10-Q 1 file1.htm Table of Contents

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

FORM 10-Q

[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JULY 1, 2006

OR

[ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 1-10857

THE WARNACO GROUP, INC.
(Exact name of registrant as specified in its charter)


Delaware 95-4032739
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
501 Seventh Avenue
New York, New York 10018
(Address of registrant’s principal executive offices)

Registrant’s telephone number, including area code: (212) 287-8000

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘‘accelerated filer’’ and ‘‘large accelerated filer’’ in Rule 12b-2 of the Exchange Act.

Large accelerated filer   [X]        Accelerated filer   [ ]        Non-accelerated filer   [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    [ ]   Yes    [X]   No.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    [X]   Yes    [ ]   No.

The number of outstanding shares of the registrant's common stock, par value $0.01 per share, as of August 10, 2006 is as follows: 46,428,816.




THE WARNACO GROUP, INC.
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JULY 1, 2006





Table of Contents

PART I
FINANCIAL INFORMATION

Item 1.  Financial Statements.

THE WARNACO GROUP, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands, excluding per share amounts)
(Unaudited)


  July 1,
2006
December 31,
2005
July 2,
2005
ASSETS   (As Restated)
(See Note 18)
 
Current assets:  
 
 
Cash and cash equivalents $ 138,372
$ 164,201
$ 153,896
Accounts receivable, less reserves of $77,342, $51,417 and $55,193 as of July 1, 2006, December 31, 2005 and July 2, 2005, respectively 278,748
210,204
204,228
Inventories 310,956
325,988
277,285
Prepaid expenses and other current assets (including deferred income taxes of $9,651, $2,666 and $1,163 as of July 1, 2006, December 31, 2005 and July 2, 2005, respectively) 75,763
47,575
48,365
Total current assets 803,839
747,968
683,774
Property, plant and equipment, net 131,389
116,995
105,998
Licenses, trademarks and other intangible assets, net 483,046
302,173
305,573
Goodwill 104,192
30,043
41,133
Other assets (including deferred income taxes of $5,181, $3,736 and $5,508 as of July 1, 2006, December 31, 2005 and July 2, 2005, respectively) 22,305
22,872
22,769
Total assets $ 1,544,771
$ 1,220,051
$ 1,159,247
LIABILITIES AND STOCKHOLDERS' EQUITY  
 
 
Current liabilities:  
 
 
Short-term debt $ 43,554
$
$
Accounts payable 149,555
126,333
91,060
Accrued liabilities 104,210
103,314
83,044
Accrued income taxes payable (including deferred income taxes of $1,469, $1,588 and $1,801 as of July 1, 2006, December 31, 2005 and July 2, 2005, respectively) 43,863
23,557
29,867
Total current liabilities 341,182
253,204
203,971
Long-term debt 382,750
210,000
210,575
Other long-term liabilities (including deferred income taxes of $100,884, $74,466 and $76,329 as of July 1, 2006, December 31, 2005 and July 2, 2005, respectively) 161,196
127,360
137,037
Commitments and contingencies (See Notes 2, 4, 6, 7, 9, 11, 15, 16 and 17)  
 
 
Stockholders' equity:  
 
 
Preferred stock (See Note 12)
Common stock: $0.01 par value, 112,500,000 shares authorized, 46,426,453, 46,146,869 and 45,855,783 issued as of July 1, 2006, December 31, 2005, and July 2, 2005, respectively 464
461
459
Additional paid-in capital 543,305
533,565
525,460
Accumulated other comprehensive income 21,284
4,668
4,028
Retained earnings 109,151
91,846
78,033
Treasury stock, at cost, 773,384, 42,498 and 13,001 shares as of July 1, 2006, December 31, 2005 and July 2, 2005, respectively (14,561
)
(1,053
)
(316
)
Total stockholders' equity 659,643
629,487
607,664
Total liabilities and stockholders' equity $ 1,544,771
$ 1,220,051
$ 1,159,247

See Notes to Consolidated Condensed Financial Statements

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Table of Contents

THE WARNACO GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Dollars in thousands, excluding per share amounts)
(Unaudited)


  For the Three Months Ended
  July 1, 2006 July 2, 2005
Net revenues $ 451,585
$ 374,679
Cost of goods sold 293,142
261,708
Gross profit 158,443
112,971
Selling, general and administrative expenses 140,370
95,333
Amortization of intangible assets 4,036
1,149
Pension expense 33
200
Restructuring items
721
Operating income 14,004
15,568
Other loss (income) (766
)
882
Interest expense, net 9,417
4,524
Income from continuing operations before provision for income taxes 5,353
10,162
Provision for income taxes 1,930
3,581
Income from continuing operations 3,423
6,581
Loss from discontinued operations, net of income taxes
(253
)
Net income $ 3,423
$ 6,328
Basic and diluted income per common share:  
 
Income from continuing operations $ 0.07
$ 0.14
Loss from discontinued operations
Net income $ 0.07
$ 0.14
Weighted average number of shares outstanding used in computing income per common share:  
 
Basic 46,082,333
45,817,470
Diluted 46,935,529
46,408,883

See Notes to Consolidated Condensed Financial Statements

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Table of Contents

THE WARNACO GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Dollars in thousands, excluding per share amounts)
(Unaudited)


  For the Six Months Ended
  July 1, 2006 July 2, 2005
Net revenues $ 914,365
$ 814,220
Cost of goods sold 584,531
544,241
Gross profit 329,834
269,979
Selling, general and administrative expenses 277,171
198,170
Amortization of intangible assets 7,465
2,126
Pension expense 5
471
Restructuring expense
727
Operating income 45,193
68,485
Other loss 1,084
791
Interest expense, net 17,361
9,558
Income from continuing operations before provision for income taxes 26,748
58,136
Provision for income taxes 9,443
22,329
Income from continuing operations 17,305
35,807
Loss from discontinued operations, net of income taxes
(128
)
Net income $ 17,305
$ 35,679
Basic income per common share:  
 
Income from continuing operations $ 0.38
$ 0.78
Loss from discontinued operations
Net income $ 0.38
$ 0.78
Diluted income per common share:  
 
Income from continuing operations $ 0.37
$ 0.77
Loss from discontinued operations
Net income $ 0.37
$ 0.77
Weighted average number of shares outstanding used in computing income per common share:  
 
Basic 46,114,751
45,752,718
Diluted 46,999,123
46,277,498

See Notes to Consolidated Condensed Financial Statements

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THE WARNACO GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)


  For the Six Months Ended
  July 1, 2006 July 2, 2005
Cash flows from operating activities:  
 
Net income $ 17,305
$ 35,679
Adjustments to reconcile net income to net cash provided by operating activities:  
 
Loss from discontinued operations
128
Depreciation and amortization 23,564
16,407
Write-off of non-trade receivable
1,230
Stock compensation 7,842
4,929
Amortization of deferred financing costs 1,224
1,146
Provision for trade and other bad debts 2,027
2,014
Inventory writedowns 21,531
18,394
Other (1,884
)
(6,064
)
Change in operating assets and liabilities:  
 
Accounts receivable (2,653
)
13,591
Inventories 52,527
39,972
Prepaid expenses and other assets (2,567
)
(1,471
)
Accounts payable, accrued expenses and other liabilities (32,396
)
(40,714
)
Accrued income taxes (2,026
)
19,097
Net cash provided by operating activities from continuing operations 84,494
104,338
Net cash provided by operating activities from discontinued operations
1,159
Net cash provided by operating activities 84,494
105,497
Cash flows from investing activities:  
 
Proceeds from disposal of assets and collection of notes receivable 2,500
3,391
Purchase of property, plant & equipment (20,010
)
(14,504
)
Purchase of intangible asset
(4,300
)
Business acquisitions, net of cash acquired (207,899
)
Other
(276
)
Net cash used in investing activities (225,409
)
(15,689
)
Cash flows from financing activities:  
 
Debt issued with business acquisition 180,000
Payment of debt assumed on business acquisition (44,518
)
Payment of short-term notes payable (3,075
)
Payment of deferred financing costs (2,897
)
Payment of long-term debt (450
)
 
Repayment of Senior Notes due 2013 (5,200
)
Purchase of treasury stock (13,508
)
Proceeds from the exercise of employee stock options 1,901
1,230
Other
(945
)
Net cash provided by financing activities 112,253
285
Translation adjustments 2,833
(1,785
)
Increase (decrease) in cash and cash equivalents (25,829
)
88,308
Cash and cash equivalents at beginning of period 164,201
65,588
Cash and cash equivalents at end of period $ 138,372
$ 153,896

See Notes to Consolidated Condensed Financial Statements

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Table of Contents

THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

Note 1—Nature of Operations and Basis of Presentation

Organization: The Warnaco Group, Inc. (‘‘Warnaco Group’’ and, collectively with its subsidiaries, the ‘‘Company’’) was incorporated in Delaware on March 14, 1986 and on May 10, 1986, acquired substantially all of the outstanding shares of Warnaco Inc. (‘‘Warnaco’’). Warnaco is the principal operating subsidiary of Warnaco Group.

Basis of Consolidation and Presentation: The accompanying unaudited condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (‘‘SEC’’). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from this report, as is permitted by such rules and regulations; however, the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these consolidated condensed financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2005 Annual Report on Form 10-K, the Company's Amended Annual Report on Form 10-K/A for Fiscal 2005 (which the Company expects to file as soon as practicable) and Part II — Item 5. Other Information included herein.

Results of acquired companies are included in the Company's operating results from the date of acquisition and, therefore, operating results on a period-to-period basis are not comparable. In the opinion of management, the information furnished reflects all adjustments (all of which are of a normal recurring nature except for the restatement entries) necessary for a fair presentation of the results for the reported interim periods. Results of operations for interim periods are not necessarily indicative of results for the full year.

All inter-company accounts have been eliminated in consolidation.

Periods Covered: The period from April 2, 2006 to July 1, 2006 (the ‘‘Three Months Ended July 1, 2006’’) and the period April 3, 2005 to July 2, 2005 (the ‘‘Three Months Ended July 2, 2005’’) each contained thirteen weeks of operations. The period from January 1, 2006 to July 1, 2006 (the ‘‘Six Months Ended July 1, 2006’’) and the period January 2, 2005 to July 2, 2005 (the ‘‘Six Months Ended July 2, 2005’’) each contained twenty-six weeks of operations.

Reclassifications: For comparative purposes, certain prior period items have been reclassified to conform to the current period presentation. See Note 7 for a discussion of certain reclassifications.

Stock-Based Compensation: In December 2004, the Financial Accounting Standards Board (‘‘FASB’’) issued Statement of Financial Accounting Standards (‘‘SFAS’’) No. 123 (revised 2004), Share-Based Payment (‘‘SFAS 123R’’). SFAS 123R requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Among other matters, SFAS 123R requires companies to estimate the forfeiture rate of stock-based compensation awards. In addition, liability awards will be remeasured each reporting period. Compensation cost will be recognized ratably over the period that an employee provides service in exchange for the award. SFAS 123R replaces SFAS No. 123, Accounting for Stock-Based Compensation (‘‘SFAS 123’’), and supersedes Accounting Principles Board (‘‘APB’’) Opinion No. 25, Accounting for Stock Issued to Employees. On April 14, 2005, the SEC announced the adoption of a rule that deferred the required effective date of SFAS 123R. The SEC rule provided that SFAS 123R would be effective for registrants as of the beginning of the first fiscal year beginning after June 15, 2005.

Effective February 5, 2003, the Company adopted the fair value method of accounting for stock options under SFAS 123 for all options granted by the Company after February 4, 2003 pursuant to

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Table of Contents

THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

the prospective method provisions of SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure (‘‘SFAS 148’’). From February 5, 2003 to December 31, 2005, the Company recorded stock-based compensation expense based on actual forfeitures of stock-based compensation awards.

On January 1, 2006, the Company adopted SFAS 123R using the modified prospective method. As such, results for prior periods have not been restated. The computation of stock-based compensation expense using SFAS 123R compared to the computation of stock-based compensation expense using SFAS 123 resulted in a reduction in stock-based compensation expense of $271 (from $4,754 to $4,483) and $631 (from $8,473 to $7,842) for the Three and Six Months Ended July 1, 2006, respectively, as a result of the use of an estimated forfeiture rate in the computation of stock-based compensation expense. For the Three Months Ended July 1, 2006, the reduction in stock-based compensation expense caused income before income taxes to increase by $271 and net income to increase by $175. For the Three Months Ended July 1, 2006, the reduction in stock-based compensation expense did not have any effect on basic or diluted income per common share, cash provided by operating activities or cash provided by financing activities. For the Six Months Ended July 1, 2006, the reduction in stock-based compensation expense caused income before income taxes to increase by $631, net income to increase by $407 and basic and diluted income per common share to increase by $0.01. The reduction in stock-based compensation expense did not have any effect on cash provided by operating activities or cash provided by financing activities for the Six Months Ended July 1, 2006. The cumulative effect of the adoption of SFAS 123R was not material.

The Company has issued stock options and granted restricted stock and restricted stock units under the following stock-based compensation plans:

2005 Stock Incentive Plan

The Warnaco Group, Inc. 2005 Stock Incentive Plan (the ‘‘2005 Stock Incentive Plan’’) permits the granting of incentive stock options, non-qualified stock options, restricted stock, stock awards and other stock-based awards (including but not limited to restricted stock units), some of which may require the satisfaction of performance-based criteria in order to become vested or payable to participants. Subject to adjustment for dividends, distributions, recapitalizations, stock splits, reverse stock splits, reorganizations, mergers, consolidations, split-ups, spin-offs, combinations, repurchases or exchanges of shares or other securities of the Company, issuances of warrants or other rights to purchase shares of common stock or other securities of the Company and other similar events, the aggregate number of shares that may be issued under the 2005 Stock Incentive Plan is 3,000,000 shares of common stock; provided, however, that the aggregate number of shares that may be subject to restricted stock awards shall not exceed 750,000. The Compensation Committee of the Warnaco Group's Board of Directors is responsible for administering the 2005 Stock Incentive Plan. The Company has reserved 3,000,000 shares of its common stock for stock based compensation awards granted pursuant to the 2005 Stock Incentive Plan. Substantially all awards granted under the 2005 Stock Incentive Plan have a contractual life of 10 years and vest annually with respect to 1/3 of the award on each anniversary of the grant date beginning in 2006 provided that the grantee is employed by the Company on such date.

2003 Stock Incentive Plan

The Board of Directors and Compensation Committee thereof are responsible for administration of The Warnaco Group, Inc. 2003 Stock Incentive Plan (the ‘‘2003 Stock Incentive Plan’’) and determine, subject to the provisions of the plans, the number of shares to be issued, the terms of

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Table of Contents

THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

awards, the sale or exercise price, the number of shares awarded and the rate at which awards vest or become exercisable. The Company has reserved 5,000,000 shares of common stock for stock-based compensation awards granted pursuant to the 2003 Stock Incentive Plan. Substantially all stock-based compensation awards granted after January 3, 2004 have a contractual life of 10 years and vest annually with respect to 1/3 of the award on each anniversary of the grant date beginning in 2005 provided that the grantee is employed by the Company on such date. Substantially all stock-based compensation awards granted prior to January 3, 2004 have a contractual life of 10 years and vest, with respect to ¼ of the award, six months after the grant date and, with respect to an additional ¼ of such award, each anniversary after the first vesting date for a period of three years provided that the grantee is employed by the Company on such date.

A summary of stock option award activity under the Company’s stock incentive plans as of July 1, 2006 and changes during the Six Months Ended July 1, 2006 is presented below:


  Options Weighted
Average
Exercise
Price
Outstanding as of January 1, 2006 3,963,300
$ 14.28
Granted 1,075,000
22.86
Exercised (93,153
)
15.36
Forfeited/Expired (90,531
)
18.54
Outstanding as of July 1, 2006 4,854,616
$ 17.75
Exercisable as of July 1, 2006 2,108,600
$ 14.86

A summary of the activity for unvested restricted share/unit awards as of July 1, 2006 and changes during the Six Months Ended July 1, 2006 is presented below:


  Restricted
Shares/Units
Weighted
Average
Grant Date
Fair Value
Unvested as of January 1, 2006 613,825
$ 19.47
Granted 391,750
22.66
Vested (161,459
)
20.72
Forfeited (19,517
)
21.34
Unvested as of July 1, 2006 824,599
$ 20.94

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

The following table summarizes information about options outstanding as of July 1, 2006:


  Options Outstanding Options Exercisable
Range of Exercise Prices Outstanding at
July 1,
2006
Weighted
Average
Remaining
Contractual
Life (Years)
Weighted
Average
Exercise
Price
Intrinsic
Value
Exercisable at
July 1,
2006
Weighted
Average
Exercise
Price
Intrinsic
Value
$9.55 – $13.20 1,382,500
6.7
$ 10.06
$ 11,917
971,000
$ 10.03
$ 8,399
$13.21 – $16.85 220,000
7.2
16.55
448
164,667
16.65
335
$16.86 – $20.50 1,251,400
7.9
18.60
707
670,068
18.31
453
$20.51 – $24.15 1,894,716
9.3
22.52
302,865
21.74
$24.16 – $27.80 106,000
9.4
25.28
  4,854,616
8.1
$ 17.75
$ 13,072
2,108,600
$ 14.86
$ 9,187

The Company uses the Black-Scholes-Merton model to calculate the fair value of stock option awards. The Black-Scholes-Merton model requires the Company to make significant judgments regarding the assumptions used within the Black-Scholes-Merton model, the most significant of which are the stock price volatility assumption, the expected life of the option award and the risk-free rate of return. In determining the stock price volatility assumption used, the Company considered the volatility of the stock prices of selected companies in the apparel industry, the nature of those companies, the Company's stock price volatility since its emergence from bankruptcy and other factors. The Company based its estimate of the expected life of a stock option of six years upon the vesting period of 36-42 months and the option term of ten years for issued and outstanding options. The Company's risk-free rate of return assumption for options granted during the Six Months Ended July 1, 2006 and the Six Months Ended July 2, 2005 was equal to the quoted yield for five-year U.S. treasury bonds as of the date of grant. Compensation expense related to stock-based compensation awards is based on the number of stock-based compensation awards that the Company expects to vest and the fair value of the stock-based compensation awards on the date of grant and is recognized over the vesting period of the stock-based awards on a straight-line basis.

The weighted average grant date fair value of options granted and the intrinsic value of options exercised and restricted shares/units vested during the Three Months and Six Months Ended July 1, 2006 and the Three Months and Six Months Ended July 2, 2005 are as follows:


  Three Months Ended Six Months Ended
  July 1, 2006 July 2, 2005 July 1, 2006 July 2, 2005
Weighted-average grant date fair value of options granted $ 7.81
$ 8.12
$ 8.54
$ 8.12
Intrinsic value of options exercised 4.80
8.31
7.62
11.50
Intrinsic value of restricted shares/units vested 21.67
22.57
23.49
23.91

The fair values of the stock options were estimated at the date of grant using a Black-Scholes-Merton option pricing model with the following assumptions:

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Table of Contents

THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)


  Three Months Ended Six Months Ended
  July 1, 2006 July 2, 2005 July 1, 2006 July 2, 2005
Weighted average risk free rate of return 5.02
%
3.83
%
4.62
%
3.83
%
Dividend yield (a)
Expected volatility of the market price of the Company's common stock 27.0% 30.0% 27.0% 30.0%
Expected option life 6 years 6 years 6 years 6 years
(a) The terms of the Company's Amended and Restated Credit Agreement and the terms of the indenture governing its 8 7/8% Senior Notes due 2013 (each as defined below) limit the Company's ability to make certain payments, including dividends, and require the Company to meet certain financial covenants. The Company has not paid dividends on its common stock in any of the last three fiscal years. See Note 11.

A summary of stock-based compensation expense is as follows:


  Three Months Ended Six Months Ended
  July 1, 2006 July 2, 2005 July 1, 2006 July 2, 2005
Stock-based compensation expense before income taxes:  
 
 
 
Stock options $ 2,517
$ 1,721
$ 4,410
$ 2,942
Restricted stock grants 1,966
1,048
3,432
1,987
Total 4,483
2,769
7,842
4,929
Income tax benefit:  
 
 
 
Stock options 893
611
1,562
1,051
Restricted stock grants 697
372
1,216
710
Total 1,590
983
2,778
1,761
Stock-based compensation expense after income taxes:  
 
 
 
Stock options 1,624
1,110
2,848
1,891
Restricted stock grants 1,269
676
2,216
1,277
Total $ 2,893
$ 1,786
$ 5,064
$ 3,168

As of July 1, 2006, there was $23,143 of total unrecognized compensation cost related to unvested stock-based compensation awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of approximately 27 months.

Recent Accounting Pronouncements: In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (‘‘SFAS 154’’). SFAS 154 replaces APB Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented reflecting the new accounting principle as if it had been adopted at the beginning of the earliest period presented. SFAS 154 also requires that a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for prospectively as a change in estimate and that the correction of errors in previously issued financial statements be termed a restatement. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. As discussed in Note 18 and Part II — Item 5. Other Information, the Company will be restating its consolidated financial statements for the quarter ended April 1, 2006 (‘‘First Quarter 2006’’), for the quarter ended December 31, 2005 (‘‘Fourth Quarter 2005’’) and for Fiscal 2005, in accordance with the provisions of SFAS 154.

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140 (‘‘SFAS 155’’). SFAS 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 10, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 155 permits an entity to measure at fair value certain financial instruments that contain an embedded derivative that otherwise would require bifurcation. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS 155 to have a material effect on its consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140 (‘‘SFAS 156’’). SFAS 156 requires recognition of a servicing asset or liability at fair value each time an obligation is undertaken to service a financial asset by entering into a servicing contract. SFAS 156 also provides guidance on subsequent measurement methods for each class of servicing assets and liabilities and specifies financial statement presentation and disclosure requirements. This statement is effective for fiscal years beginning after September 15, 2006. The Company does not expect adoption of SFAS 156 to have a material effect on its consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (‘‘FIN 48’’). FIN 48 prescribes a recognition threshold and measurement principles for financial statement disclosure of tax positions taken or expected to be taken on a tax return. FIN 48 also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income tax in interim periods and income tax disclosures. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of the beginning of fiscal 2007 and is in the process of evaluating the impact, if any, the adoption will have on the Company’s consolidated financial statements.

Note 2—CKJEA Acquisition

On January 31, 2006, the Company acquired 100% of the shares of the companies (the ‘‘CKJEA Business’’) that operate the wholesale and retail businesses of Calvin Klein jeanswear and accessories in Europe and Asia and the CK Calvin Klein ‘‘bridge’’ line of sportswear and accessories in Europe (the ‘‘CKJEA Acquisition’’) from Fingen Apparel N.V., Fingen S.p.A., Euro Cormar S.p.A. and Calvin Klein, Inc. for total consideration of approximately €240,000 (approximately $291,647), consisting of cash consideration, net of cash acquired, of approximately €166,000 (approximately $202,300) and assumption of indebtedness of approximately €74,000 (approximately $89,347). In addition, the Company had incurred professional fees and other related costs of approximately $6,850 in connection with the acquisition. The CKJEA Acquisition provided the Company with rights to distribute Calvin Klein jeanswear products worldwide and expand its retail channel of distribution. The purchase price is subject to certain post-closing adjustments, including adjustments to the amount of working capital acquired. Approximately €37,000 (approximately $44,518) of the assumed debt was repaid simultaneously with the closing, leaving approximately €37,000 (approximately $44,829) of assumed debt outstanding. The CKJEA Acquisition was consummated pursuant to the terms and conditions of a Stock Purchase Agreement, dated as of December 20, 2005 (as amended as of January 30, 2006). The Company is in the process of determining the final allocation of the purchase price to the fair values of the assets acquired and liabilities assumed on acquisition and obtaining final independent third party appraisals of certain acquired assets. As a result, the purchase price allocation is preliminary and is subject to change.

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

The Company funded the acquisition using a combination of cash on hand and borrowings under a new $180,000 term loan facility under its Amended and Restated Credit Agreement. See Note 11.

In connection with the consummation of the CKJEA Acquisition, on January 31, 2006, the Company acquired various exclusive license agreements and entered into amendments to certain of its existing license agreements with Calvin Klein, Inc. (in its capacity as licensor). The acquisition of additional licenses and the amendments to certain existing licenses did not and will not require any additional consideration from the Company. The exclusive license agreements acquired in the CKJEA Acquisition have a duration of approximately 41 years from January 31, 2006 (except the license for Calvin Klein collection, which expires in 2013), subject to the terms and conditions of each such exclusive agreement.

In connection with the consummation of the CKJEA Acquisition, the Company will, for no additional consideration and subject to certain conditions which are ministerial in nature, acquire 100% of the shares of the company that operates the license for Calvin Klein men’s and women’s collection apparel and accessories worldwide on or about January 2, 2008, which license will expire in December 2013, subject to certain conditions.

The Company accounted for the CKJEA Acquisition as a purchase. The estimated excess of purchase price over the preliminary fair value of the net assets acquired and liabilities assumed (approximately $74,290) has been recorded as goodwill. The results of the CKJEA Business’ operations have been included in the Company’s results of operations (as part of the Company’s Sportswear Group) commencing February 1, 2006 and the acquired assets and liabilities have been included in the Company’s consolidated condensed balance sheet at July 1, 2006.

Assets acquired and liabilities assumed on January 31, 2006, based upon the Company’s preliminary allocation of the purchase price to the fair value of the assets acquired and liabilities assumed, are as follows:


Assets acquired  
Accounts receivable $ 63,747
Inventory 54,504
Prepaid and other current assets 21,496
Property, plant and equipment 14,477
Licenses and other intangible assets (a) 177,300
Goodwill (a) 74,290
Other assets 2,090
Total assets 407,904
Liabilities assumed  
Accounts payable, accrued liabilities and other current liabilities 57,157
Accrued income taxes payable 16,701
Third party debt 44,829
Related party debt (b) 44,518
Deferred taxes 23,728
Other noncurrent liabilities 11,821
Total liabilities 198,754
Purchase price, net of cash acquired of $16,578 $ 209,150
(a) See Note 10 for additional information regarding acquired intangible assets and goodwill.
(b) Repaid by the acquired entities simultaneously with the closing.

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

The following unaudited pro forma statement of operations data for the Six Months Ended July 1, 2006 and the Three and Six Months Ended July 2, 2005 gives effect to the CKJEA Acquisition as if it had occurred at the beginning of each fiscal year of each period presented. The pro forma information, as presented below, is not necessarily indicative of the results that would have been obtained had the transaction occurred at the beginning of each period presented, nor is it indicative of the Company’s future results. The unaudited pro forma information is presented based on the Company’s preliminary purchase price allocation. Definitive allocations (which will be based on, among other things, independent appraisals and estimates of the fair values of assets and liabilities acquired) may differ significantly from the unaudited pro forma amounts included herein and may also effect the actual net income reported in future periods.


  Three Months
Ended
Six Months Ended
  July 2, 2005 July 1, 2006 July 2, 2005
Net revenues $ 418,275
$ 947,472
$ 936,597
Net income 798
19,930
36,985
Net income per share – basic 0.02
0.43
0.81
Net income per share – diluted 0.02
0.42
0.80

The above pro forma amounts reflect adjustments related to: (i) the elimination of sales by the Company to the CKJEA Business; (ii) depreciation and amortization expense (based on the preliminary allocation of the purchase price to the estimated fair value of the assets acquired); (iii) interest expense resulting from the cash used in, and the financing obtained for, the acquisition; and (iv) income tax effect based upon an unaudited pro forma effective tax rate of 35.30% and 38.02% for the Six Months Ended July 1, 2006 and Three and Six Months Ended July 2, 2005, respectively. The unaudited pro forma information does not reflect management’s estimate of any anticipated cost savings or other benefits that may ultimately result from the acquisition.

In addition, the unaudited pro forma amounts exclude material non-recurring charges of approximately $5,458 related to the following:

a)  The write up to fair value of inventory as part of the preliminary purchase price allocation: $2,400 (recorded in cost of goods sold in the consolidated condensed statement of operations);
b)  The amortization of sales order backlog: $1,900 (recorded in amortization of intangible assets in the consolidated condensed statement of operations);
c)  A net exchange loss realized by the Company in connection with the consummation of the acquisition: $1,558 (recorded in other loss (income) in the consolidated condensed statement of operations).

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

Note 3—Discontinued Operations

As disclosed in its Annual Report on Form 10-K for Fiscal 2005, the Company discontinued certain operations in prior periods. Summarized operating results for the discontinued operations are as follows:


  Three Months Ended
July 2, 2005
Six Months Ended
July 2, 2005
Net revenues $ 26
$ 222
Income before benefit for income taxes (428
)
(235
)
Provision for income taxes (175
)
(107
)
Income from discontinued operations $ (253
)
$ (128
)

Note 4—Restructuring Expense

During the Three Months Ended July 1, 2006 and the Six Months Ended July 1, 2006, the Company did not incur any restructuring expenses. During the Three Months Ended July 2, 2005 and the Six Months Ended July 2, 2005, the Company incurred restructuring expense of $721 and $727, respectively, primarily related to the continuation of activities commenced in prior periods associated with the closure, consolidation or sale of certain facilities.

A summary of restructuring expense for the Three Months Ended July 2, 2005 and the Six Months Ended July 2, 2005 is as follows:


  Three Months Ended
July 2, 2005
Six Months Ended
July 2, 2005
Employee termination costs and related items (a) $ 108
$ 75
Facility shutdown costs and loss on disposal/write-down of property, plant and equipment (b) 743
779
Lease and contract termination costs (c) (130
)
(130
)
Legal and professional fees
3
Total restructuring expense $ 721
$ 727
Cash portion of restructuring items $ 23
$ 11
Non-cash portion of restructuring items 698
716
(a) For the Six Months Ended July 2, 2005, includes employee termination costs of $136 related to 19 employees, offset by a $61 reduction in employee termination accruals which were no longer required.
(b) For the Three and Six Months Ended July 2, 2005, includes $698 and $716, respectively, of losses on disposal/writedowns of assets related to facilities that were either closed or sold in prior periods.
(c) Reflects the reversal of an accrual no longer required related to the closure of a technical production support center located in Van Nuys, California. The Company settled the lease with the landlord earlier than anticipated.

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

Changes in liabilities related to restructuring expense (income) for the Six Months Ended July 1, 2006 are summarized below:


  Employee
Termination
Costs
Legal and
Professional
Fees
Total
Balance at December 31, 2005 $ 302
$ 10
$ 312
Cash reductions for the Six Months Ended July 1, 2006 (42
)
(8
)
(50
)
Non-cash changes and foreign currency effects 22
22
Balance at July 1, 2006 (a) $ 282
$ 2
$ 284
(a) The Company expects that substantially all of the liabilities related to these restructuring items will be paid within 12 months.

Note 5—Business Segments and Geographic Information

Business Segments: The Company operates in three business segments: (i) Intimate Apparel Group; (ii) Sportswear Group; and (iii) Swimwear Group.

The Intimate Apparel Group designs, manufactures, sources and markets moderate to premium priced intimate apparel and other products for women and better to premium priced men's underwear and loungewear under the Warner's, Olga®, Body Nancy GanzTM/Bodyslimmers®, J. Lo by Jennifer Lopez®, Calvin Klein®, Lejaby®, Axcelerate Engineered by Speedo™ and Rasurel® brand names. As of July 1, 2006, the Intimate Apparel Group also operated 156 Calvin Klein retail stores worldwide (consisting of 94 stores directly operated by the Intimate Apparel Group, including one on-line store, and 62 stores operated under retail licenses or distributor agreements).

The Sportswear Group designs, sources and markets moderate to premium priced men's, women's and junior's sportswear under the Calvin Klein and Chaps® brands. During the First Quarter 2006, the Company acquired (as part of its Sportswear Group) the wholesale and retail businesses of Calvin Klein jeanswear and accessories in Europe and Asia and the CK Calvin Klein ‘‘bridge’’ line of sportswear and accessories in Europe. See Note 2. As of July 1, 2006, the Sportswear Group operated 333 Calvin Klein retail stores worldwide (consisting of 197 stores/shop-in-shop locations directly operated by the Sportswear Group and 136 stores/shop-in-shop locations operated under retail licenses or distributor agreements). The majority of these Calvin Klein retail stores were acquired as part of the CKJEA Acquisition.

The Swimwear Group designs, licenses, sources, manufactures and markets mass market to premium priced swimwear, fitness apparel, swim accessories and related products under the Speedo, Anne Cole®, Cole of California®, Catalina®, Lifeguard®, Nautica®, Michael Kors®, Ocean Pacific®, Axcelerate/Axcelerate Engineered by Speedo and Calvin Klein brand names. As of July 1, 2006, the Swimwear Group operated three Speedo outlet stores and one on-line store.

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THE WARNACO GROUP, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands, excluding per share amounts)
(Unaudited)

Information by business group, excluding discontinued operations, is set forth below:


  Sportswear
Group
Intimate
Apparel
Group
Swimwear
Group
Group
Total
Corporate /
Other Items
Total
Three Months Ended July 1, 2006  
 
 
 
 
 
Net revenues $ 167,622
$ 153,147
$ 130,816
$ 451,585
$
$ 451,585
Operating income (loss) 2,499
18,237
1,554
22,290
(8,286
)
14,004
Depreciation and amortization 4,946
2,764
3,041
10,751
933
11,684
Capital expenditures 2,460
1,980
724
5,164
2,666
7,830
Three Months Ended July 2, 2005  
 
 
 
 
 
Net revenues $ 120,073
$ 143,328
$ 111,278
$ 374,679
$
$ 374,679
Operating income (loss) 12,175
8,295
1,928
22,398
(6,830
)
15,568
Depreciation and amortization 2,696
2,597
2,303
7,596
600
8,196
Restructuring expense
721
721
Capital expenditures 263
2,816
1,204
4,283
3,405
7,688
Six Months Ended July 1, 2006  
 
 
 
 
 
Net revenues $ 335,494
$ 306,850
$ 272,021
$ 914,365
$
$ 914,365
Operating income (loss) 10,441
34,050
15,636
60,127
(14,934
)
45,193
Depreciation and amortization 10,257
5,674
5,968
21,899
1,665
23,564
Capital expenditures 3,718
2,892
1,948
8,558
6,964
15,522
Six Months Ended July 2, 2005  
 
 
 
 
 
Net revenues $ 250,436
$ 295,103
$ 268,681
$ 814,220
$
$ 814,220
Operating income (loss) 26,792
20,394
36,060
83,246
(14,761
)
68,485
Depreciation and amortization 5,405
5,199
4,443
15,047
1,360
16,407
Restructuring expense
727
727
Capital expenditures 468
3,577
1,724
5,769
8,157
13,926
Balance Sheet