**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, DC 20549**

 

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**FORM 10-Q**

 

| **ý**                             |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY  PERIOD ENDED JULY 5, 2003** |
|----------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
|                                   |   |                                                                                                                                      |
| **OR**                                 |
|                                   |   |                                                                                                                                      |
| **o**                                  |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                             |
|                                   |   |                                                                                                                                      |
| **Commission file number:  333-22155** |

 

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**THE WILLIAM CARTER COMPANY**

(Exact name of registrant as specified in charter)

 

| **Massachusetts**                                               |                                                                                  | **04-1156680**                    |
|-----------------------------------------------------------------|---------------------------------------------------------------------------------------|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |                                                                                  | (IRS Employer Identification No.) |
|                                                            |                                                                                  |                              |
|                                                            | **The Proscenium  1170 Peachtree Street NE, Suite 900  Atlanta, Georgia  30309** |                              |
| (Address of principal executive offices, including zip code)    |
|                                                            |                                                                                  |                              |
|                                                            | **(404) 745-2700**                                                                    |                              |
| (Registrant’s telephone number, including area code)       |
|                                                                 |                                                                                       |                                   |  |  |  |  |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý     No o

 

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

 

Applicable only to corporate issuers:

 

As of August 19, 2003, there were 1,000 shares of Common Stockoutstanding.

 

 

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**FORM 10-Q**

 

**THE WILLIAM CARTERCOMPANY**

**(A WHOLLY-OWNEDSUBSIDIARY OF CARTER HOLDINGS, INC.)**

**INDEX**

 
| **Part I.**  | Financial  Information                                                                                                               |
|--------------|--------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                 |
| Item 1.      | Financial  Statements                                                                                                                |
|         |                                                                                                                                 |
|         | Condensed Consolidated Balance Sheets as of  July 5, 2003 (unaudited) and December 28, 2002                                          |
|         |                                                                                                                                 |
|         | Unaudited Condensed Consolidated Statements  of Operations for the three and six-month periods ended July 5, 2003 and June  29, 2002 |
|         |                                                                                                                                 |
|         | Unaudited Condensed Consolidated Statements  of Cash Flows for the six-month periods ended July 5, 2003 and June 29, 2002            |
|         |                                                                                                                                 |
|         | Notes to the Unaudited Condensed  Consolidated Financial Statements                                                                  |
|         |                                                                                                                                 |
| Item 2.      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                          |
|         |                                                                                                                                 |
| Item 3.      | Quantitative and Qualitative Disclosures  about Market Risks                                                                         |
|         |                                                                                                                                 |
| Item 4.      | Disclosure Controls and Procedures                                                                                                   |
|         |                                                                                                                                 |
| **Part II.** | Other Information                                                                                                                    |

 

2

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**THE WILLIAM CARTERCOMPANY**

**(A WHOLLY-OWNEDSUBSIDIARY OF CARTER HOLDINGS, INC.)**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(dollars in thousands, except per share data)

 
|                                                                                                                                                   |   | **July 5,  2003** |    | **December  28,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-------------------------|--------|
|                                                                                                                                                   |   | **(unaudited)**   |    |                    |   |
| **ASSETS**                                                                                                                                             |   |              |    |                    |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Current assets:                                                                                                                                        |   |              |    |                    |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Cash  and cash equivalents                                                                                                                             |   | $                 | 4,959   |                    | $      | 35,562 |   |
| Accounts receivable, net                                                                                                                               |   | 59,904            |    | 53,600                  |   |
| Inventories, net                                                                                                                                       |   | 132,910           |    | 105,700                 |   |
| Prepaid expenses and other current assets                                                                                                              |   | 5,065             |    | 4,903                   |   |
| Deferred income taxes                                                                                                                                  |   | 11,096            |    | 10,021                  |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Total current assets                                                                                                                                   |   | 213,934           |    | 209,786                 |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Property, plant, and equipment, net                                                                                                                    |   | 49,952            |    | 50,476                  |   |
| Tradename                                                                                                                                              |   | 220,233           |    | 220,233                 |   |
| Cost in excess of fair value of net assets  acquired                                                                                                   |   | 139,282           |    | 139,282                 |   |
| Licensing agreements, net of accumulated  amortization of $9,375 and $6,875                                                                            |   | 5,625             |    | 8,125                   |   |
| Deferred debt issuance costs, net                                                                                                                      |   | 10,433            |    | 11,248                  |   |
| Other assets                                                                                                                                           |   | 3,659             |    | 4,199                   |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Total assets                                                                                                                                           |   | $                 | 643,118 |                    | $      | 643,349 |   |
|                                                                                                                                                   |   |              |    |                    |   |
| **LIABILITIES AND STOCKHOLDER’S EQUITY**                                                                                                          |   |              |    |                    |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Current liabilities:                                                                                                                                   |   |              |    |                    |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Current maturities of long-term debt                                                                                                                   |   | $                 | 1,201   |                    | $      | 6,346 |   |
| Accounts payable                                                                                                                                       |   | 34,253            |    | 34,669                  |   |
| Other current liabilities                                                                                                                              |   | 36,161            |    | 38,309                  |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Total current liabilities                                                                                                                              |   | 71,615            |    | 79,324                  |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Long-term debt                                                                                                                                         |   | 290,742           |    | 291,276                 |   |
| Deferred income taxes                                                                                                                                  |   | 82,926            |    | 83,873                  |   |
| Other long-term liabilities                                                                                                                            |   | 10,001            |    | 10,140                  |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Total liabilities                                                                                                                                      |   | 455,284           |    | 464,613                 |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Commitments and contingencies                                                                                                                          |   |              |    |                    |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Common stockholder’s equity:                                                                                                                      |   |              |    |                    |   |
| Common stock, voting; par value $.01 per  share; 200,000 shares authorized, 1,000 shares issued and outstanding at July  5, 2003 and December 28, 2002 |   | —            |    | —                  |   |
| Additional paid-in capital                                                                                                                             |   | 146,745           |    | 146,645                 |   |
| Retained earnings                                                                                                                                      |   | 41,089            |    | 32,091                  |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Total common stockholder’s equity                                                                                                                 |   | 187,834           |    | 178,736                 |   |
|                                                                                                                                                   |   |              |    |                    |   |
| Total liabilities and stockholder’s equity                                                                                                        |   | $                 | 643,118 |                    | $      | 643,349 |   |

 

See accompanying notes to the unaudited condensed consolidatedfinancial statements

 

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**THE WILLIAM CARTERCOMPANY**

**(A WHOLLY-OWNEDSUBSIDIARY OF CARTER HOLDINGS, INC.)**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(dollars in thousands)

(unaudited)

 
|                                           |   | **For the  three-month periods ended** |    | **For the  six-month periods ended** |   |
|------------------------------------------------|--------|----------------------------------------|---------|--------------------------------------|--------|
|                                           |   | **July 5,  2003**                      |    | **June 29,  2002**                   |   | **July 5,  2003** |   | **June 29,  2002** |   |
|                                           |   |                                   |    |                                 |   |   |   |   |   |
| Net  sales                                     |   | $                                      | 140,008 |                                 | $      | 119,095 |   | $ | 306,001 |   | $ | 243,690 |   |
| Cost  of goods sold                            |   | 90,153                                 |    | 73,363                               |   | 195,542 |   | 150,069 |   |
|                                           |   |                                   |    |                                 |   |   |   |   |   |
| Gross  profit                                  |   | 49,855                                 |    | 45,732                               |   | 110,459 |   | 93,621 |   |
| Selling,  general, and administrative expenses |   | 41,843                                 |    | 39,642                               |   | 86,764 |   | 78,913 |   |
| Royalty income                                 |   | (1,903                                 | )       | (1,814                               | )      | (4,457 | ) | (3,775 | ) |
|                                           |   |                                   |    |                                 |   |   |   |   |   |
| Operating income                               |   | 9,915                                  |    | 7,904                                |   | 28,152 |   | 18,483 |   |
| Interest expense, net                          |   | 6,519                                  |    | 7,081                                |   | 13,521 |   | 13,970 |   |
|                                           |   |                                   |    |                                 |   |   |   |   |   |
| Income before income taxes                     |   | 3,396                                  |    | 823                                  |   | 14,631 |   | 4,513 |   |
| Provision for income taxes                     |   | 1,308                                  |    | 317                                  |   | 5,633 |   | 1,738 |   |
|                                           |   |                                   |    |                                 |   |   |   |   |   |
| Net income                                     |   | $                                      | 2,088   |                                 | $      | 506 |   | $ | 8,998 |   | $ | 2,775 |   |

 

See accompanying notes to the unaudited condensed consolidatedfinancial statements

 

4

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**THEWILLIAM CARTER COMPANY**

**(A WHOLLY-OWNEDSUBSIDIARY OF CARTER HOLDINGS, INC.)**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(dollars in thousands)

(unaudited)

 
|                                                                           |   | **For the  six-month periods ended** |   |
|--------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                           |   | **July 5,  2003**                    |   | **June 29,  2002** |   |
| Cash flows from operating activities:                                          |   |                                 |   |   |   |
|                                                                           |   |                                 |   |   |   |
| Net  income                                                                    |   | $                                    | 8,998  |   | $ | 2,775 |   |
| Adjustments to reconcile net income to net  cash used in operating activities: |   |                                 |   |   |   |
| Depreciation and amortization                                                  |   | 9,991                                |   | 8,565 |   |
| Amortization of debt issuance costs                                            |   | 815                                  |   | 815 |   |
| Accretion of debt discount                                                     |   | 66                                   |   | 65 |   |
| Non-cash compensation expense                                                  |   | —                               |   | 308 |   |
| Gain on sale of property, plant, and  equipment                                |   | (21                                  | )      | (200 | ) |
| Deferred tax benefit                                                           |   | (2,022                               | )      | (661 | ) |
| Effect of changes in operating assets and  liabilities:                        |   |                                 |   |   |   |
| (Increase) decrease in assets:                                                 |   |                                 |   |   |   |
| Accounts receivable                                                            |   | (6,304                               | )      | (4,612 | ) |
| Inventories                                                                    |   | (27,210                              | )      | (9,032 | ) |
| Prepaid expenses and other assets                                              |   | (672                                 | )      | 1,118 |   |
| (Decrease) increase in liabilities:                                            |   |                                 |   |   |   |
| Accounts payable and other liabilities                                         |   | (5,579                               | )      | 227 |   |
|                                                                           |   |                                 |   |   |   |
| Net cash used in operating activities                                          |   | (21,938                              | )      | (632 | ) |
|                                                                           |   |                                 |   |   |   |
| Cash  flows from investing activities:                                         |   |                                 |   |   |   |
|                                                                           |   |                                 |   |   |   |
| Capital expenditures                                                           |   | (6,810                               | )      | (5,552 | ) |
| Proceeds  from sale of property, plant, and equipment                          |   | 275                                  |   | 498 |   |
| Collections on loan                                                            |   | 600                                  |   | — |   |
|                                                                           |   |                                 |   |   |   |
| Net cash used in investing activities                                          |   | (5,935                               | )      | (5,054 | ) |
|                                                                           |   |                                 |   |   |   |
| Cash flows from financing activities:                                          |   |                                 |   |   |   |
|                                                                           |   |                                 |   |   |   |
| Payments of term loan                                                          |   | (5,745                               | )      | (937 | ) |
| Payments of capital lease obligations                                          |   | (129                                 | )      | (415 | ) |
| Proceeds  from contributions from Holdings                                     |   | 100                                  |   | 500 |   |
| Other                                                                          |   | 3,044                                |   | — |   |
|                                                                           |   |                                 |   |   |   |
| Net cash used in financing activities                                          |   | (2,730                               | )      | (852 | ) |
|                                                                           |   |                                 |   |   |   |
| Net decrease in cash and cash equivalents                                      |   | (30,603                              | )      | (6,538 | ) |
| Cash and cash equivalents, beginning of  period                                |   | 35,562                               |   | 24,692 |   |
|                                                                           |   |                                 |   |   |   |
| Cash and cash equivalents, end of period                                       |   | $                                    | 4,959  |   | $ | 18,154 |   |

 

See accompanying notes to the unaudited condensed consolidatedfinancial statements

 

5

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**THE WILLIAM CARTER COMPANY**

**(A WHOLLY-OWNEDSUBSIDIARY OF CARTER HOLDINGS, INC.)**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

(unaudited)

 

**NOTE 1 — BASIS OF PREPARATION:**

 

In our opinion, the accompanying unaudited condensed consolidatedfinancial statements of The William Carter Company (“Carter’s,” “we,” “us,” and“our”) contain all adjustments necessary to present fairly our financialposition as of July 5, 2003, the results of our operations for the three-monthand six-month periods ended July 5, 2003 and June 29, 2002, and cash flows forthe six-month periods ended July 5, 2003 and June 29, 2002.  Operating results for the six-month periodended July 5, 2003 are not necessarily indicative of the results that may beexpected for the fiscal year ending January 3, 2004.  Our accompanying condensed consolidated balance sheet as ofDecember 28, 2002 is from our audited consolidated financial statementsincluded in our most recently filed annual report on Form 10-K.

 

Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples in the United States of America have been condensed or omittedpursuant to the rules and regulations of the Securities and Exchange Commissionand the instructions to Form 10-Q.  Theaccounting policies we follow, except as described in Note 7, are set forth inour most recently filed annual report on Form 10-K in the Notes to ourConsolidated Financial Statements for the fiscal year ended December 28, 2002.

 

Our fiscal year ends on the Saturday in December or January nearest thelast day of December.  Consistent withthis policy, fiscal 2002 ended on December 28, 2002, and fiscal 2003 will endon January 3, 2004.  As a result, fiscal2003 will contain 53 weeks of financial results.  The additional week in fiscal 2003 was included in the first halfof 2003.  Therefore, the accompanyingconsolidated financial statements for the first half of 2003 reflect our financialposition as of July 5, 2003 and for the 27-week period then ended.  The first half of 2002 ended on June 29,2002 and included 26 weeks of financial results.  The accompanying consolidated financial statements for the secondquarter periods ended July 5, 2003 and June 29, 2002 each contain 13 weeks offinancial results.

 

Certain prior year amounts have beenreclassified for comparative purposes.

 

STOCK BASED COMPENSATION:

 

We account for stock-based compensation on stock options under theintrinsic value method consistent with Accounting Principles Board Opinion No.25 (“APB 25”).  Under this method, werecord compensation expense equal to the difference between the exercise priceof the stock option and the fair market value of the underlying stock as of thedate of the option grant.  Fordisclosure purposes only, we also estimate the impact on our net income ofapplying the fair value method of measuring compensation cost on stock optionswith the fair value determined under the minimum value method as provided byStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”) as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”).

 

6

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The following table illustrates the effect on net income ifcompensation expense for our option grants had been determined based on thefair value as of the grant dates consistent with the methodology of SFAS 123and SFAS 148 ($000):

 
|                                                                                                                                                                     |   | **For the  three-month periods ended** |   | **For the****six-month periods ended** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                                                                     |   | **July 5,****2003**                    |   | **June 29,****2002**                   |   | **July 5,****2003** |   | **June 29,****2002** |   |
|                                                                                                                                                                     |   |                                   |   |                                   |   |   |   |   |   |
| Net  income, as reported                                                                                                                                                 |   | $                                      | 2,088  |                                   | $      | 506 |   | $ | 8,998 |   | $ | 2,775 |   |
|                                                                                                                                                                     |   |                                   |   |                                   |   |   |   |   |   |
| Add:                                                                                                                                                                     |   |                                   |   |                                   |   |   |   |   |   |
| Stock-based  employee compensation (under APB 25) included in reported net income, net of  related tax effects                                                           |   | 4                                      |   | 2                                      |   | 8 |   | 2 |   |
| Deduct:                                                                                                                                                                  |   |                                   |   |                                   |   |   |   |   |   |
| Total  stock-based employee compensation expense determined under the fair value  based method (under SFAS 123 and SFAS 148) for all awards, net of related tax  effects |   | (135                                   | )      | (123                                   | )      | (267 | ) | (245 | ) |
|                                                                                                                                                                     |   |                                   |   |                                   |   |   |   |   |   |
| Pro forma  net income                                                                                                                                                    |   | $                                      | 1,957  |                                   | $      | 385 |   | $ | 8,739 |   | $ | 2,532 |   |

 

For basicoptions, using a minimum value method, the fair value of each option as of thedate of grant has been estimated to be approximately $10 per share for optionsgranted in 2003, $10 to $17 per share for options granted in 2002, and $10 pershare for options granted in 2001. These per share option values were calculated at an assumed risk freeinterest rate of 2.9% for 2003, 4.4% to 3.0% for 2002, and 5.5% for 2001, withan expected life of 10 years.  Nodividends were assumed.

 

Forperformance options, using a minimum value method, the fair value of eachoption as of the date of grant has been estimated to be approximately $10 pershare for options granted in 2003, $10 to $17 per share for options granted in2002, and $9 per share for options granted in 2001.  These per share option values were calculated at the same assumedrisk free interest rates shown above with an expected life of 10 years.  No dividends were assumed.

 

**NOTE 2 — THE COMPANY:**

 

Carter’s is awholly-owned subsidiary of Carter Holdings, Inc. (“Holdings”).  Holdings has no significant assets orinvestments other than the shares of Carter’s common stock.

 

We design,source, manufacture, and market premier branded childrenswear under the *Carter’s*,*Carter’s Classics,**Child of Mine,* and *Tykes*brand names.  Our products are sourced through productionat company-based sewing facilities located in Costa Rica and Mexico and throughcontractual arrangements with third-party manufacturers throughout theworld.  Products are manufactured forwholesale distribution to major domestic retailers and for our 159 retailstores that market our brand name merchandise and certain products manufacturedby other companies.  Our retailoperations represented approximately 40% and 46% of our consolidated net salesin the second quarter of 2003 and 2002, and approximately 37% and 45% in thefirst half of 2003 and 2002.

 

7

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**NOTE 3 — INVENTORIES:**

 

Inventoriesconsisted of the following ($000):

 
|                       |   | **July 5,  2003** |    | **December  28,  2002** |   |
|----------------------------|--------|-------------------|---------|-------------------------|--------|
| Finished goods             |   | $                 | 124,861 |                    | $      | 99,609 |   |
| Work in process            |   | 6,502             |    | 3,509                   |   |
| Raw materials and supplies |   | 1,547             |    | 2,582                   |   |
|                       |   |              |    |                    |   |
| Total                      |   | $                 | 132,910 |                    | $      | 105,700 |   |

 

**NOTE 4 — PARENT COMPANY TRANSACTIONS:**

 

During thefirst quarter of 2003, Holdings issued options to purchase its common stock toa director and certain employees. Additionally, during the second quarter ended July 5, 2003, Holdingssold shares of its common stock to one of our directors for cash proceeds of$100,000.  In connection with thistransaction, we recorded contributions from Holdings to our additional paid-incapital in the amount of $100,000.  Nocompensation expense was recorded on these option grants or stock purchase, asthe stock was purchased at its fair market value and options were issued withan exercise price equal to the fair market value of a share of stock as of thedate of grant.

 

During thesecond quarter ended June 29, 2002, Holdings sold shares of its common stock toone of our directors for cash proceeds of $500,000 and issued shares of itscommon stock to a consultant.  Inconnection with these transactions, as well as Holdings’ stock option grants tocertain employees, we recorded compensation expense during the second quarterended June 29, 2002 in the amount of approximately $641,000, received cash of$500,000, and recorded contributions from Holdings to our additional paid-incapital in the amount of approximately $1.1 million.

 

**NOTE 5 — GOODWILL AND OTHER INTANGIBLEASSETS:**

 

On August 15,2001, we adopted the provisions of SFAS No. 141, “Business Combinations” (“SFAS141”) and applied the required provisions of SFAS No. 142, “Goodwill and OtherIntangible Assets” (“SFAS 142”). Accordingly, our tradename and goodwill have been deemed to haveindefinite lives and are no longer being amortized.  Our licensing agreements are being amortized over the averagethree-year life of such agreements. Amortization expense for the second quarter and first half of 2003 and2002 was $1.3 million and $2.5 million, respectively, and is expected to be atotal of $5.0 million for fiscal 2003 and $3.1 million for 2004.

 

**NOTE 6 — SEGMENT INFORMATION:**

 

Our twobusiness segments are “Wholesale” and “Retail.”  We generally sell the same products in each businesssegment.  Wholesale products are offeredthrough our Wholesale distribution channel while the Retail segment reflectsthe operations of our retail stores. Each segment’s results include the costs directly related to thesegment’s revenue and all other costs are allocated based on the relationshipof such costs to consolidated net sales or units produced to support eachsegment’s revenue.

 

8

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

 
|            |   | **For the****three-month periods ended** |    | **For the****six-month periods ended** |   |
|-----------------|--------|------------------------------------------|---------|----------------------------------------|--------|
|            |   | **July 5,****2003**                      |    | **June 29,  2002**                     |   | **July 5,  2003** |   | **June 29,****2002** |   |
|            |   |                                     |    |                                   |   |   |   |   |   |
| **Net sales:**  |   |                                     |    |                                   |   |   |   |   |   |
| Wholesale       |   | $                                        | 83,429  |                                   | $      | 64,168 |   | $ | 192,480 |   | $ | 135,228 |   |
| Retail          |   | 56,579                                   |    | 54,927                                 |   | 113,521 |   | 108,462 |   |
| Total net sales |   | $                                        | 140,008 |                                   | $      | 119,095 |   | $ | 306,001 |   | $ | 243,690 |   |
|            |   |                                     |    |                                   |   |   |   |   |   |
| **EBITDA:**     |   |                                     |    |                                   |   |   |   |   |   |
| Wholesale       |   | $                                        | 6,450   |                                   | $      | 4,920 |   | $ | 22,635 |   | $ | 13,486 |   |
| Retail          |   | 8,507                                    |    | 7,382                                  |   | 15,508 |   | 13,562 |   |
| Total EBITDA    |   | $                                        | 14,957  |                                   | $      | 12,302 |   | $ | 38,143 |   | $ | 27,048 |   |

 

EBITDA shownabove, represents earnings before interest, income tax expense, depreciation,and amortization.  EBITDA is presentedbecause it is one measurement used by management in assessing financialperformance, and we believe it is helpful to investors, securities analysts,and other interested parties in evaluating performance of companies in ourindustry.  EBITDA is also a measure usedas a basis for calculating our financial covenants under our senior creditfacility.  Additionally, we believeEBITDA is an accepted indicator of our ability to incur and service debtobligations and make capital expenditures. EBITDA is not a measurement of financial performance under generallyaccepted accounting principles in the United States of America.  It should not be considered as analternative to cash flow from operating activities, as a measure of liquidity,an alternative to net income or any other measures of performance derived inaccordance with generally accepted accounting principles.  Our definition and calculation of EBITDA maynot be comparable to similarly titled measures used by other companies.

 

Areconciliation of total EBITDA to net income is presented below ($000):

 
|                                   |   | **For the  three-month periods ended** |   | **For the****six-month periods ended** |   |
|----------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|
|                                   |   | **July 5,****2003**                    |   | **June 29,****2002**                   |   | **July 5,****2003** |   | **June 29,****2002** |   |
|                                   |   |                                   |   |                                   |   |   |   |   |   |
|                                   |   |                                   |   |                                   |   |   |   |   |   |
| Total EBITDA                           |   | $                                      | 14,957 |                                   | $      | 12,302 |   | $ | 38,143 |   | $ | 27,048 |   |
| Depreciation and amortization  expense |   | (5,042                                 | )      | (4,398                                 | )      | (9,991 | ) | (8,565 | ) |
| Interest expense, net                  |   | (6,519                                 | )      | (7,081                                 | )      | (13,521 | ) | (13,970 | ) |
| Provision for income taxes             |   | (1,308                                 | )      | (317                                   | )      | (5,633 | ) | (1,738 | ) |
| Net income                             |   | $                                      | 2,088  |                                   | $      | 506 |   | $ | 8,998 |   | $ | 2,775 |   |

* *

**NOTE 7 — RECENT ACCOUNTING PRONOUNCEMENTS:**

 

In August2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143,“Accounting for Asset Retirement Obligations” (“SFAS 143”).  SFAS 143 requires recording the fair marketvalue of an asset retirement obligation as a liability in the period in which alegal obligation associated with the retirement of tangible long-lived assetsis incurred (including certain lease obligations).  SFAS 143 also requires recording an asset offsetting the initialobligation as an increase to the carrying amount of the related long-livedasset and depreciation of that cost over the life of the asset.  We adopted the provisions of SFAS 143 in thefirst quarter of 2003, and the impact of such adoption was not material to ourfinancial position or results of operations for the second quarter or firsthalf of 2003.

 

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In April 2002,the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS145”).  SFAS 145 rescinds FASB StatementNo. 4, which required all gains and losses from extinguishments of debt to beaggregated and, if material, classified as an extraordinary item, net of therelated income tax effect.  As a result,the criteria in Accounting Principles Board Opinion 30 will now be used toclassify those gains and losses.  Theprovisions of SFAS 145, as related to the rescission of FASB Statement No. 4,are effective for fiscal 2003.  In thefirst quarter of 2003, we adopted the provisions of SFAS 145 and theextraordinary item recorded in the Predecessor period from December 31, 2000through August 14, 2001 will be reclassified in our Annual Report on Form 10-Kfor the year ended January 3, 2004.

 

In July 2002,the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (“SFAS 146”).  SFAS146 sets forth various modifications to existing accounting guidance, whichprescribes the conditions that must be met in order for costs associated withcontract terminations, facility consolidations, and employee relocations andterminations to be accrued and recorded as liabilities in financialstatements.  Accordingly, SFAS 146 mayaffect the timing of recognizing any of our future restructuring costs as wellas the amount recognized.  SFAS 146 alsoestablishes that the liability should initially be measured and recorded atfair value.  The provisions of SFAS 146are required to be applied prospectively to exit or disposal activitiesinitiated by us after December 31, 2002. See Note 8 to the unaudited consolidated financial statements regardingour decision to close two of our production facilities.

 

In November2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” (“FIN 45”).  FIN45 requires that a liability be recorded in the guarantor’s balance sheet uponissuance of a guarantee.  In addition,FIN 45 requires disclosures about the guarantees, including indemnifications,that an entity has issued and a rollforward of the entity’s product warrantyliabilities.  The disclosure provisionsof FIN 45 were effective for financial statements of interim periods or annualperiods ending after December 15, 2002. In addition, we adopted the recognition provisions of FIN 45 effectiveJanuary 1, 2003 for guarantees issued or modified after December 31, 2002.  The adoption of FIN 45 did not have amaterial impact on our financial position, results of operations, or cashflows.

 

In December2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure.” SFAS 148 provides alternate methods of transition for a voluntary changeto the fair value based method of accounting for stock-based employeecompensation.  SFAS 148 also requiresthat disclosures of the pro forma effect of using the fair value method ofaccounting for stock-based employee compensation be displayed more prominentlyand in tabular format.  Additionally,SFAS 148 requires disclosure of the pro forma effect of using the fair valuemethod of accounting for stock-based employee compensation in interim financialstatements.  The transition and annualdisclosure requirements were effective for us as of December 28, 2002.  The interim disclosure requirements wereeffective for the first quarter of fiscal 2003 and have been reflected in Note1 to the unaudited condensed consolidated financial statements.

 

In April 2003,the FASB issued SFAS No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“SFAS 149”).  SFAS 149 amends and clarifies the accounting for derivativeinstruments, including certain derivative instruments embedded in othercontracts, and for hedging activities under SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities.”  SFAS 149 is generally effective for contracts entered into ormodified after June 30, 2003 and for hedging relationships designated afterJune 30, 2003.  The adoption of SFAS 149is not expected to have a material effect on our financial position, results ofoperations, or cash flows.

 

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In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity” (“SFAS 150”).  SFAS 150 requires that certain financialinstruments, which under previous guidance were accounted for as equity, mustnow be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock,certain financial instruments that require or may require the issuer to buyback some of its shares in exchange for cash or other assets and certainobligations that can be settled with shares of stock.  SFAS 150 is effective for all financial instruments entered intoor modified after May 31, 2003 and must be applied to our existing financial instrumentseffective July 6, 2003, the beginning of the first fiscal period after June 15,2003.  We adopted SFAS 150 on June 1,2003.  The adoption of this statementdid not have an effect on our financial position, results of operations, orcash flows.

 

**NOTE 8 — RECENT EVENTS:**

 

Effective July29, 2003, our senior credit facility was amended to, among other things,increase the amount of the commitments under the revolving portion of thecredit facility from $60.0 million to $75.0 million and allow for a maximumamount of commitments of up to $80.0 million, provide for a 75 basis pointreduction in the applicable interest margin by prepaying our existing Tranche Bterm loan and replacing it with a new Tranche C term loan, reduce the amount ofour mandatory loan prepayment requirement following the consummation of aninitial public offering by Holdings from a prepayment of 50% or 75% of excesscash flow to 25% or 50% of excess cash flow, depending on the applicableleverage ratio, and permit a $24.9 million dividend to Holdings’ equity holdersand a $2.5 million bonus to vested option holders of Holdings as describedbelow.  Additionally, our senior creditfacility was amended to provide that, upon the consummation of an initialpublic offering by Holdings, it is permitted to repurchase up to $61.3 millionof our senior subordinated notes (including any prepayment fees) with proceedsfrom an equity offering and settle our obligations of up to $3.6 million underthe management agreement with Berkshire Partners LLC. These payments may bemade from the proceeds of an equity offering prior to being required to use 50%of the net proceeds of such an equity offering to prepay borrowings under oursenior credit facility.  Following theconsummation of an initial public offering by Holdings, we will also bepermitted to repurchase up to $15.0 million of additional senior subordinatednotes.

 

On July 31,2003, Carter’s paid a cash dividend of approximately $24.9 million toHoldings.  Holdings utilized theproceeds to pay a dividend of $24.9 million on the outstanding shares of commonstock of Holdings to the stockholders of record as of July 30, 2003.  At the same time, we paid a special bonus ofapproximately $2.5 million to Holdings’ vested option holders.  This special bonus will be recorded ascompensation expense during the third quarter of 2003.

 

In July 2003,we decided to exit two of our production facilities given our ability to obtainlower costs with third-party suppliers. Prior to planned closure dates, the facilities will be held and used forproduction.  During the second half offiscal 2003 and the first half of 2004, it is estimated that the aggregatecosts associated with such closures will be approximately $4.4 million,consisting primarily of accelerated depreciation, impairment charges,severance, and lease termination costs.

 

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

 

The followingis a discussion of the risks relating to our business, our results ofoperations, and our current financial position.  You should read this discussion in conjunction with our unauditedcondensed consolidated financial statements and notes included elsewhere inthis quarterly report.  Our discussionof our results of operations and financial condition includes variousforward-looking statements about our markets, the demand for our products andservices, and our future results.  Webase these statements on certain assumptions that we consider reasonable.  For further information about risks andexposures relating to our business and our company, you should read Item 3 ofthis quarterly report entitled “Quantitative and Qualitative Disclosures aboutMarket Risks” and the section entitled “Risks Relating To Our Business” in ourlatest annual report on Form 10-K. Actual results may differ materially from those suggested by ourforward-looking statements for various reasons including those discussed inItem 3.  Except for any ongoingobligations to disclose material information as required by the federalsecurities laws, we have no intention or obligation to update forward-lookingstatements after we file this quarterly report.

 

**RESULTS OF OPERATIONS**

 

The followingtable sets forth, for the periods indicated, (i) selected statement ofoperations data expressed as a percentage of net sales and (ii) the number ofretail stores open at the end of each such period:

 
|                                           |   | **As a percentage of net sales**       |   |
|------------------------------------------------|--------|----------------------------------------|--------|
|                                           |   | **For the  three-month periods ended** |   | **For the  six-month periods ended** |   |
|                                           |   | **July 5,  2003**                      |   | **June 29,  2002** |   | **July 5,  2003** |   | **June 29,  2002** |   |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Wholesale sales                                |   | 59.6                                   | %      | 53.9 | % | 62.9 | % | 55.5 | % |
| Retail sales                                   |   | 40.4                                   |   | 46.1 |   | 37.1 |   | 44.5 |   |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Net sales                                      |   | 100.0                                  |   | 100.0 |   | 100.0 |   | 100.0 |   |
| Cost of goods sold                             |   | 64.4                                   |   | 61.6 |   | 63.9 |   | 61.6 |   |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Gross profit                                   |   | 35.6                                   |   | 38.4 |   | 36.1 |   | 38.4 |   |
| Selling, general, and administrative  expenses |   | 29.9                                   |   | 33.3 |   | 28.4 |   | 32.4 |   |
| Royalty income                                 |   | (1.4                                   | )      | (1.5 | ) | (1.5 | ) | (1.6 | ) |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Operating income                               |   | 7.1                                    |   | 6.6 |   | 9.2 |   | 7.6 |   |
| Interest expense, net                          |   | 4.7                                    |   | 5.9 |   | 4.4 |   | 5.7 |   |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Income before income taxes                     |   | 2.4                                    |   | 0.7 |   | 4.8 |   | 1.9 |   |
| Provision for income taxes                     |   | 0.9                                    |   | 0.3 |   | 1.8 |   | 0.8 |   |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Net income                                     |   | 1.5                                    | %      | 0.4 | % | 2.9 | % | 1.1 | % |
|                                           |   |                                   |   |   |   |   |   |   |   |
| Number of retail stores at end of period       |   | 159                                    |   | 155 |   | 159 |   | 155 |   |

 

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**Three and six-month periods ended July 5,2003 compared to three and six-month periods ended June 29, 2002**

 

*NET SALES.*   The three-month periods ended July 5, 2003and June 29, 2002 each contained 13 weeks of financial results.  The six-month period ended July 5, 2003contained 27 weeks as compared to the six-month period ended June 29, 2002,which contained 26 weeks.  In the secondquarter of fiscal 2003, consolidated net sales increased $20.9 million, or17.6%, to $140.0 million from $119.1 million in the second quarter of fiscal2002. * *In the first half of 2003, consolidated net sales were$306.0 million, an increase of $62.3 million, or 25.6%, as compared with $243.7million for the first half of 2002. This revenue growth is driven by strong product performance resultingfrom our focus on improving the value of our core products through our globalsourcing network, effective merchandising and pricing strategies, theadditional week of selling in the first half of 2003, and the initial shipmentduring the second quarter of 2003 of our new *Childof Mine* brand that will be sold in substantially all Wal-Mart storesin the United States beginning in August 2003.

 

Totalwholesale sales increased $19.3 million, or 30.0%, to $83.4 million in thesecond quarter of 2003 from $64.2 million in the second quarter of 2002.  In the first half of 2003, wholesale salesincreased $57.3 million, or 42.3%, to $192.5 million from $135.2 million in thefirst half of 2002.  Wholesale sales,excluding discount store channel and off-price sales, increased $4.4 million,or 8.1%, in the second quarter of 2003 to $58.5 million from $54.1 million inthe second quarter of 2002.  In thefirst half of 2003, wholesale sales, excluding discount store channel andoff-price sales, increased $34.4 million, or 29.2%, to $151.9 million from$117.6 million in the first half of 2002. These increases reflect growth in our baby and playclothes productlines.  This growth has occurred at themajority of our key wholesale accounts as a result of our focus on improvingthe value of our core products.

 

Wholesalediscount store sales in the second quarter of 2003 increased $12.3 million to$17.8 million from $5.5 million in the second quarter of 2002.  In the first half of 2003, our wholesalediscount store sales increased $20.3 million to $30.2 million from $9.9 millionin the first half of 2002.  Contributingto this significant growth was the initial shipment during the second quarterof 2003 of our new *Child of Mine*brand that will be sold in substantially all Wal-Mart stores in the UnitedStates beginning in August 2003.  Alsocontributing to this growth for the second quarter and first half of 2003 isthe continued strong performance of our *Tykes*brand with Target.

 

Our retailstore sales were $56.6 million for the second quarter of 2003, whichrepresented an increase of $1.7 million, or 3.0%, compared to the second quarterof 2002.  Comparable store sales for thesecond quarter of 2003, based on 145 locations, declined 1.5% and reflectcontinued weakness in the economy.  Theprimary driver of the revenue increase was incremental revenue generated fromnew stores opened subsequent to June 29, 2002, offset by the impact of storesclosed over the last twelve months and the comparable store sales decline.  In the first half of 2003, retail storesales increased $5.0 million, or 4.7%, to $113.5 million from $108.5 million inthe first half of 2002.  Comparablestore sales for the first half of 2003, on a 27-week versus 26-week basisincreased 0.5%, based on 145 locations. The drivers of the revenue increase in the first half of 2003 wereincremental revenue of $7.1 million from new store openings and the comparablestore sales increase of $0.5 million. The comparable store sales increase was driven by the additional week ofsales included in the first half of 2003, offset by the impact of stores closedin the last twelve months of $2.6 million. Comparing the first 27 weeks of 2003 to the first 27 weeks of 2002,comparable store sales declined 3.7%, based on 145 locations.  This decline reflects the effect ofunfavorable weather conditions, particulary in February 2003.  We opened four retail stores and closed oneduring the first half of 2003.  Therewere a total of 159 stores as of July 5, 2003 compared to 155 stores at June29, 2002.  We plan to open eleven storesand close four stores during the balance of 2003.

 

*GROSS PROFIT.*    Our gross profit increased $4.1 million,or 9.0%, to $49.9 million in the second quarter of 2003 from $45.7 million inthe second quarter of 2002.  Grossprofit increased $16.8 million, or 18.0%, to $110.5 million in the first halfof 2003 compared to $93.6 million in the first half of 2002.  Gross profit, as a percentage of net sales,in the second quarter and first half of 2003 decreased to 35.6% and 36.1% from38.4% in similar periods in 2002.  Suchdecreases in gross profit, relative to sales, have resulted primarily from ahigher mix of wholesale revenues, which include discount and off-price channelrevenues, that generally yield lower margins than similar products sold throughour retail channel.  Wholesale saleswere 63% of total sales in the first half of 2003 as compared to 55% in thefirst half of 2002.  These decreasesalso reflect the impact of our new pricing strategies with lower average priceson certain core products which were partially offset by additional product costreductions achieved through the continued expansion and leverage of our globalsourcing network.

 

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*SELLING, GENERAL, AND ADMINISTRATIVEEXPENSES.*   Selling, general, and administrative expenses for the second quarter of2003 increased $2.2 million, or 5.6%, to $41.8 million from $39.6 million inthe second quarter of 2002.  Thesecosts, as a percentage of net sales, decreased to 29.9% in the second quarterof 2003 from 33.3% in the second quarter of 2002.  In the first half of 2003, selling, general, and administrativeexpenses increased $7.9 million, or 9.9%, to $86.8 million from $78.9 millionin the first half of 2002.  As apercentage of net sales, these expenses decreased to 28.4% in the first half of2003 from 32.4% in the first half of 2002. Such decreases for the second quarter and first half of 2003 are due tothe benefit of leveraging operating expenses on higher levels of revenuepartially offset by higher distribution costs driven by unit volume growth.

 

*ROYALTY INCOME.*    We license the use of the *Carter’s, Carter’s Classics,*and*Child of Mine*names**and sublicense the*Tykes*name to certain licensees.  Our royalty income in the second quarter of2003 was approximately $1.9 million, an increase of 4.9%, over the secondquarter of 2002.  During the first halfof 2003, royalty income was approximately $4.5 million, an increase of $0.7million, or 18.1%, over the first half of 2002.  These increases resulted from expansion of our licensed productplacement with key wholesale customers. We licensed our *Child of Mine*brandto many of our licensee partners for further brand extension into Wal-Mart,which will begin shipping in the third quarter of 2003.

 

*OPERATING INCOME.   *Operating income for the secondquarter of 2003 increased $2.0 million to $9.9 million compared to $7.9 millionin the second quarter of 2002. Operating income for the first half of 2003 increased $9.7 million to$28.2 million from $18.5 million in the first half of 2002.  These increases reflect the benefit fromrevenue growth, increased gross profit, and leveraging of operating expenses asdescribed above.

 

*INTEREST EXPENSE*, *NET*.   Net interest expense for the second quarter of 2003 decreased $0.6million to $6.5 million from $7.1 million in the second quarter of 2002.  In the first half of 2003, interest expensedecreased $0.4 million to $13.5 million from $14.0 million in the first half of2002.  These decreases were due to lowervariable interest rates on reduced levels of term loan indebtedness partiallyoffset by an additional week of interest.

 

*INCOME TAXES.   *We recorded a provision for incometaxes of $1.3 million in the second quarter of 2003 compared to $0.3 million inthe second quarter of 2002.  In thefirst half of 2003, we recorded a provision for income taxes of $5.6 millioncompared to $1.7 million in the first half of 2002.  Our effective tax rate was approximately 38.5% during the secondquarter and first half of 2003 and 2002.

 

*NET INCOME.   *As a result of the factors noted above,our second quarter 2003 net income was $2.1 million compared to $0.5 million inthe second quarter of 2002.  Net incomefor the first half of 2003 was $9.0 million compared to $2.8 million in thefirst half of 2002.

 

**FINANCIAL CONDITION, CAPITAL RESOURCES, ANDLIQUIDITY**

 

Our primarycash needs are working capital, capital expenditures, and debt service.  Historically, we have financed these needsprimarily through internally generated cash flow and funds borrowed under oursenior credit facility (“Credit Facility”). Our primary source of liquidity will continue to be cash flow fromoperations and borrowings under our revolving loan facility, and we expect thatthese sources will fund our ongoing requirements for debt service and capitalexpenditures.  These sources ofliquidity may be impacted by continued demand for our products and our abilityto meet debt covenants under our Credit Facility.

 

Net accountsreceivable at July 5, 2003 were $59.9 million compared to $40.1 million at June29, 2002 and $53.6 million at December 28, 2002.  The increase over June 29, 2002 reflects the shipment of our *Child of Mine* brand to Wal-Mart and ahigher level of other wholesale shipments in the latter part of the secondquarter ended July 5, 2003.  Due to theseasonal nature of our operations, the net accounts receivable balance at July5, 2003 is not comparable to the net accounts receivable balance at December28, 2002.

 

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Netinventories at July 5, 2003 were $132.9 million compared to $98.1 million atJune 29, 2002 and $105.7 million at December 28, 2002.  This increase over June 29, 2002 ininventory levels was planned to support third quarter 2003 shippingrequirements, including inventory required to support our new *Child of Mine* brand for Wal-Mart.  Average inventory levels in 2003 areexpected to be higher than average 2002 year-end net inventory levels of $93.8million based on increases in forecasted demand and our focus on superior shippingperformance to our customers.  Due tothe seasonal nature of our operations, net inventories at July 5, 2003 are notcomparable to net inventories at December 28, 2002.

 

Net cash usedin operating activities for the first half of 2003 was $21.9 million comparedto $0.6 million for the first half of 2002. The increase in net cash used in operating activities in the first halfof 2003 compared to the first half of 2002 is primarily attributed to theincreases in inventory and accounts receivable, described above, reductions incurrent liabilities, and partially offset by increases in net income.

 

We haveinvested $6.8 million in capital expenditures during the first half of 2003compared to $5.6 million during the first half of 2002.  We plan to invest an additional $16.2million in capital expenditures during the remainder of fiscal 2003.  Major investments include retail storeopenings and remodeling, fixturing programs for wholesale customers, and theexpansion of our distribution centers.

 

At July 5,2003, we had approximately $291.9 million of debt outstanding, consisting of$173.9 million of senior subordinated notes (the “Notes”), $118.0 million interm loan borrowings (“Term Loan”) and no borrowings on our revolving loanfacility (“Revolver”), exclusive of approximately $8.7 million of outstandingletters of credit.  At July 5, 2003, wehad approximately $51.3 million of financing available under our Revolver.  At December 28, 2002, we had approximately$297.6 million of debt outstanding, consisting of $173.9 million of Notes,$123.8 million in Term Loan borrowings and no Revolver borrowings, exclusive ofapproximately $16.3 million of outstanding letters of credit.  The borrowings under the Revolver will beavailable to fund our working capital requirements, capital expenditures, andother general corporate purposes.

 

Principalborrowings under the Term Loan are due and payable in seventeen remainingquarterly installments of $300,267 from September 30, 2003 through September30, 2007 and four quarterly payments of approximately $28.2 million fromDecember 31, 2007 through September 30, 2008. Interest on the Term Loan is payable at the end of interest rate resetperiods, which vary in length but in no case exceed six months.  The outstanding balance under the Revolveris payable in full on August 15, 2006, and interest is payable quarterly ormore frequently in the event we have chosen a Eurodollar rate option availableunder the terms of our Credit Facility. No principal payments are required on the Notes prior to their scheduledmaturity in August 2011.  Interest ispayable semi-annually on the Notes in February and August of each year, in theamount of approximately $9.5 million for each payment.  These payments commenced on February 15,2002.

 

The terms ofthe consolidated excess cash flow condition, as required under our CreditFacility were effective for fiscal 2002, and, accordingly, we made a principalprepayment of approximately $4.8 million on March 26, 2003.  This excess cash flow condition may resultin future annual prepayments depending on the consolidated excess cash flowgenerated in each year.  The lenderswill apply such prepayments first to the Term Loan and, second, to reduce theRevolver.  Subject to certain conditionsin our Credit Facility, we may make optional prepayments of our debtobligations without premium or penalty. The lenders will apply such optional prepayments according to ourinstruction.

 

As provided bya management agreement with Berkshire Partners LLC (the “ManagementAgreement”), we agreed, among other things, to pay Berkshire Partners an annualmanagement fee of $1.65 million per year for four years, commencing on thefirst anniversary of the Acquisition. We pay this fee quarterly, in advance. As described below, upon completion of an initial public offering byHoldings, this management fee requirement will be settled in full.  We have agreed to pay Berkshire Partners anacquisition fee of 1% of any future financing or 1% of the value of any acquisitionfor their advice in connection with any future financing or acquisition.

 

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Effective July29, 2003, our Credit Facility was amended to, among other things, increase theamount of the commitments under the Revolver from $60.0 million to $75.0million and allow for a maximum amount of commitments of up to $80.0 million,provide for a 75 basis point reduction in the applicable interest margin byprepaying our existing Tranche B term loan and replacing it with a new TrancheC term loan, reduce the amount of our mandatory loan prepayment requirementfollowing the consummation of an initial public offering by Holdings from aprepayment of 50% or 75% of excess cash flow to 25% or 50% of excess cash flow,depending on the applicable leverage ratio, and permit a $24.9 million dividendto Holdings’ equity holders and a $2.5 million bonus to vested option holdersof Holdings as described below. Additionally, our Credit Facility was amended to provide that, upon theconsummation of an initial public offering by Holdings, it is permitted torepurchase up to $61.3 million of our Notes (including any prepayment fees)with proceeds from an equity offering and settle our obligations of up to $3.6million under the Management Agreement. These payments may be made from theproceeds of an equity offering prior to being required to use 50% of the netproceeds of such an equity offering to prepay borrowings under our CreditFacility.  Following the consummation ofan initial public offering by Holdings, we will also be permitted to repurchaseup to $15.0 million of additional Notes.

 

On July 31,2003, Carter’s paid a cash dividend of approximately $24.9 million toHoldings.  Holdings utilized theproceeds to pay a dividend of $24.9 million on the outstanding shares of commonstock of Holdings to the stockholders of record as of July 30, 2003.  At the same time, we paid a special bonus ofapproximately $2.5 million to Holdings’ vested option holders.  This payment was funded through our amendedCredit Facility, as described above.

 

In July 2003,we decided to exit two of our production facilities given our ability to obtainlower costs with third-party suppliers. Prior to planned closure dates, the facilities will be held and used forproduction.  During the second half offiscal 2003 and the first half of 2004, it is estimated that the aggregatecosts associated with such closures will be approximately $4.4 million,consisting primarily of accelerated depreciation, impairment charges,severance, and lease termination costs.

 

Based on ourcurrent level of operations and anticipated cost savings and operatingimprovements, we believe that cash generated from operations and availablecash, together with amounts available under the Revolver, will be adequate tomeet our debt service requirements, capital expenditures, and working capitalneeds for the foreseeable future, although no assurance can be given in thisregard.  We may, however, need torefinance all or a portion of the principal amount of the Notes on or prior tomaturity.

 

Our CreditFacility imposes certain covenants, requirements, and restrictions on ouractions by us and our subsidiaries that, among other things, restrict thepayment of dividends beyond the dividend noted above.

 

On August 23,2002, Holdings filed a registration statement with the Securities and ExchangeCommission to register an initial public offering of up to $100.0 million ofits common stock.  That registrationstatement has not yet become effective. If the initial public offering is completed, Holdings intends tocontribute to the Company a portion of its net proceeds from the offering to beused to repurchase up to $61.3 million of our Notes (including any prepaymentfees) and settle our obligations of up to $3.6 million under the ManagementAgreement.  In the fourth quarter of2002, we decided to postpone the initial public offering process given thedeterioration in equity market conditions. We continue to evaluate equity market conditions and plan to proceedwith the offering when such conditions improve.

 

**EFFECTS OF INFLATION**

 

We areaffected by inflation and changing prices primarily through the purchase of rawmaterials, increased operating costs and expenses, and higher interestrates.  The effects of inflation inchanging prices on our net sales, revenues, and operations have not beenmaterial in recent years.  In recentyears, there has been deflationary pressure on selling prices.  Due to the competitive nature of thechildren’s apparel industry, there is no assurance that this trend will notcontinue.  While we have been successfulin offsetting such deflationary pressures through expansion of our globalsourcing network, if the trend in selling prices outpaces our ability to obtainfurther price reductions from our global suppliers, our profitability may beaffected.

 

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**SEASONALITY**

 

We experienceseasonal fluctuations in our sales and profitability, with generally lowersales and gross profit in the first and second quarters of our fiscalyear.  Over the past five fiscal years,approximately 58% of our consolidated net sales were generated in the secondhalf of our fiscal year.  We believe,generally, that the seasonality of sales and profitability is a factor thataffects the baby and young children’s apparel industry, and is primarily due toretailers’ emphasis on price reductions in the first quarter, promotionalretailers’ and manufacturers’ emphasis on closeouts of the prior year’s productlines, and “back-to-school” and holiday shopping patterns.

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Our discussion and analysisof our financial condition and results of operations are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America.  The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues, expenses, and related disclosure ofcontingent assets and liabilities.  Webase our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from these estimates under differentassumptions or conditions.

 

Oursignificant accounting policies are described in Note 2 to our consolidated financialstatements contained in our most recently filed annual report on Form10-K.  The following discussionaddresses our critical accounting policies, which are those that requiremanagement’s most difficult and subjective judgments, often as a result of theneed to make estimates about the effect of matters that are inherentlyuncertain.

 

*Revenue recognition: *We recognizewholesale revenue after shipment of products to customers, when title passesand when all risks and rewards of ownership have transferred.  As discussed in Note 2 to our consolidatedfinancial statements contained in our most recently filed annual report on Form10-K, in certain cases, this does not occur until the goods have reached thespecified customer.  We consider revenuerealized or realizable and earned when the product has been shipped, the salesprice is fixed or determinable and collectibility is reasonably assured.  In the normal course of business, we grantcertain accommodations and allowances to our wholesale customers.  Such amounts are reflected as reductions ofnet sales.  Retail store revenues arerecognized at the point of sale.  Wereduce revenue for customer returns and deductions.  We also maintain an allowance for doubtful accounts for estimatedlosses resulting from the inability of our customers to make payments.  If the financial condition of our customerswere to deteriorate, resulting in an impairment of their ability to makepayments, an additional allowance could be required.

 

*Inventory: *We write down our inventory for estimatedexcess and obsolescence equal to the difference between the cost of inventoryand the estimated market value based upon assumptions about future demand andmarket conditions.  If actual marketconditions are less favorable than those we project, additional write-downs maybe required.

 

*Goodwill and tradename:*  As of July 5, 2003, we have approximately$360 million in goodwill and tradename assets. The fair value of the *Carter’s*tradename was estimated at the Acquisition to be approximately $220 millionusing a discounted cash flow analysis, which examined the hypothetical costsavings that accrue as a result of our ownership of the tradename.  The cash flows, which incorporated bothhistorical and projected financial performance, were discounted using adiscount rate of 11%.  The tradename wasdetermined to have an indefinite life. The carrying value of these assets is subject to annual impairmentreviews as of the last day of each fiscal year.  Factors affecting such impairment reviews include the continuedmarket acceptance of our offered products and the development of newproducts.  Impairment reviews may alsobe triggered by any significant events or changes in circumstances.  Our impairment review of goodwill is basedon the estimated fair values of

 

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the underlyingbusinesses.  These estimated fair valuesare based on estimates of the future cash flows of the businesses.

 

*Accrued expenses: *Accrued expenses for health insurance,workers compensation, incentive compensation, professional fees, and otheroutstanding obligations are assessed based on actual commitments, statisticaltrends, and estimates based on projections and current expectations, and theseestimates are updated periodically as additional information becomes available.

 

*Accounting for income taxes:*  As part of the process of preparing ourconsolidated financial statements, we are required to estimate our actualcurrent tax exposure (state, federal, and foreign), together with assessingpermanent and temporary differences resulting from differing bases andtreatment of items for tax and accounting purposes, such as the carrying valueof intangibles, deductibility of expenses, depreciation of property andequipment, 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 ourdeferred tax assets will be recovered from future taxable income.  Actual results could differ from thisassessment if sufficient taxable income is not generated in futureperiods.  To the extent we determine theneed to establish a valuation allowance or increase such allowance in a period,we must include an expense within the tax provision in the accompanyingunaudited condensed consolidated statement of operations.

 

*Stock-based compensation arrangements: *Weaccount for stock-based compensation on stock options under the intrinsic valuemethod, whereby we record compensation expense equal to the difference betweenthe exercise price of the stock option and the fair market value of theunderlying stock at the date of the option grant.  For disclosure purposes only, we also estimate the impact on ournet income of applying the fair value method of measuring compensation cost onstock options with the fair value determined under the minimum value method asprovided by Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation” as amended by SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS148”).  For stock issued or soldoutright to employees, directors, or third parties, we measure expense as thedifference between the price paid by the recipient and the fair market value ofthe stock on the date of issuance or sale. In the absence of a public market for Holdings common stock, managementand the Board of Directors estimate the market value of Holdings common stockfor all option grant and stock issuance dates using an approach based upon amultiple of Adjusted EBITDA less net debt. Adjusted EBITDA represents earnings before interest, income tax expense,depreciation and amortization, and also excludes Acquisition-related non-recurringcharges, write-downs of long-lived assets, non-recurring charges-plant closurecosts, and non-recurring charges-other. Adjusted EBITDA is not a measurement under generally accepted accountingprinciples.

 

*Accounting for contingencies: *From time to time, we are named as adefendant in legal actions arising from normal operations.  We account for such contingencies inaccordance with SFAS No. 5, “Accounting for Contingencies,” which requires usto record an estimated loss liability when information available prior toissuance of our financial statements indicates that it is probable that anasset has been impaired or a liability has been incurred at the date of thefinancial statements and the amount of the loss can be reasonably estimated.  Accounting for contingencies arising fromcontractual or legal proceedings requires company management to use its bestjudgment when estimating an accrual related to such contingencies.  As additional information becomes known,such estimates are revised and updated as necessary and may fluctuate fromperiod to period.

 

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**RECENTACCOUNTING PRONOUNCEMENTS**

 

In August2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143,“Accounting for Asset Retirement Obligations” (“SFAS 143”).  SFAS 143 requires recording the fair marketvalue of an asset retirement obligation as a liability in the period in which alegal obligation associated with the retirement of tangible long-lived assetsis incurred (including certain lease obligations).  The statement also requires recording an asset offsetting theinitial obligation as an increase to the carrying amount of the relatedlong-lived asset and depreciation of that cost over the life of the asset.  We adopted the provisions of SFAS 143 in thefirst quarter of 2003, and the impact of such adoption was not material to ourfinancial position or results of operations for the second quarter or firsthalf of 2003.

 

In April 2002,the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS145”).  SFAS 145 rescinds FASB StatementNo. 4, which required all gains and losses from extinguishments of debt to beaggregated and, if material, classified as an extraordinary item, net of therelated income tax effect.  As a result,the criteria in Accounting Principles Board Opinion 30 will now be used toclassify those gains and losses.  Theprovisions of SFAS 145, as related to the rescission of FASB Statement No. 4,are effective for fiscal 2003.  In thefirst quarter of 2003, we adopted the provisions of SFAS 145 and theextraordinary item recorded in the Predecessor period from December 31, 2000 throughAugust 14, 2001 will be reclassified in our Annual Report on Form 10-K for theyear ended January 3, 2004.

 

In July 2002,the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (“SFAS 146”).  SFAS146 sets forth various modifications to existing accounting guidance, whichprescribes the conditions which must be met in order for costs associated withcontract terminations, facility consolidations, and employee relocations andterminations to be accrued and recorded as liabilities in financial statements.  Accordingly, SFAS 146 may affect the timingof recognizing any of our future restructuring costs as well as the amountrecognized.  SFAS 146 also establishesthat the liability should initially be measured and recorded at fairvalue.  The provisions of SFAS 146 arerequired to be applied prospectively to exit or disposal activities initiatedby us after December 31, 2002.  See Note8 to the unaudited consolidated financial statements regarding our decision toclose two of our production facilities.

 

In November2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” (“FIN 45”).  FIN45 requires that a liability be recorded in the guarantor’s balance sheet uponissuance of a guarantee.  In addition,FIN 45 requires disclosures about the guarantees, including indemnifications,that an entity has issued and a rollforward of the entity’s product warrantyliabilities.  The disclosure provisionsof FIN 45 were effective for financial statements of interim periods or annualperiods ending after December 15, 2002. In addition, we adopted the recognition provisions of FIN 45 effectiveJanuary 1, 2003 for guarantees issued or modified after December 31, 2002.  The adoption of FIN 45 did not have amaterial impact on our financial position, results of operations, or cashflows.

 

In December2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure.” SFAS 148 provides alternate methods of transition for a voluntary changeto the fair value based method of accounting for stock-based employeecompensation.  SFAS 148 also requiresthat disclosures of the pro forma effect of using the fair value method of accountingfor stock-based employee compensation be displayed more prominently and intabular format.  Additionally, SFAS 148requires disclosure of the pro forma effect of using the fair value method ofaccounting for stock-based employee compensation in interim financialstatements.  The transition and annualdisclosure requirements were effective for us as of December 28, 2002.  The interim disclosure requirements wereeffective for the first quarter of fiscal 2003 and have been reflected in Note1 to the unaudited condensed consolidated financial statements.

 

In April 2003,the FASB issued SFAS No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“SFAS 149”).  SFAS 149 amends and clarifies the accounting for derivative instruments,including certain derivative instruments embedded in other contracts, and forhedging activities under SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities.”  SFAS 149 isgenerally effective for contracts entered into or modified after June 30, 2003and for hedging relationships

 

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designatedafter June 30, 2003.  The adoption ofSFAS 149 is not expected to have a material effect on our financial position,results of operations, or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity” (“SFAS 150”).  SFAS 150 requires that certain financialinstruments, which under previous guidance were accounted for as equity, mustnow be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock,certain financial instruments that require or may require the issuer to buyback some of its shares in exchange for cash or other assets and certainobligations that can be settled with shares of stock.  SFAS 150 is effective for all financial instruments entered intoor modified after May 31, 2003 and must be applied to our existing financialinstruments effective July 6, 2003, the beginning of the first fiscal periodafter June 15, 2003.  We adopted SFAS150 on June 1, 2003.  The adoption ofthis statement did not have an effect on our financial position, results ofoperations, or cash flows.

 

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**ITEM 3.****                           QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

In theoperation of our business, we have market risk exposures to global sourcing,raw material prices, and interest rates. Each of these risks and our strategies to manage our exposure to themare discussed below.

 

We currentlysource substantially all of our production from our offshore operations andthird-party manufacturers located in foreign countries.  As a result, we may be adversely affected bypolitical instability resulting in the disruption of trade from foreigncountries, the imposition of new regulations relating to imports, duties,taxes, and other charges on imports, any significant decreases in the value ofthe dollar against foreign currencies, and restrictions on the transfer offunds.  These and other factors couldresult in the interruption of production in offshore facilities, delay receiptof the products into the United States or affect our operating income.  Our future performance may be subject tosuch factors, which are beyond our control, and there can be no assurance thatsuch factors would not have a material adverse effect on our financialcondition and results of operations.  Wecarefully select our sourcing agents, and in an effort to mitigate the possibledisruption in product flow, we place production in various countries we believeto be of lower risk.

 

We enter intovarious purchase order commitments with full package suppliers.  We can cancel these arrangements, althoughin some instances, we may be subject to a termination charge reflecting apercentage of work performed prior to cancellation.  Historically, such cancellations and related termination chargeshave not had a material impact on our business.

 

The principalraw materials we use are finished fabrics and trim materials.  Prices for these materials are affected bychanges in market demand and there can be no assurance that prices for theseand other raw materials will not increase in the near future.  These materials are available from more thanone supplier, which enables us to negotiate pricing.  However, the loss of one or more of these suppliers couldinterrupt our supply, which could have an adverse effect on our sales andincrease our costs.

 

We contractfor production with third parties primarily in the Far East and South andCentral America.  While these contractsare stated in United States dollars, there can be no assurance that the costfor the future production of our products will not be affected by exchange ratefluctuations between the United States dollar and the local currencies of thesecontractors.  Due to the number ofcurrencies involved, we cannot quantify the potential impact of future currencyfluctuations on net income in future years. To date, such exchange fluctuations have not had a material impact onour financial condition or results of operations.

 

Our operatingresults are subject to risk from interest rate fluctuations on our debt, whichcarries variable interest rates.  At July 5, 2003, outstanding debt aggregated$291.9 million, of which $118.0 million bore interest at a variable rate.  An increase of 1% in the applicable ratewould increase our annual interest cost by $1,180,000 and could have an adverseeffect on our net income and cash flow. Pursuant to the provisions of our Credit Facility, we purchasedan interest rate cap as an economic hedge against approximately $31.3 millionof variable rate debt.  The cap rate is7.0% and the arrangement expires on December 7, 2004.

 

**ITEM 4.          DISCLOSURECONTROLS AND PROCEDURES**

 

Our ChiefExecutive Officer and Chief Financial Officer have evaluated the effectivenessof the design and operation of our disclosure controls and procedures (asdefined under Rules 13a-15(e) and 15d-15(e) promulgated under the SecuritiesExchange Act of 1934, as amended) as of the end of the period covered by thisreport.  Based upon that evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures are adequate and effective.

 

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**PART II—OTHER INFORMATION:**

 

**ITEM 1. LEGAL PROCEEDINGS:**

 

From time totime, we have been involved in various legal proceedings.  We believe that all such litigation is routinein nature and incidental to the conduct of our business, and we believe that nosuch litigation, if resolved adversely to us, would have a material adverseeffect on our financial condition or results of operations or cash flows.

 

During 2002, alawsuit was filed against us in which the plaintiff is claiming damages ofapproximately $830,000 related to an alleged oral guarantee of money owed to itby a third-party vendor.  We have notprovided for this exposure, as we believe that this claim is without merit andwe intend to vigorously defend this matter.

 

**ITEM 2. CHANGES IN SECURITIES:**

 

None

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES:**

 

None

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS:**

 

None

 

**ITEM 5. OTHER INFORMATION:**

 

None

 

**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:**

 

(a)               Exhibits:

 
| **Exhibit Number** |   | **Description of Exhibits**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10                 |   | Second Amendment dated as of July 29, 2003  to the Credit and Guaranty Agreement dated as of August 15, 2001, as amended  by that certain First Amendment dated as of March 27, 2002, among The William  Carter Company, a Massachusetts corporation, Carter Holdings, Inc., a  Massachusetts corporation, Carter’s de San Pedro, Inc., a Delaware  corporation, Carter’s Imagination, Inc., a Delaware corporation, the Lenders  from time to time party thereto, Goldman Sachs Credit Partners L.P., as Lead  Arranger, Book Runner and Syndication Agent, and Fleet National Bank, as  Administrative Agent and Collateral Agent. |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 31.1               |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 31.2               |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 32                 |   | Section 1350 Certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

(b) Reports onForm 8-K:  None

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities and Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
| THE WILLIAM  CARTER COMPANY |
|-----------------------------|
|                        |   |   |
|                        |   |   |   |
|                        | Date:  August  19, 2003 |   | /s/ FREDERICK J.  ROWAN, II |   |   |
|                        |   |   |   |   |   |
|                        |   |   |   |
|                        |   | Frederick J.  Rowan, II |   |
|                        |   | *Chairman, President, and  Chief Executive Officer* |   |
|                        |   |   |   |
|                        | Date:  August  19, 2003 |   | /s/ MICHAEL D.  CASEY |   |   |
|                        |   |   |   |   |   |
|                        |   |   |   |
|                        |   | Michael D. Casey |   |
|                        |   | *Executive Vice President and  Chief Financial Officer* |   |
|                             |  |  |  |  |  |  |  |  |  |  |

 

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