expenses and other current assets on the accompanying audited consolidated balance sheets) to reflect the new anticipated selling price. During fiscal 2009, the Company wrote down the carrying value of its White House, Tennessee distribution facility by approximately $0.7 million to $2.8 million to reflect the decrease in the fair market value. During the third quarter of fiscal 2009, the Company sold the facility for net proceeds of approximately $2.8 million.
NOTE 16-INVESTIGATION EXPENSES:
In connection with the investigation of customer margin support, the Company recorded pre-tax charges in the fourth quarter of fiscal 2009 of approximately $5.7 million in professional service fees.
NOTE 17-EXECUTIVE RETIREMENT CHARGES:
On June 11, 2008, the Company announced the retirement of an executive officer. In connection with this retirement, the Company recorded charges during the second quarter of fiscal 2008 of $5.3 million, $3.1 million of which related to the present value of severance and benefit obligations, and $2.2 million of which related to the accelerated vesting of stock options.
CARTER’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 18-UNAUDITED QUARTERLY FINANCIAL DATA:
The unaudited summarized financial data by quarter for the fiscal years ended January 1, 2011 and January 2, 2010 is presented in the table below:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of January 1, 2011.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, 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. Internal control over financial reporting includes those policies and procedures that:
· pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of
the Company;
· 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
· 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.
Management, including our Chief Executive Officer and Chief Financial Officer assessed the effectiveness of the Company’s internal control over financial reporting as of January 1, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of January 1, 2011.
The effectiveness of Carter’s, Inc. and its subsidiaries’ internal control over financial reporting as of January 1, 2011 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Remediation Actions
In our Annual Report on Form 10-K for the year ended January 2, 2010, management identified material weaknesses in our internal control over financial reporting with respect to internal controls associated with its customer accommodations processes and the control environment of the sales organization. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
In response to these material weaknesses, management has implemented the following remediation actions during the fiscal year ended January 1, 2011:
·
Making personnel changes, including the separation of certain employees from the Company, and a restructuring of the Company’s sales organization;
·
Establishing more comprehensive procedures for authorizing accommodations, including tiered accommodations approval levels that include the Chief Financial Officer and Chief Executive Officer;
·
Implementing a periodic training program for all sales personnel regarding the appropriate accounting for accommodations and the impact on the Company’s financial statements of recording such customer accommodations;
·
Implementing procedures to improve the capture, review, approval, and recording of all accommodation arrangements in the appropriate accounting period;
·
Establishing a new position in the finance organization with responsibilities to include tracking, monitoring, and reviewing all customer accommodations, including certain budgetary responsibilities for accommodations;
·
Improving the method of educating employees on the Company’s Code of Business Ethics and Professional Conduct; and
·
Reemphasizing to all employees the availability of the Company’s Financial Accounting and Reporting Hotline and communicating information to the Company’s vendors and customers about this Hotline, which is available to both Company employees and its business partners.
Management has determined as of January 1, 2011, that the remediation actions discussed above were effectively designed and demonstrated effective operation for a sufficient period of time to enable the Company to conclude that the material weaknesses regarding its internal controls associated with its customer accommodations processes and the control environment of the sales organization have been remediated.
Changes in Internal Control over Financial Reporting
During the fourth quarter ended January 1, 2011, the Company completed its remediation effort related to reemphasizing to all employees the availability of the Company’s Financial Accounting and Reporting Hotline and communicating information to the Company’s vendors and customers about this Hotline, which is available to both Company employees and its business partners. This completed remediation effort represents changes in internal control over financial reporting during the quarter ended January 1, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by Item 10 is incorporated herein by reference to the definitive proxy statement relating to the Annual Meeting of Stockholders of Carter’s, Inc. to be held on May 13, 2011. Carter’s, Inc. intends to file such definitive proxy statement with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 is incorporated herein by reference to the definitive proxy statement referenced above in Item 10.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information about our equity compensation plan as of our last fiscal year:
(1)
Represents stock options that are outstanding or that are available for future issuance pursuant to the Carter’s, Inc.’s Amended and Restated 2003 Equity Incentive Plan.
Additional information called for by Item 12 is incorporated herein by reference to the definitive proxy statement referenced above in Item 10.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 13 is incorporated herein by reference to the definitive proxy statement referenced above in Item 10.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by Item 14 is incorporated herein by reference to the definitive proxy statement referenced above in Item 10.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Page
(A)
1.
Financial Statements filed as part of this report
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at January 1, 2011 and January 2, 2010
Consolidated Statements of Operations for the fiscal years ended January 1, 2011, January 2, 2010, and January 3, 2009
Consolidated Statements of Cash Flows for the fiscal years ended January 1, 2011, January 2, 2010, and January 3, 2009
Consolidated Statements of Changes in Stockholders’ Equity for the fiscal years ended January 1, 2011, January 2, 2010, and January 3, 2009
Notes to Consolidated Financial Statements
2.
Financial Statement Schedules: None
(B)
Exhibits:
Exhibit Number
Description of Exhibits
3.1
Certificate of Incorporation of Carter’s, Inc., as amended on May 12, 2006.*******
3.2
By-laws of Carter’s, Inc.**
4.1
Specimen Certificate of Common Stock. ***
10.1
Credit Agreement dated as of October 15, 2010, among The William Carter Company, as borrower, Bank of America, N.A., as Administrative Agent, Swing Line Lender, L/C Issuer and Collateral Agent, JPMorgan Chase Bank, N.A., as Syndication Agent, Royal Bank of Canada, SunTrust Bank and U.S. Bank National Association, as Co-Documentation Agents, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Bookrunning Manager, and certain other lenders party thereto. *********
10.2
Amended and Restated Severance Agreement between The William Carter Company and Michael D. Casey, dated as of March 2, 2011.
10.3
Severance Agreement between The William Carter Company and Lisa A. Fitzgerald, dated as of March 2, 2011.
10.4
Amended and Restated Severance Agreement between The William Carter Company and Greg Foglesong, dated as of March 2, 2011.
10.5
Amended and Restated Severance Agreement between The William Carter Company and Brendan M. Gibbons, dated as of March 2, 2011.
10.6
Amended and Restated Severance Agreement between The William Carter Company and Brian J. Lynch, dated as of March 2, 2011.
10.7
Amended and Restated Severance Agreement between Carter’s Retail, Inc. and James C. Petty, dated as of March 2, 2011.
10.8
Amended and Restated Severance Agreement between The William Carter Company and Richard F. Westenberger, dated as of March 2, 2011.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(a) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized, in Atlanta, Georgia on March 2, 2011.
CARTER’S, INC.
/s/ MICHAEL D. CASEY
Michael D. Casey
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated.
Name
Title
/s/ MICHAEL D. CASEY
Chairman and Chief Executive Officer
Michael D. Casey
(Principal Executive Officer)
/s/ RICHARD F. WESTENBERGER
Executive Vice President and Chief Financial Officer
Richard F. Westenberger
(Principal Financial and Accounting Officer)
/s/ AMY WOODS BRINKLEY
Director
Amy Woods Brinkley
/s/ VANESSA J. CASTAGNA
Director
Vanessa J. Castagna
/s/ A. BRUCE CLEVERLY
Director
A. Bruce Cleverly
/s/ JEVIN S. EAGLE
Director
Jevin S. Eagle
/s/ PAUL FULTON
Director
Paul Fulton
/s/ WILLIAM J. MONTGORIS
Director
William J. Montgoris
/s/ DAVID PULVER
Director
David Pulver
/s/ JOHN R. WELCH
Director
John R. Welch
/s/ THOMAS E. WHIDDON
Director
Thomas E. Whiddon