**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 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  OCTOBER 2, 2004** |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                |
| **OR**     |
| ** ** | ** ** | ** **                                                                                                                                                |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                             |

 

**Commissionfile numbers:**

 

**001-31829and 333-22155**

 

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**CARTER’S, INC.****THE WILLIAM CARTER COMPANY**(Exact names of registrants as specified in their charters)

 
| **Delaware**                       | ** ** | **13-3912933**                         |
|------------------------------------|------------|----------------------------------------|
| **Massachusetts**                  | ** ** | **04-1156680**                         |
| (States  or other jurisdictions of |       | (I.R.S.  Employer Identification Nos.) |
| Incorporation  or Organization)    |       |                                   |

 

**TheProscenium****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)

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes ý  No o

 

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

 

The common equity of Carter’s, Inc. was notpublicly traded as of the end of the second fiscal quarter of our most recentlycompleted fiscal year.  Accordingly,Carter’s, Inc. does not meet the definition of an accelerated filer under Rule12b-2 of the Securities Exchange Act of 1934.

 

Applicable only to corporateissuers:

 

Carter’s, Inc. has one classof common stock.  There were 28,421,417shares of Carter’s, Inc.’s common stock, par value of $0.01 per share,outstanding as of the close of business on November 12, 2004.

 

This Form 10-Q is a combined quarterlyreport being filed separately by two registrants:  Carter’s, Inc. and The William CarterCompany, the wholly-owned operating subsidiary of Carter’s, Inc.  Unless the context indicates otherwise, anyreference in this report to “TWCC” refers to The William Carter Company. “Carter’s,”“we,” “us,” and “our” refer to Carter’s, Inc. together with TWCC.

 

The William Carter Company meets the conditions set forth in generalinstruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form withthe reduced disclosure format.

 

 

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**CARTER’S,INC.**

**AND THEWILLIAM CARTER COMPANY**

# **INDEX**

 
| ** **         | ** **                | ** **                                                                                                                                       | ** ** |
|--------------------|---------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Part I.**        | **Financial Information** |                                                                                                                                             |
| ** **         | ** **                |                                                                                                                                             |
|               | Item 1.                   | Financial Statements                                                                                                                             |       |
|               |                      |                                                                                                                                             |       |
|               |                      | Unaudited  Condensed Consolidated Balance Sheets as of October 2, 2004 and  January 3, 2004                                            |       |
|               |                      |                                                                                                                                             |       |
|               |                      | Unaudited  Condensed Consolidated Statements of Income for the three and nine-month  periods ended October 2, 2004 and October 4, 2003 |       |
|               |                      |                                                                                                                                             |       |
|               |                      | Unaudited  Condensed Consolidated Statements of Cash Flows for the nine-month periods  ended October 2, 2004 and October 4, 2003       |       |
|               |                      |                                                                                                                                             |       |
|               |                      | 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 Risk                                                                                      |       |
|               |                      |                                                                                                                                             |       |
| ** **         | Item 4.                   | Controls and Procedures                                                                                                                          |       |
|               |                      |                                                                                                                                             |       |
| **Part II.**       | **Other Information**     |                                                                                                                                             |
|               |                      |                                                                                                                                             |       |
| ** **         | Item 1.                   | Legal Proceedings                                                                                                                                |       |
| ** **         |                      |                                                                                                                                             |       |
| ** **         | Item 2.                   | Change in Securities                                                                                                                             |       |
| ** **         |                      |                                                                                                                                             |       |
| ** **         | Item 3.                   | Defaults upon  Senior Securities                                                                                                                 |       |
| ** **         |                      |                                                                                                                                             |       |
| ** **         | Item  4.                  | Submission  of Matters to a Vote of Security Holders                                                                                             |       |
| ** **         |                      |                                                                                                                                             |       |
| ** **         | Item 5.                   | Other Information                                                                                                                                |       |
| ** **         |                      |                                                                                                                                             |       |
| ** **         | Item 6.                   | Exhibits and  Reports on Form 8-K                                                                                                                |       |
| ** **         |                      |                                                                                                                                             |       |
| **Signatures**     |                      |                                                                                                                                             |
| ** **         | ** **                | ** **                                                                                                                                       |       |
| **Certifications** | ** **                |                                                                                                                                             |

 

2

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**PART I — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

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

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **October 2,  2004** | ** ** | **January 3,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Current assets:                                                                                                                                                                                                                                                                                                                                                                                                             |       |                 |       |                 |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                                                                                   |       | $                    | 12,004     |                 | $          | 36,061 |   |
| Accounts receivable, net                                                                                                                                                                                                                                                                                                                                                                                                    |       | 103,108              |       | 65,318               |       |
| Inventories, net                                                                                                                                                                                                                                                                                                                                                                                                            |       | 148,414              |       | 104,760              |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                                                                                                   |       | 2,680                |       | 6,575                |       |
| Assets held for sale                                                                                                                                                                                                                                                                                                                                                                                                        |       | 864                  |       | 50                   |       |
| Deferred income taxes                                                                                                                                                                                                                                                                                                                                                                                                       |       | 10,692               |       | 9,045                |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Total current assets                                                                                                                                                                                                                                                                                                                                                                                                        |       | 277,762              |       | 221,809              |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Property, plant, and equipment, net                                                                                                                                                                                                                                                                                                                                                                                         |       | 51,177               |       | 50,502               |       |
| 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 $15,000 and  $11,875                                                                                                                                                                                                                                                                                                                                               |       | —               |       | 3,125                |       |
| Deferred debt issuance costs, net                                                                                                                                                                                                                                                                                                                                                                                           |       | 6,486                |       | 7,666                |       |
| Other assets                                                                                                                                                                                                                                                                                                                                                                                                                |       | 2,881                |       | 3,485                |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Total assets                                                                                                                                                                                                                                                                                                                                                                                                                |       | $                    | 697,821    |                 | $          | 646,102 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                                                                                               |       |                 |       |                 |       |
| Current liabilities:                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Current maturities of long-term debt                                                                                                                                                                                                                                                                                                                                                                                        |       | $                    | 927        |                 | $          | 3,336 |   |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                                                                            |       | 42,371               |       | 30,436               |       |
| Other current liabilities                                                                                                                                                                                                                                                                                                                                                                                                   |       | 37,274               |       | 37,405               |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                                                                                                                   |       | 80,572               |       | 71,177               |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Long-term debt                                                                                                                                                                                                                                                                                                                                                                                                              |       | 213,788              |       | 209,377              |       |
| Deferred income taxes                                                                                                                                                                                                                                                                                                                                                                                                       |       | 82,078               |       | 83,196               |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                                                                                                                                                 |       | 9,816                |       | 9,816                |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Total liabilities                                                                                                                                                                                                                                                                                                                                                                                                           |       | 386,254              |       | 373,566              |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Commitments and contingencies                                                                                                                                                                                                                                                                                                                                                                                               |       |                 |       |                 |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Carter’s, Inc., preferred stock; par value $.01 per share; 100,000  shares authorized; none issued or outstanding at October 2, 2004 and  January 3, 2004                                                                                                                                                                                                                                                    |       | —               |       | —               |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Carter’s, Inc., common stock, voting; par value $.01 per share;  40,000,000 shares authorized; 28,331,337 shares issued and outstanding at  October 2, 2004 and 27,985,360 shares issued and outstanding at January 3,  2004 (TWCC’s common stock, voting; par value $.01 per share; 200,000 shares  authorized; 1,000 shares issued and outstanding at October 2, 2004 and  January 3, 2004) |       | 283                  |       | 280                  |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                                                                                                  |       | 246,166              |       | 241,780              |       |
| Retained earnings                                                                                                                                                                                                                                                                                                                                                                                                           |       | 65,118               |       | 30,476               |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Total stockholders’ equity                                                                                                                                                                                                                                                                                                                                                                                             |       | 311,567              |       | 272,536              |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                 |       |                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                                                                                                                                             |       | $                    | 697,821    |                 | $          | 646,102 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                             |            |                      |            |                      |            |  |  |  |  |

 

See accompanying notes tothe unaudited condensed consolidated financial statements

 

 

3

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**CARTER’S,INC.AND THE WILLIAM CARTER COMPANYCONDENSED CONSOLIDATED STATEMENTSOF INCOME**(dollars in thousands, except for share data)

 (unaudited)

** **
| ** **                                            | ** ** | **For the  three-month periods ended** | ** ** | **For the  nine-month periods ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                            | ** ** | **October 2,  2004**                   | ** ** | **October 4,  2003**                  | ** ** | **October 2,  2004** | ** ** | **October 4,  2003** | ** ** |
|                                                  |       |                                   |       |                                  |       |   |   |   |   |
| Net sales                                             |       | $                                      | 251,357    |                                  | $          | 212,135 |   | $ | 590,384 |   | $ | 518,136 |   |
| Cost of goods sold                                    |       | 163,490                                |       | 136,451                               |       | 376,656 |   | 331,993 |   |
|                                                  |       |                                   |       |                                  |       |   |   |   |   |
| Gross profit                                          |       | 87,867                                 |       | 75,684                                |       | 213,728 |   | 186,143 |   |
| Selling, general, and administrative expenses         |       | 56,280                                 |       | 51,896                                |       | 151,674 |   | 138,660 |   |
| Closure costs                                         |       | 49                                     |       | 115                                   |       | 589 |   | 115 |   |
| Royalty income                                        |       | (3,589                                 | )          | (3,692                                | )          | (9,257 | ) | (8,149 | ) |
|                                                  |       |                                   |       |                                  |       |   |   |   |   |
| Operating income                                      |       | 35,127                                 |       | 27,365                                |       | 70,722 |   | 55,517 |   |
| Interest expense, net                                 |       | 4,666                                  |       | 6,788                                 |       | 13,654 |   | 20,309 |   |
|                                                  |       |                                   |       |                                  |       |   |   |   |   |
| Income before income taxes                            |       | 30,461                                 |       | 20,577                                |       | 57,068 |   | 35,208 |   |
| Provision for income taxes                            |       | 12,049                                 |       | 7,922                                 |       | 22,426 |   | 13,555 |   |
|                                                  |       |                                   |       |                                  |       |   |   |   |   |
| Net income                                            |       | $                                      | 18,412     |                                  | $          | 12,655 |   | $ | 34,642 |   | $ | 21,653 |   |
|                                                  |       |                                   |       |                                  |       |   |   |   |   |
| **Carter’s, Inc.**                               |       |                                   |       |                                  |       |   |   |   |   |
| Basic net income per common share                     |       | $                                      | 0.65       |                                  | $          | 0.56 |   | $ | 1.24 |   | $ | 0.96 |   |
| Diluted net income per common share                   |       | $                                      | 0.62       |                                  | $          | 0.52 |   | $ | 1.16 |   | $ | 0.90 |   |
| Basic weighted average number of shares outstanding   |       | 28,109,978                             |       | 22,564,856                            |       | 28,032,520 |   | 22,560,872 |   |
| Diluted weighted average number of shares outstanding |       | 29,902,137                             |       | 24,236,255                            |       | 29,887,853 |   | 24,084,183 |   |
|                                                       |            |                                        |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Seeaccompanying notes to the unaudited condensed consolidated financial statements

 

4

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**CARTER’S, INC.****AND THE WILLIAM CARTER COMPANY****CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**(dollars in thousands)

(unaudited)

 
| ** **                                                                                   | ** ** | **For the  nine-month periods ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                   | ** ** | **October 2,  2004**                  | ** ** | **October 4,  2003** | ** ** |
| Cash flows from operating activities:                                                        |       |                                  |       |   |   |
| Net income                                                                                   |       | $                                     | 34,642     |   | $ | 21,653 |   |
| Adjustments to reconcile net income to net cash (used in) provided by  operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                                |       | 15,145                                |       | 16,009 |   |
| Amortization of debt issuance costs                                                          |       | 1,180                                 |       | 1,264 |   |
| Accretion of debt discount                                                                   |       | 56                                    |       | 99 |   |
| Tax benefit from exercise of stock options                                                   |       | 2,887                                 |       | — |   |
| Non-cash stock compensation expense                                                          |       | 294                                   |       | 256 |   |
| Non-cash closure costs                                                                       |       | —                                |       | 115 |   |
| Loss (gain) on sale of property, plant, and equipment                                        |       | 84                                    |       | (21 | ) |
| Deferred tax (benefit) provision                                                             |       | (2,765                                | )          | 1,440 |   |
| Effect of changes in operating assets and liabilities:                                       |       |                                  |       |   |   |
| Accounts receivable                                                                          |       | (37,790                               | )          | (17,293 | ) |
| Inventories                                                                                  |       | (43,654                               | )          | (12,380 | ) |
| Prepaid expenses and other assets                                                            |       | 3,899                                 |       | 1,515 |   |
| Accounts payable and other liabilities                                                       |       | 11,934                                |       | (3,245 | ) |
|                                                                                         |       |                                  |       |   |   |
| Net cash (used in) provided by operating activities                                          |       | (14,088                               | )          | 9,412 |   |
|                                                                                         |       |                                  |       |   |   |
| Cash flows from investing activities:                                                        |       |                                  |       |   |   |
| Capital expenditures                                                                         |       | (13,967                               | )          | (9,367 | ) |
| Proceeds from sale of property, plant, and equipment                                         |       | 408                                   |       | 275 |   |
| Collections on loan                                                                          |       | 600                                   |       | 600 |   |
|                                                                                         |       |                                  |       |   |   |
| Net cash used in investing activities                                                        |       | (12,959                               | )          | (8,492 | ) |
|                                                                                         |       |                                  |       |   |   |
| Cash flows from financing activities:                                                        |       |                                  |       |   |   |
| Payments of term loan                                                                        |       | (8,054                                | )          | (6,040 | ) |
| Payments on revolving loan facility                                                          |       | (79,760                               | )          | (89,700 | ) |
| Proceeds from revolving loan facility                                                        |       | 89,760                                |       | 91,600 |   |
| Payment of dividend                                                                          |       | —                                |       | (24,893 | ) |
| Payment of debt issuance costs                                                               |       | —                                |       | (799 | ) |
| Payments of capital lease obligations                                                        |       | (164                                  | )          | (195 | ) |
| Proceeds from exercise of stock options                                                      |       | 1,208                                 |       | — |   |
| Proceeds from sale of common stock                                                           |       | —                                |       | 600 |   |
|                                                                                         |       |                                  |       |   |   |
| Net cash provided by (used in) financing activities                                          |       | 2,990                                 |       | (29,427 | ) |
|                                                                                         |       |                                  |       |   |   |
| Net decrease in cash and cash equivalents                                                    |       | (24,057                               | )          | (28,507 | ) |
| Cash and cash equivalents, beginning of period                                               |       | 36,061                                |       | 35,562 |   |
|                                                                                         |       |                                  |       |   |   |
| Cash and cash equivalents, end of period                                                     |       | $                                     | 12,004     |   | $ | 7,055 |   |
|                                                                                              |            |                                       |            |  |  |  |  |  |

 

Seeaccompanying notes to the unaudited condensed consolidated financial statements

 

5

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**CARTER’S, INC.****AND THE WILLIAM CARTER COMPANY****NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**(unaudited)

 

**NOTE 1 — THE COMPANY:**

 

        On September 30, 2003, CarterHoldings, Inc., a Massachusetts corporation, re-incorporated inDelaware and changed its name by forming and subsequently merging with and intoits new wholly-owned Delaware subsidiary, Carter’s, Inc.  The surviving company in the merger wasCarter’s, Inc.  In connection withthe re-incorporation, Carter’s, Inc. effected a 4-for-1 split of its commonstock.

 

        Carter’s, Inc. conducts itsoperations and derives all of its operating income and cash flow through itswholly-owned subsidiary, The William Carter Company (“TWCC”).  Carter’s, Inc., together with TWCC(collectively “Carter’s,” “we,” “us,” and “our”) design, source, manufacture,and market branded childrenswear under the *Carter’s, Carter’sClassics, Child of Mine,*and*Tykes*labels.  Weintend to replace the *Tykes* brandname with our *Just One Year* brandbeginning in December 2004.  Our productsare sourced through contractual arrangements with numerous manufacturersthroughout the world and through production at company-managed sewingfacilities in Mexico.  Our sewingoperations in Costa Rica were closed in the fourth quarter of fiscal 2003.  (See Note 9 regarding the closure of ourCosta Rican facilities).  Products aremanufactured for wholesale distribution to major domestic retailers, includingthe mass channel, and for our 177 retail stores, which market our brand namemerchandise and certain products manufactured by other companies.

 

        On October 29, 2003, we completed an initial public offeringof Carter’s, Inc.’s common stock (the “offering”) including the sale of5,390,625 shares by us and 1,796,875 shares by the selling stockholders,primarily Berkshire Partners LLC and its affiliates.  Net proceeds to us from the offering totaled$93.9 million.  On November 28, 2003, weused approximately $68.7 million of the proceeds to redeem approximately $61.3million in outstanding senior subordinated notes and pay a redemption premiumof approximately $6.7 million and related accrued interest charges of $0.7million.  We used approximately $2.6million of the net proceeds to terminate a management agreement with BerkshirePartners LLC and used approximately $11.3 million to prepay amounts outstandingunder our term loan, as required by our senior credit facility.  The remaining proceeds were utilized forworking capital and other general corporate purposes.

 

**NOTE 2 — BASIS OF PREPARATION:**

 

        The accompanying financial statements comprise theconsolidated financial statements of Carter’s, Inc. and TWCC.  Carter’s, Inc.’s only asset is its investmentin the common stock of TWCC, its wholly-owned subsidiary.  As a result, the consolidated financialpositions, results of operations, and cash flows of Carter’s, Inc. and TWCC aresubstantially the same.

 

        In our opinion, the accompanying unaudited condensedconsolidated financial statements of Carter’s, Inc. and TWCC contain alladjustments necessary to present fairly our financial position as of October 2,2004, the results of our operations for the three and nine-month periods endedOctober 2, 2004 and October 4, 2003, and cash flows for the nine-month periodsended October 2, 2004 and October 4, 2003. Operating results for the nine-month period ended October 2, 2004 arenot necessarily indicative of the results that may be expected for the fiscalyear ending January 1, 2005.  Ouraccompanying condensed consolidated balance sheet as of January 3, 2004 is fromour audited consolidated financial statements included in our most recentlyfiled annual report on Form 10-K.

 

        Certain information and footnote disclosure normally includedin financial statements prepared in accordance with generally acceptedaccounting principles in the United States of America has been condensed oromitted pursuant to the rules and regulations of the Securities and ExchangeCommission and the instructions to Form 10-Q. The accounting policies we follow are set forth in the notes to ourconsolidated financial statements contained in our most recently filed annualreport on Form 10-K for the fiscal year ended January 3, 2004.

 

6

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        Our fiscal year ends on the Saturday in December or Januarynearest to the last day of December. Consistent with this policy, fiscal 2003 ended on January 3, 2004and fiscal 2004 will end on January 1, 2005. As a result, fiscal 2003 contained 53 weeks of financial results andfiscal 2004 will contain 52 weeks of financial results.  The additional week in fiscal 2003 wasincluded in the first nine months of fiscal 2003.  Therefore, the accompanying unauditedconsolidated financial statements for the first nine months of fiscal 2004 reflectour financial position as of October 2, 2004 and for the 39-week period thenended.  The first nine months of fiscal2003 ended on October 4, 2003 and included 40 weeks of financial results.  The accompanying unaudited consolidatedfinancial statements for the third quarter periods ended October 2, 2004 andOctober 4, 2003 each contain 13 weeks of financial results.

 

        During the first nine months of fiscal 2004, we contractedwith a third-party service to provide us with the fair value of co-opadvertising arrangements entered into with certain of our major wholesale andmass channel customers.  Such fair valueis determined based upon, among other factors, comparable market analysis forsimilar advertisements.  In accordancewith Emerging Issues Task Force Issue No. 01-09, “Accounting for ConsiderationGiven by a Vendor to a Customer/Reseller” (“EITF 01-09”), we have included thefair value of these arrangements of approximately $930,000 in the third quarterof fiscal 2004 and $2,582,000 in the first nine months of fiscal 2004 as acomponent of selling, general, and administrative expenses on the accompanyingunaudited condensed consolidated statements of income rather than as areduction of revenue.  We treated co-opadvertising arrangements in fiscal 2003 as a reduction of revenue in accordancewith EITF 01-09 as we had determined that it was impracticable to obtain thefair value of those arrangements in order to classify these costs as acomponent of selling, general, and administrative expenses.

 

**NOTE 3 — STOCK-BASEDCOMPENSATION:**

 

        We account for stock-based compensation on stock optionsunder the intrinsic value method consistent with Accounting Principles BoardOpinion No. 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.  For disclosurepurposes only, we also estimate the impact on our net income of applying thefair value method of measuring compensation cost on stock options with the fairvalue of our common stock, prior to our initial public offering, determinedunder the minimum value method as provided by Statement of Financial AccountingStandards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS123”) as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure” (“SFAS 148”).  Stock options granted subsequent to ourinitial public offering have been valued using the Black-Scholes option pricingmodel.

 

7

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        The following table illustrates, for disclosure purposesonly, the effect on net income if compensation expense for our stock optiongrants had been determined based on the fair value as of the grant datesconsistent with the methodology of SFAS 123 and SFAS 148 (dollars in thousands,except per share data):

 
| ** **                                                                                                                                                                        | ** ** | **For the****three-month periods ended** | ** ** | **For the****nine-month periods ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **October 2,****2004**                   | ** ** | **October 4,****2003**                  | ** ** | **October 2,****2004** | ** ** | **October 4,****2003** | ** ** |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Net income, as reported                                                                                                                                                           |       | $                                        | 18,412     |                                    | $          | 12,655 |   | $ | 34,642 |   | $ | 21,653 |   |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Add:                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Stock-based employee compensation (under APB 25) included in reported  net income, net of related tax effects                                                                     |       | 33                                       |       | 35                                      |       | 114 |   | 43 |   |
| 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 |       | (497                                     | )          | (168                                    | )          | (1,020 | ) | (435 | ) |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Pro forma net income                                                                                                                                                              |       | $                                        | 17,948     |                                    | $          | 12,522 |   | $ | 33,736 |   | $ | 21,261 |   |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Carter’s, Inc.’s net income per common share:                                                                                                                           |       |                                     |       |                                    |       |   |   |   |   |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Basic-as reported                                                                                                                                                                 |       | $                                        | 0.65       |                                    | $          | 0.56 |   | $ | 1.24 |   | $ | 0.96 |   |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Basic-pro forma                                                                                                                                                                   |       | $                                        | 0.64       |                                    | $          | 0.55 |   | $ | 1.20 |   | $ | 0.94 |   |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Diluted-as reported                                                                                                                                                               |       | $                                        | 0.62       |                                    | $          | 0.52 |   | $ | 1.16 |   | $ | 0.90 |   |
|                                                                                                                                                                              |       |                                     |       |                                    |       |   |   |   |   |
| Diluted-pro forma                                                                                                                                                                 |       | $                                        | 0.60       |                                    | $          | 0.52 |   | $ | 1.13 |   | $ | 0.88 |   |
|                                                                                                                                                                                   |            |                                          |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |

* *

*       *For basic stock options,using a minimum value method, the fair value of each stock option as of thedate of grant was estimated to range from $3.08 to $9.76 per share for stockoptions granted in fiscal 2003.  Forbasic stock options, using a fair value method, the fair value of each stockoption at the date of the grant was estimated to range from $12.81 to $14.15per share for stock options granted in fiscal 2004 and range from $6.40 to$13.55 per share for stock options granted in fiscal 2003.  These per share stock option values werecalculated at an assumed risk-free interest rate of 3.2% to 4.5% for fiscal2004 and 3.8% to 4.2% for 2003, with an expected life of 7 to 10 years andexpected volatility from 36.7% to 50.0%. No dividends were assumed.

 

*        Forperformance stock options, using a minimum value method, the fair value of eachstock option as of the date of grant was estimated to range from $3.08 to $9.76per share for stock options granted in fiscal 2003.  For performance stock options, using a fair valuemethod, the fair value of each stock option at the date of grant was estimatedto range from $6.40 to $13.55 per share for stock options granted in fiscal2003.  These per share stock optionvalues were calculated at the same assumed risk-free interest rates shown abovewith an expected life of 10 years and expected volatility of 50.0%.  No dividends were assumed.*

 

8

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        Coincident with the completion of the secondary offering asdiscussed in Note 5, certain performance objectives have been met and adetermination event, as defined, has occurred. Accordingly, performance optionswill now vest ratably over a five-year period from the grant date.

 

**NOTE 4 — INVENTORIES:**

 

        Inventories consisted of the following ($000):

 

| ** **                 | ** ** | **October 2,  2004** | ** ** | **January 3,  2004** | ** ** |
|----------------------------|------------|----------------------|------------|----------------------|------------|
|                       |       |                 |       |                 |       |
| Finished goods             |       | $                    | 142,628    |                 | $          | 102,921 |   |
| Work in process            |       | 3,704                |       | 1,572                |       |
| Raw materials and supplies |       | 2,082                |       | 267                  |       |
|                       |       |                 |       |                 |       |
| Total                      |       | $                    | 148,414    |                 | $          | 104,760 |   |

 

**NOTE 5 — STOCK TRANSACTIONS OFCARTER’S, INC:**

 

        On July 31, 2003, we paid a dividend of approximately $24.9million on the outstanding shares of our common stock to the stockholders ofrecord as of July 30, 2003.  At the sametime, we paid a special bonus of approximately $2.5 million to our vestedoption holders.  This special bonus wasrecorded as compensation expense during the third quarter of fiscal 2003.

 

        During the nine-month period ended October 2, 2004, we issued366,200 stock options to purchase Carter’s, Inc.’s common stock to certain employees.  During the first nine months of fiscal 2003,we issued 398,000 stock options to purchase Carter’s, Inc.’s common stock toone of our directors and to certain employees. No compensation expense was recorded during the first nine months offiscal 2004 as a result of options granted during that period as the optionswere issued as of the date of grant with an exercise price equal to the fairmarket value of a share of stock.  Werecorded approximately $50,000 in compensation expense during the third quarterof fiscal 2003 related to stock option grants.

 

        Additionally, during the first nine months of fiscal 2003, wesold shares of our common stock to two of our directors for cash proceeds of$600,000 (one during the second quarter and one during the third quarter).  In connection with these transactions, werecorded additional paid-in capital in the amount of $600,000.  Additionally, we recorded approximately$206,000 in compensation expense during the first nine months of fiscal 2003related to these stock sales.

 

        During the second and third quarters of fiscal 2004, certainemployees exercised 87,743 and 258,234 options for cash proceeds of $200,000and $1,008,000.

 

**       **On September 29, 2004, wecompleted a secondary offering of 8,687,457 shares of Carter’s, Inc.’s commonstock, including the underwriters’ over-allotment option, which was sold byBerkshire Partners LLC and its affiliates and certain members ofmanagement.  We did not receive any ofthe proceeds from this offering except for proceeds from the exercise of stockoptions exercised in connection with this offering.  The sale reduced the beneficial ownership, ona fully-diluted basis, of Berkshire Partners LLC and its affiliates to 36.2%from 66.0% and management’s ownership to 8.9% from 10.1%.  We incurred $553,000 of costs related to theoffering in the third quarter of fiscal 2004 that are recorded as a componentof selling, general, and administrative expenses in the unaudited condensedconsolidated statements of income.

 

9

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**NOTE 6 — GOODWILL AND OTHERINTANGIBLE ASSETS:**

 

        In connection with our 2001 acquisition by Berkshire PartnersLLC and affiliates (the “Acquisition”), as more fully described in Note 1 toour consolidated financial statements in our most recently filed annual reporton Form 10-K, we adopted provisions of SFAS No. 141, “Business Combinations”and applied the required provisions of SFAS No. 142, “Goodwill and OtherIntangible Assets.”  Accordingly, ourtradename and goodwill have been deemed to have indefinite lives and are nolonger being amortized.  Our licensingagreements were amortized over the average three-year life of suchagreements.  Amortization expense for thethird quarter and first nine-month period of fiscal 2003 was $1.3 million and$3.8 million.  Amortization expense forthe third quarter and first nine-month period of fiscal 2004 was $0.6 millionand $3.1 million.  The licensingagreements were fully amortized as of October 2, 2004.

 

**NOTE 7 — EMPLOYEE BENEFIT PLANS:**

 

        We have an obligation under a definedbenefit plan covering certain former officers. We also offer a comprehensive post-retirement medical plan and lifeinsurance to current and certain future retirees and their spouses until theybecome eligible for Medicare or a Medicare supplement plan.  See Note 7 “Employee Benefit Plans” to theconsolidated financial statements in our most recently filed annual report onForm 10-K for further information.

 

        The components of pension benefitexpense charged to operations are as follows ($000):

 
| ** **                                                           | ** ** | **For the  three-month periods ended** | ** ** | **For the  nine-month periods ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **October 2,  2004**                   | ** ** | **October 4,  2003**                  | ** ** | **October 2,  2004** | ** ** | **October 4,  2003** | ** ** |
|                                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Service cost — benefits attributed to service during the period |       | $                                      | —     |                                  | $          | — |   | $ | — |   | $ | — |   |
| Interest cost on accumulated pension benefit obligation              |       | 20                                     |       | 22                                    |       | 59 |   | 65 |   |
| Amortization of prior service cost                                   |       | —                                 |       | —                                |       | — |   | — |   |
| Amortization of net actuarial loss                                   |       | —                                 |       | 15                                    |       | — |   | 47 |   |
| Total net periodic pension benefit cost                              |       | $                                      | 20         |                                  | $          | 37 |   | $ | 59 |   | $ | 112 |   |

 

                The components of post-retirement life and medicalbenefit expense charged to operations are as follows ($000):

 
| ** **                                                           | ** ** | **For the  three-month periods ended** | ** ** | **For the  nine-month periods ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **October 2,  2004**                   | ** ** | **October 4,  2003**                  | ** ** | **October 2,  2004** | ** ** | **October 4,  2003** | ** ** |
|                                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Service cost — benefits attributed to service during the period |       | $                                      | 23         |                                  | $          | 20 |   | $ | 70 |   | $ | 60 |   |
| Interest cost on accumulated post-retirement benefit obligation      |       | 162                                    |       | 158                                   |       | 468 |   | 473 |   |
| Amortization of net actuarial loss                                   |       | —                                 |       | —                                |       | — |   | — |   |
| Total net periodic post-retirement benefit cost                      |       | $                                      | 185        |                                  | $          | 178 |   | $ | 538 |   | $ | 533 |   |

 

10

----

 

**NOTE 8 — SEGMENT INFORMATION:**

 

        We report segment information in accordance with theprovisions of SFAS No. 131, “Disclosure about Segments of an Enterprise andRelated Information” (“SFAS 131”), which requires segment information to bedisclosed based upon a “management approach.” The management approach refers to the internal reporting that is used bymanagement for making operating decisions and assessing the performance of ourreportable segments.

 

        Under our methodology, segment resultsinclude the direct costs of each segment and all other costs are allocatedbased upon detailed estimates and analysis of actual time and expenses incurredto support the operations of each segment or units produced or sourced tosupport each segment’s revenue.  Certaincosts, including incentive compensation for certain employees, the BerkshirePartners LLC management fee (terminated in connection with our initial publicoffering, see Note 1 to the unaudited condensed consolidated financialstatements), and various other general corporate costs that are notspecifically allocable to our segments, are included in other reconciling itemsbelow.  Intersegment sales and transfersare recorded at cost and treated as a transfer of inventory.  The accounting policies of the segments arethe same as those described in Note 2 “Summary of Significant AccountingPolicies” to the consolidated financial statements in our most recently filedannual report on Form 10-K.

* *

        The table below presents certain segmentinformation for the periods indicated ($000):

 
| ** **              | ** ** | **For the  three-month periods ended** | ** ** | **For the  nine-month periods ended** | ** ** |
|-------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **October 2,  2004**                   | ** ** | **% of  Total**                       | ** ** | **October 4,  2003** | ** ** | **% of  Total** | ** ** | **October 2,  2004** | ** ** | **% of  Total** | ** ** | **October 4,  2003** | ** ** | **% of  Total** | ** ** |
| **Net sales:**          |       |                                   |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Wholesale               |       | $                                      | 113,932    |                                  | 45.3%      |   | $ | 103,341 |   | 48.7% |   | $ | 278,020 |   | 47.1% |   | $ | 265,573 |   | 51.2% |   |
| Retail                  |       | 86,186                                 |       | 34.3%                                 |       | 77,471 |   | 36.5% |   | 205,421 |   | 34.8% |   | 190,992 |   | 36.9% |   |
| Mass Channel            |       | 51,239                                 |       | 20.4%                                 |       | 31,323 |   | 14.8% |   | 106,943 |   | 18.1% |   | 61,571 |   | 11.9% |   |
| Total net sales         |       | $                                      | 251,357    |                                  | 100.0%     |   | $ | 212,135 |   | 100.0% |   | $ | 590,384 |   | 100.0% |   | $ | 518,136 |   | 100.0% |   |
|                    |       |                                   |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **EBITDA:**             |       |                                   |       | **% of  Net Sales**                   |       |   |   | **% of  Net Sales** |   |   |   | **% of  Net Sales** |   |   |   | **% of  Net Sales** |   |
| Wholesale               |       | $                                      | 20,155     |                                  | 17.7%      |   | $ | 16,891 |   | 16.3% |   | $ | 47,989 |   | 17.3% |   | $ | 42,716 |   | 16.1% |   |
| Retail                  |       | 22,547                                 |       | 26.2%                                 |       | 19,690 |   | 25.4% |   | 45,010 |   | 21.9% |   | 42,115 |   | 22.1% |   |
| Mass Channel            |       | 5,150                                  |       | 10.1%                                 |       | 4,898 |   | 15.6% |   | 13,199 |   | 12.3% |   | 6,602 |   | 10.7% |   |
| Other reconciling items |       | (8,527                                 | )          | (3.4)%                                |       | (8,096 | ) | (3.8)% |   | (20,331 | ) | (3.4)% |   | (19,907 | ) | (3.8)% |   |
| Total EBITDA            |       | $                                      | 39,325     |                                  | 15.6%      |   | $ | 33,383 |   | 15.7% |   | $ | 85,867 |   | 14.5% |   | $ | 71,526 |   | 13.8% |   |
|                         |            |                                        |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

        EBITDA shown above represents earnings before interest,income tax expense, depreciation, and amortization.  EBITDA is presented because it is onemeasurement used by management in assessing financial performance, and webelieve it is helpful to investors, securities analysts, and other interestedparties in evaluating performance of companies in our industry.  EBITDA is also a measure used as a basis forcalculating our financial covenants under our senior credit facility.  EBITDA is not a measurement of financialperformance under generally accepted accounting principles in the United Statesof America.  It should not be consideredas an alternative to cash flow from operating activities, as a measure ofliquidity,

 

11

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an alternative to netincome, or any other measure of performance derived in accordance withgenerally accepted accounting principles in the United States of America.  Our definition and calculation of EBITDA maynot be comparable to similarly titled measures used by other companies.

 

        A reconciliation of EBITDA to net income ispresented below ($000):

 
| ** **                            | ** ** | **For the****three-month periods ended** | ** ** | **For the****nine-month periods ended** | ** ** |
|---------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                            | ** ** | **October 2,****2004**                   | ** ** | **October 4,****2003**                  | ** ** | **October 2,****2004** | ** ** | **October 4,****2003** | ** ** |
|                                  |       |                                     |       |                                    |       |   |   |   |   |
| Total EBITDA                          |       | $                                        | 39,325     |                                    | $          | 33,383 |   | $ | 85,867 |   | $ | 71,526 |   |
| Depreciation and amortization expense |       | (4,198                                   | )          | (6,018                                  | )          | (15,145 | ) | (16,009 | ) |
| Interest expense, net                 |       | (4,666                                   | )          | (6,788                                  | )          | (13,654 | ) | (20,309 | ) |
| Provision for income taxes            |       | (12,049                                  | )          | (7,922                                  | )          | (22,426 | ) | (13,555 | ) |
| Net income                            |       | $                                        | 18,412     |                                    | $          | 12,655 |   | $ | 34,642 |   | $ | 21,653 |   |
|                                       |            |                                          |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 9 — CLOSURE COSTS:**

 

          On July 3, 2004, we closed ourdistribution facility located in Leola, Pennsylvania in order to consolidateshipping operations with our remaining three distribution facilities located inGeorgia.  This closure was announced toaffected employees on June 1, 2004. Total employees terminated as of October 2, 2004 were 33.  As a result of this closure, we recordedapproximately $77,000 in other exit costs and reversed approximately $28,000 ofpreviously estimated severance during the third quarter of fiscal 2004.  During the first nine months of fiscal 2004,we recorded approximately $67,000 in severance and $77,000 in other exit costs.  During the fourth quarter of fiscal 2004, weexpect to incur approximately $31,000 in additional severance and other exitcosts.

 

          In July 2003, we decided toexit our sewing facilities located in Costa Rica given our ability to obtainlower costs from third-party suppliers. The facilities were held and used for production through the end ofNovember 2003.  Total employeesterminated as of October 2, 2004 were approximately 1,492.  As a result of the Costa Rican closures, werecorded approximately $1,306,000 in accelerated depreciation during the thirdand fourth quarters of fiscal 2003 (included in cost of goods sold) and plantclosure costs of approximately $1,041,000 comprised of $184,000 of assetimpairment charges, $483,000 of severance, and $374,000 in other exit costs.  We also incurred approximately $424,000 inthe fourth quarter of fiscal 2003 and $11,000 in the first quarter of fiscal2004 of federal income tax expense related to the dissolution of our CostaRican subsidiary (included in the provision for income taxes).  In the first nine months offiscal 2004, we reversed approximately $136,000 of severance costs and othertermination benefits previously estimated for this closure and recordedapproximately $74,000 of severance and $371,000 of other closure costs.

 

        Activity associated with the closurecost reserves for our Costa Rican sewing facility and our distribution facilityin Leola, Pennsylvania for the three-month period ended October 2, 2004 is asfollows:

 

| ** **                               | ** ** | **July 3,  2004  Reserves** | ** ** | **Provisions** | ** ** | **Payments** | ** ** | **October 2,  2004  Reserves** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|----------------|------------|--------------|------------|--------------------------------|------------|
|                                     |       |                        |       |           |       |         |       |                           |       |
| Severance and other termination benefits |       | $                           | 100,000    |           | $          | (28,000      | )          | $                              | (41,000    | ) | $ | 31,000 |   |
| Other exit costs                         |       | —                      |       | 77,000         |       | (77,000      | )          | —                         |       |
|                                     |       |                        |       |           |       |         |       |                           |       |
| Total                                    |       | $                           | 100,000    |           | $          | 49,000       |       | $                              | (118,000   | ) | $ | 31,000 |   |
|                                          |            |                             |            |                |            |              |            |                                |            |  |  |  |  |  |

 

12

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Activityfor the nine-month period ended October 2, 2004 is as follows:

** **

| ** **                               | ** ** | **January 3,  2004  Reserves** | ** ** | **Provisions** | ** ** | **Payments** | ** ** | **October 2,  2004  Reserves** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|----------------|------------|--------------|------------|--------------------------------|------------|
|                                     |       |                           |       |           |       |         |       |                           |       |
| Severance and other termination benefits |       | $                              | 274,000    |           | $          | 141,000      |       | $                              | (384,000   | ) | $ | 31,000 |   |
| Other exit costs                         |       | —                         |       | 448,000        |       | (448,000     | )          | —                         |       |
|                                     |       |                           |       |           |       |         |       |                           |       |
| Total                                    |       | $                              | 274,000    |           | $          | 589,000      |       | $                              | (832,000   | ) | $ | 31,000 |   |
|                                          |            |                                |            |                |            |              |            |                                |            |  |  |  |  |  |

 

**NOTE 10 — EARNINGS PERSHARE:**

 

        In accordance with SFAS No. 128, “EarningsPer Share,” basic earnings per share is based on the weighted average number ofcommon shares outstanding during the period, whereas diluted earnings per sharealso gives effect to all potentially dilutive common shares, which includestock options, that were outstanding during the period.  All such stock options are reflected in thedenominator using the treasury stock method. This method assumes that shares are issued for options that are “in themoney,” but that we use the proceeds of such option exercises (generally, cashto be paid plus future compensation expense to be recognized) to repurchaseshares at the average market value of our shares for the respectiveperiods.  We have used our best estimateof the average fair market value of our shares for the respective periods priorto our initial public offering completed on October 29, 2003.

 

        Thefollowing is a reconciliation of basic number of Carter’s, Inc.’s common sharesoutstanding to diluted number of common and common equivalent sharesoutstanding:

 
| ** **                                                                                              | ** ** | **For the  three-month periods ended** | ** ** | **For the  nine-month periods ended** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                              | ** ** | **October 2,  2004**                   | ** ** | **October 4,  2003**                  | ** ** | **October 2,  2004** | ** ** | **October 4,  2003** | ** ** |
|                                                                                                    |       |                                   |       |                                  |       |   |   |   |   |
| Net income                                                                                              |       | $                                      | 18,412,000 |                                  | $          | 12,655,000 |   | $ | 34,642,000 |   | $ | 21,653,000 |   |
| Carter’s, Inc.’s weighted average number of common and common equivalent  shares outstanding: |       |                                   |       |                                  |       |   |   |   |   |
| Basic number of common shares outstanding                                                               |       | 28,109,978                             |       | 22,564,856                            |       | 28,032,520 |   | 22,560,872 |   |
| Dilutive effect of stock options                                                                        |       | 1,792,159                              |       | 1,671,399                             |       | 1,855,333 |   | 1,523,311 |   |
| Diluted number of common and common equivalent shares outstanding                                       |       | 29,902,137                             |       | 24,236,255                            |       | 29,887,853 |   | 24,084,183 |   |
|                                                                                                    |       |                                   |       |                                  |       |   |   |   |   |
| Basic net income per common shares                                                                      |       | $                                      | 0.65       |                                  | $          | 0.56 |   | $ | 1.24 |   | $ | 0.96 |   |
| Diluted net income per common shares                                                                    |       | $                                      | 0.62       |                                  | $          | 0.52 |   | $ | 1.16 |   | $ | 0.90 |   |
|                                                                                                         |            |                                        |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

13

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**ITEM 2.****                            ****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION****ANDRESULTS OF OPERATIONS:**

 

        The following is a discussion of ourresults of operations and current financial position.  You should read this discussion inconjunction with our unaudited condensed consolidated financial statements andnotes included elsewhere in this quarterly report.  Actual results may differ materially fromthose suggested by our forward-looking statements for various reasons includingthose discussed in the section entitled “Risks Factors” in our final prospectusdated September 23, 2004.  Those riskfactors expressly qualify all subsequent oral and written forward-lookingstatements attributable to us or persons acting on our behalf.  Except for any ongoing obligations todisclose material information as required by the federal securities laws, we donot have any intention or obligation to update forward-looking statements afterwe file this quarterly report.

 

        Our fiscal year ends on the Saturday inDecember or January nearest to the last day of December.  Consistent with this policy, fiscal 2003ended on January 3, 2004 and fiscal 2004 will end on January 1, 2005.  As a result, fiscal 2003 contained 53 weeksof financial results and fiscal 2004 will contain 52 weeks of financialresults.  The additional week in fiscal2003 was included in the first half of fiscal 2003.  Therefore, the accompanying unauditedcondensed consolidated financial statements for the first nine months of fiscal2004 reflect our financial position as of October 2, 2004 and for the 39-weekperiod then ended.  The first nine monthsof fiscal 2003 ended on October 4, 2003 and included 40 weeks of financialresults.  The three-month periods endedOctober 2, 2004 and October 4, 2003 each contained 13 weeks of financialresults.

 

**RESULTS OF OPERATIONS**

 

        The following table sets forth, for the periods indicated,(i) selected statement of income data expressed as a percentage of net salesand (ii) the number of retail stores open at the end of each period:

 

| ** **                                    | ** ** | **Three-month periods ended** | ** ** | **Nine-month periods ended** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **October 2,  2004**          | ** ** | **October 4,  2003**         | ** ** | **October 2,  2004** | ** ** | **October 4,  2003** | ** ** |
|                                          |       |                          |       |                         |       |   |   |   |   |   |
| Wholesale sales                               |       | 45.3                          | %          |                         | 48.7       | % |   | 47.1 | % |   | 51.2 | % |   |
| Retail sales                                  |       | 34.3                          |       |                         | 36.5       |   |   | 34.8 |   |   | 36.9 |   |   |
| Mass Channel sales                            |       | 20.4                          |       |                         | 14.8       |   |   | 18.1 |   |   | 11.9 |   |   |
|                                          |       |                          |       |                         |       |   |   |   |   |   |   |   |   |
| Net sales                                     |       | 100.0                         |       |                         | 100.0      |   |   | 100.0 |   |   | 100.0 |   |   |
| Cost of goods sold                            |       | 65.0                          |       |                         | 64.3       |   |   | 63.8 |   |   | 64.1 |   |   |
|                                          |       |                          |       |                         |       |   |   |   |   |   |   |   |   |
| Gross profit                                  |       | 35.0                          |       |                         | 35.7       |   |   | 36.2 |   |   | 35.9 |   |   |
| Selling, general, and administrative expenses |       | 22.4                          |       |                         | 24.5       |   |   | 25.7 |   |   | 26.8 |   |   |
| Closure costs                                 |       | —                        |       |                         | —     |   |   | 0.1 |   |   | — |   |   |
| Royalty income                                |       | (1.4                          | )          |                         | (1.7       | ) |   | (1.6 | ) |   | (1.6 | ) |   |
|                                          |       |                          |       |                         |       |   |   |   |   |   |   |   |   |
| Operating income                              |       | 14.0                          |       |                         | 12.9       |   |   | 12.0 |   |   | 10.7 |   |   |
| Interest expense, net                         |       | 1.9                           |       |                         | 3.2        |   |   | 2.3 |   |   | 3.9 |   |   |
|                                          |       |                          |       |                         |       |   |   |   |   |   |   |   |   |
| Income before income taxes                    |       | 12.1                          |       |                         | 9.7        |   |   | 9.7 |   |   | 6.8 |   |   |
| Provision for income taxes                    |       | 4.8                           |       |                         | 3.7        |   |   | 3.8 |   |   | 2.6 |   |   |
|                                          |       |                          |       |                         |       |   |   |   |   |   |   |   |   |
| Net income                                    |       | 7.3                           | %          |                         | 6.0        | % |   | 5.9 | % |   | 4.2 | % |   |
|                                          |       |                          |       |                         |       |   |   |   |   |   |   |   |   |
| Number of retail stores at end of period      |       | 177                           |       |                         | 164        |   |   | 177 |   |   | 164 |   |   |

 

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**Three and nine-month periodsended October 2, 2004 compared to three and nine-month periods ended October 4,2003**

 

*      NET SALES.*  In the third quarter of fiscal 2004,consolidated net sales increased $39.2 million, or 18.5%, to $251.4 millionfrom $212.1 million in the third quarter of fiscal 2003.  This increase for the third quarter of fiscal2004 over the prior year was driven by growth in each of our channels ofdistribution.  In the first nine monthsof fiscal 2004, consolidated net sales were $590.4 million, an increase of$72.2 million, or 13.9%, as compared with $518.1 million for the first ninemonths of fiscal 2003.  The increase inthe first nine months of fiscal 2004 over the prior year reflects growth insales to the mass channel, including sales of our *Child of Mine* brand to Wal-Mart, which launched in June of2003, and growth in sales in our retail and wholesale channels.

 

      Total wholesale sales increased $10.6 million, or 10.2%, to$113.9 million in the third quarter of fiscal 2004 from $103.3 million in thethird quarter of fiscal 2003.  Wholesalesales, excluding off-price sales, increased $13.0 million, or 13.5%, to $109.4million from $96.4 million in the third quarter of fiscal 2003, driven bygrowth in our baby product category. Sales growth in our baby product category has resulted from our focus onimproving our core products.  In the firstnine months of fiscal 2004, wholesale sales increased $12.4 million, or 4.7%,to $278.0 million from $265.6 million in the first nine months of fiscal2003.  Wholesale sales, excludingoff-price sales in the first nine months of fiscal 2004, increased $16.4million, or 6.6%, to $264.7 million from $248.3 million in the first nine monthsof fiscal 2003.  The increase inwholesale sales for the first nine months was driven primarily by strong babyand sleepwear sales, offset by a slight decline in playwear due to the timingof demand and related shipments. Increased sleepwear sales were driven by our focus on improved sleepwearproduct design and sourcing capabilities.

 

      Mass channel sales in the third quarter of fiscal 2004increased $19.9 million, or 63.6%, to $51.2 million from $31.3 million in thethird quarter of fiscal 2003.  Masschannel sales in the first nine months of fiscal 2004 increased $45.4 million,or 73.7% to $106.9 million from $61.6 million in the first nine months offiscal 2003.  This revenue growth for thethird quarter and first nine months of fiscal 2004 primarily reflects sales ofour *Child of Mine* brand thatbegan selling to Wal-Mart in the latter part of the second quarter of fiscal2003.  Also contributing to this growthwere increased sales of the *Tykes*brand sold to Target.  We intend toreplace the *Tykes* brand name withour *Just One Year* brand beginningin December 2004.

 

      Retail store sales were $86.2 million for the third quarter offiscal 2004, an increase of $8.7 million, or 11.2%, from $77.5 million in thethird quarter of fiscal 2003.  Theprimary driver of the revenue increase was a comparable store salesincrease of 6.1%, based on 161 locations, and incremental revenue generatedfrom new stores opened subsequent to October 4, 2003, offset by the impact ofstores closed over the last twelve months. In the first nine months of fiscal 2004, retail store sales increased$14.4 million, or 7.6%, to $205.4 million from $191.0 million in the first ninemonths of fiscal 2003.  Such revenuegrowth was driven by incremental sales of $11.7 million generated from newstores opened subsequent to October 4, 2003 and a comparable store salesincrease of $6.5 million, or 3.5%, based on 161 locations.  Such increases were partially offset by theimpact of store closures of $0.8 million and an additional week of selling inthe first nine months of fiscal 2003 of $3.1 million.  There were a total of 177 stores as ofOctober 2, 2004.  We plan to open threemore stores for a total of ten store openings and we plan to close four storesduring the balance of fiscal 2004.  We donot expect to incur any significant costs as a result of these store closures.

 

*        GROSS PROFIT.*    Our gross profit increased $12.2 million,or 16.1%, to $87.9 million in the third quarter of fiscal 2004 from $75.7million in the third quarter of fiscal 2003. Gross profit as a percentage of net sales in the third quarter of fiscal2004 decreased to 35.0% from 35.7% in the third quarter of fiscal 2003 due tochannel mix and higher levels of inventory provisions for excessinventory.  Gross profit increased $27.6million, or 14.8%, to $213.7 million in the first nine months of fiscal 2004compared to $186.1 million in the first nine months of fiscal 2003.  As a percentage of net sales, gross profit inthe first nine months of fiscal 2004 increased to 36.2% from 35.9% in the firstnine months of fiscal 2003.  Thisincrease in gross profit, relative to net sales, for the first nine months offiscal 2004 resulted primarily from favorable product costs offset by a higher mixof mass channel revenues that generally yield lower margins than our wholesaleand retail channels.

 

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*        SELLING,GENERAL, AND ADMINISTRATIVE EXPENSES.*    Selling, general, and administrativeexpenses for the third quarter of fiscal 2004 increased $4.4 million, or 8.4%,to $56.3 million from $51.9 million in the third quarter of fiscal 2003.  Selling, general, and administrativeexpenses, as a percentage of net sales, decreased to 22.4% in the third quarterof fiscal 2004 from 24.5% in the third quarter of fiscal 2003.  This decrease was driven primarily byleveraging operating expenses against higher levels of revenue and control overthe growth in spending.  The prior yearalso included the payment of a special dividend bonus to vested option holdersof approximately $2.5 million.  In thefirst nine months of fiscal 2004, selling, general, and administrative expensesincreased $13.0 million, or 9.4%, to $151.7 million from $138.7 million in thefirst nine months of fiscal 2003.  As apercentage of net sales, these expenses decreased to 25.7% in the first ninemonths of fiscal 2004 from 26.8% in the first half of fiscal 2003.  Such improvements reflect the benefit ofleveraging operating expenses, mostly notably in the mass channel, againsthigher levels of revenue.

 

*        CLOSURE COSTS*.    In June of 2004, we exited our distributionfacility in Leola, Pennsylvania in order to consolidate our distributionoperations and reduce costs.  We recordedapproximately $77,000 of other exit costs during the third quarter of fiscal2004 and reversed approximately $28,000 of severance costs previously estimatedfor this closure.  During the first ninemonths of fiscal 2004, we recorded approximately $144,000 in severance andother exit costs.

 

        In July of 2003, we decided to exit our Costa Rican sewingfacilities, given our ability to obtain lower costs from third-partysuppliers.  During the second quarter offiscal 2004, we reversed approximately $136,000 of severance costs and othertermination benefits previously estimated for this closure. During the firstnine months of fiscal 2004, we recorded approximately $74,000 of severance and$371,000 of other closure costs.

 

*        ROYALTY INCOME.*    We license the use of our *Carter’s, Carter’s Classics,*and*Child of Mine*names and sublicense the*Tykes*name to certain licensees.  Our royalty income in the third quarter offiscal 2004 decreased 2.8% to $3.6 million compared to $3.7 million in thethird quarter of fiscal 2003.  During thefirst nine months of fiscal 2004, royalty income was approximately $9.3million, an increase of $1.1 million, or 13.6%, compared to the first ninemonths of fiscal 2003.  The increase inthe first nine months of fiscal 2004 resulted primarily from royalties earnedon licensed sales of our *Child of Mine*brand by our licensee partners who began shipping their products during thethird quarter of fiscal 2003.

 

*        OPERATINGINCOME.   *Operatingincome for the third quarter of fiscal 2004 increased $7.8 million, or 28.4%,to $35.1 million compared to $27.4 million in the third quarter of fiscal2003.  As a percentage of net sales,operating income increased to 14.0% in the third quarter of fiscal 2004compared to 12.9% in the third quarter of fiscal 2003.  Operating income for the first nine months offiscal 2004 increased $15.2 million to $70.7 million from $55.5 million in thefirst nine months of fiscal 2003. Operating income, as a percentage of net sales, increased to 12.0% inthe first nine months of fiscal 2004 compared to 10.7% in the first nine monthsof fiscal 2003.  These increases in operatingincome for the third quarter and first nine months of fiscal 2004 reflect thebenefits from revenue growth, increased gross profit, and the leveraging ofoperating expenses, described above.

 

        *INTEREST EXPENSE*,*NET*.    Interest expense in the third quarter offiscal 2004 decreased $2.1 million, or 31.3%, to $4.7 million compared to $6.8million in the third quarter of fiscal 2003. In the first nine months of fiscal 2004, interest expense decreased $6.7million, or 32.8%, to $13.7 million from $20.3 million in the first nine monthsof fiscal 2003.  These decreases areattributable to the redemption of approximately $61.3 million of our 10.875%senior subordinated notes in the fourth quarter of fiscal 2003, lower variableinterest rates on reduced levels of term loan indebtedness, and the additionalweek of interest in the first nine months of fiscal 2003.

 

*        INCOMETAXES.   *We recorded a provision forincome taxes of $12.0 million in the third quarter of fiscal 2004 compared to$7.9 million in the third quarter of fiscal 2003.  In the first nine months of fiscal 2004, werecorded a provision for income taxes of $22.4 million compared to $13.6million in the first nine months of fiscal 2003.  Our effective tax rate was approximately39.6% during the third quarter and 39.3% during the first nine months of fiscal2004 and 38.5% during the third quarter and first nine months of fiscal2003.  The increase in the effective taxrate as compared to the prior year periods resulted from the impact of certainnon-deductible secondary offering costs incurred during the third quarter offiscal 2004.

 

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*        NETINCOME.   *As a result ofthe factors noted above, our third quarter 2004 net income was approximately$18.4 million compared to approximately $12.7 million in the third quarter offiscal 2003.  Net income for the firstnine months of fiscal 2004 was $34.6 million compared to $21.7 million in thefirst nine months of fiscal 2003.

 

**FINANCIAL CONDITION, CAPITALRESOURCES, AND LIQUIDITY**

 

        Our cash needs are primarily for workingcapital, capital expenditures, and debt service.  Historically, we have financed these needsthrough internally generated cash flow and funds borrowed under our seniorcredit facility.  Our primary source ofliquidity will continue to be cash flow from operations and borrowingsavailable under our revolving loan facility, and we expect that these sourceswill fund our ongoing requirements for debt service and capitalexpenditures.  These sources of liquiditymay be impacted by continued demand for our products and our ability to meetdebt covenants under our senior credit facility.

 

        Net accounts receivable at October 2, 2004 were $103.1million compared to $70.9 million at October 4, 2003 and $65.3 million atJanuary 3, 2004.  The increase comparedto October 4, 2003 reflects higher levels of revenue in the latter part of thethird quarter of fiscal 2004 as compared to the end of the third quarter of fiscal2003.  Due to the seasonal nature of ouroperations, the net accounts receivable balance at October 2, 2004 is notcomparable to the net accounts receivable balance at January 3, 2004.

 

        Net inventories at October 2, 2004 were $148.4 millioncompared to $118.1 million at October 4, 2003 and $104.8 million at January 3,2004.  This increase over October 4, 2003was planned to support fall 2004 and spring 2005 shipping requirements.  Due to the seasonal nature of our operations,net inventories at October 2, 2004 are not comparable to net inventories atJanuary 3, 2004.

 

        Net cash used in operating activities for the first ninemonths of fiscal 2004 was $14.1 million compared to net cash provided byoperating activities of $9.4 million in the first nine months of fiscal2003.  The change in net cash usedin/provided by operating activities in the first nine months of fiscal 2004compared to the first nine months of fiscal 2003 is primarily attributable toincreases in inventory and accounts receivable, partially offset by increasesin accounts payable and the growth in earnings.

 

        We have invested $14.0 million in capital expenditures duringthe first nine months of fiscal 2004 compared to $9.4 million during the firstnine months of fiscal 2003.  We plan toinvest an additional $10.0 million in capital expenditures during the remainderof fiscal 2004.  Major investments infiscal 2004 include the expansion of our distribution capabilities, retailstore openings and remodeling, and fixturing programs for wholesale and masschannel customers.

 

        On October 29, 2003, we completed aninitial public offering of Carter’s, Inc.’s common stock including the sale of5,390,625 shares by us and 1,796,875 shares by the selling stockholders,primarily Berkshire Partners LLC and its affiliates.  Net proceeds to us from the offering totaled$93.9 million.  On November 28, 2003, weused approximately $68.7 million of the proceeds to redeem approximately $61.3million in outstanding senior subordinated notes and pay a redemption premiumof approximately $6.7 million and related accrued interest charges of $0.7million.  We used approximately $2.6million of the net proceeds to terminate a management agreement with BerkshirePartners LLC and used approximately $11.3 million to prepay amounts outstandingunder our term loan as required by our senior credit facility.  We used remaining proceeds for workingcapital and other general corporate purposes.

 

        Effective July 29, 2003, our senior credit facility wasamended to, among other things, increase the amount of the commitments underthe revolving loan facility from $60.0 million to $80.0 million; provide for a75 basis point reduction in the applicable interest margin by prepaying ourexisting Tranche B term loan and replacing it with a new Tranche C term loan;and reduce the amount of our mandatory loan prepayment requirement from 50% or75% of excess cash flow to 25% or 50% of excess cash flow, depending on theapplicable leverage ratio.  Pursuant tothe amendment, we are also permitted to repurchase up to $15.0 million ofadditional senior subordinated notes, which we may consider from time to time.

 

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        Our senior credit facility, as amended,sets forth mandatory and optional prepayment conditions that may result in ouruse of cash to reduce our debt obligations, including payments of:  (i) 50% of the net cash proceeds from anequity issuance by Carter’s, Inc., excluding, among other things, any issuanceof equity in connection with employee or director stock plans or a permittedacquisition and (ii) 25% or 50% of consolidated excess cash flow, depending onthe applicable leverage ratio, as both terms are defined in the amended seniorcredit facility.  The terms of theconsolidated excess cash flow condition were effective for fiscal 2002, andaccordingly, we made a principal prepayment of approximately $4.8 million onMarch 26, 2003 and approximately $2.4 million on March 22, 2004.  This excess cash flow condition may result infuture annual prepayments depending on the consolidated excess cash flowgenerated in each year.  The lenders willapply such prepayments first to the term loan and, second, to permanentlyreduce our revolving loan facility. Subject to certain conditions in our senior credit facility, we may makeoptional prepayments of our debt obligations without premium or penalty.  The lenders will apply such optionalprepayments according to our instruction.

 

        On March 22,2004, we prepaid an additional $5.0 million of term loan indebtedness.  At October 2, 2004, we had approximately$214.7 million of debt outstanding, consisting of $113.1 million ofsenior subordinated notes (the “Notes”), $91.6 million in term loanborrowings, and $10.0 million in borrowings under our revolving loan facility,exclusive of approximately $10.6 million of outstanding letters ofcredit.  At October 2, 2004, we had approximately$59.4 million of financing available under our revolving loan facility.  At January 3, 2004, we had approximately$212.7 million of debt outstanding, consisting of $113.1 million ofNotes, $99.6 million in term loan borrowings and no revolver borrowings,exclusive of approximately $6.5 million of outstanding letters ofcredit.  The revolver will be availableto fund our working capital requirements, capital expenditures, and othergeneral corporate purposes.

 

        After giving effect to the prepayments of our term loandescribed above, principal borrowings under our term loan are due and payablein twelve quarterly installments of $231,792 from December 31, 2004 throughSeptember 30, 2007 and four quarterly payments of approximately $22.2 millionfrom December 31, 2007 through September 30, 2008.  Interest on our term loan is payable at theend of interest rate reset periods, which vary in length but in no case exceedsix months.  The outstanding balance ofour revolving loan facility is payable in full on August 15, 2006, and interestis payable quarterly, or more frequently in the event we have chosen aEurodollar rate option available under the terms of our senior creditfacility.  No principal payments arerequired on the Notes prior to their scheduled maturity in August 2011.  Beginning August 15, 2006, wemay redeem all or part of the Notes as further described in Note 5 to our mostrecently filed annual report on Form 10-K. Interest is payable semi-annually on the Notes in February and Augustof each year.  Prior to the completion ofour initial public offering, our semi-annual interest payment on the Notes was$9.5 million for each payment.  After giving effect to the redemption of$61.3 million of the principal amount of the Notes in November2003, our semi-annual interest payment is now approximately$6.2 million.

 

        As previously provided by a managementagreement with Berkshire Partners LLC, we agreed, among other things, to payBerkshire Partners an annual management fee of $1.65 million per year for fouryears, commencing on the first anniversary of our 2001 acquisition.  We paid this fee quarterly, in advance.  As described above, upon completion of ourinitial public offering, this management fee agreement was terminated.

 

        Based on our current level of operationsand anticipated cost savings and operating improvements, we believe thatcash generated from operations and available cash, together with amountsavailable under our revolving loan facility, will be adequate to meet our debtservice requirements, capital expenditures, and working capital needs for theforeseeable future, although no assurance can be given in this regard.  We may,however, need to refinance all or a portion of the principal amount of theNotes on or prior to maturity in 2011.

 

        Our senior credit facility imposes certain covenants,requirements, and restrictions on actions by us and our subsidiaries that,among other things, restrict the payment of dividends.

 

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**EFFECTS OF INFLATION ANDDEFLATION**

 

        We are affected by inflation and changing prices primarilythrough the purchase of raw materials, increased operating costs and expenses,and fluctuations in interest rates.  Theeffects of inflation on our net sales and operations have not been material inrecent years.  In recent years, there hasbeen deflationary pressure on selling prices. While we have been successful in offsetting such deflationary pressuresthrough product improvements and lower costs with the expansion of our globalsourcing network, if deflationary pricing trends outpace our ability to obtainfurther price reductions from our global suppliers and other cost reductioninitiatives, our profitability may be affected.

 

**SEASONALITY**

 

        We experience seasonal fluctuations inour sales and profitability, with generally lower sales and gross profit in thefirst and second quarters of our fiscal year. On average, over the past five fiscal years, approximately 57% of ourconsolidated net sales were generated in the second half of our fiscalyear.  Accordingly,our results of operations for the first half of any year are not indicative ofthe results we expect for the full year.

 

        As a resultof this seasonality, our inventory levels and other working capitalrequirements generally begin to increase during the second quarter and into thethird quarter of each year.  During thesepeak periods we have historically borrowed under the revolver.

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

        Our discussion and analysis of ourfinancial condition and results of operations are based upon our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America.  The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues, expenses, and related disclosure of contingentassets and liabilities.  We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions.

 

        Our significant accounting policies are described in Note 2to our consolidated financial statements contained in our most recently filedannual report on Form 10-K.  Thefollowing discussion addresses our critical accounting policies, which arethose that require management’s most difficult and subjective judgments, oftenas a result of the need to make estimates about the effect of matters that areinherently uncertain.

 

*Revenue recognition:** ***We recognize wholesale andmass channel revenue after shipment of products to customers, when title passesand when all risks and rewards of ownership have transferred.  In certain cases, in which we retain the riskof loss during shipment, revenue recognition does not occur until the goodshave reached the specified customer.  Weconsider revenue realized or realizable and earned when the product has beenshipped and when all risks and rewards of ownership have transferred, 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 and mass channelcustomers.  Such amounts are reflected asreductions of net sales. Certain accommodations related to co-op advertising forwhich we can determine the fair value are classified as a component of selling,general, and administrative expenses. Retail store revenues are recognized atthe point of sale.  We reduce revenue forcustomer returns and deductions.  We alsomaintain an allowance for doubtful accounts for estimated losses resulting fromthe inability of our customers to make payments and reserve for certainaccommodations and allowances that we have granted to our wholesale and masschannel customers.  If the financial conditionof our customers were to deteriorate, resulting in an impairment of theirability to make payments, an additional allowance could be required.

 

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*Inventory: *We providereserves for slow-moving inventory equal to the difference between the cost ofinventory and the estimated fair market value based upon assumptions aboutfuture demand and market conditions.  Ifactual market conditions are less favorable than those we project, additionalwrite-downs may be required.

 

*Goodwill and tradename:*  As of October 2, 2004, we had 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 12%.  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 continued market acceptanceof our offered products and the development of new products.  Impairment reviews may also be triggered byany significant events or changes in circumstances.  Our impairment review of goodwill is based onthe estimated fair values of the underlying businesses.  These estimated fair values are based onestimates of the future cash flows of the businesses.

 

*Accrued expenses: *Accruedexpenses for health insurance, workers compensation, incentive compensation,professional fees, and other outstanding obligations are assessed based onactual commitments, statistical trends, and estimates based on projections andcurrent expectations, and these estimates are updated periodically asadditional 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, plant, 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 income.

 

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*Stock-basedcompensation arrangements:  *We account for stock-basedcompensation on stock options under the intrinsic value method, whereby werecord compensation expense equal to the difference between the exercise priceof the stock option and the fair market value of the underlying stock at thedate of the option grant.  For disclosurepurposes only, we also estimate the impact on our net income of applying thefair value method of measuring compensation cost on stock options with the fairvalue, prior to our initial public offering, determined under the minimum valuemethod as provided by Statement of Financial Accounting Standards (“SFAS”) No.123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure.”  For stock issued or sold outright toemployees, directors, or third parties, we measure expense as the differencebetween the price paid by the recipient and the fair market value of the stockon the date of issuance or sale.  Priorto our initial public offering, in the absence of a public market for Carter’s,Inc.’s common stock, management and the Board of Directors estimated the marketvalue of Carter’s, Inc.’s common stock for all option grants and stockissuances using an approach that applies a multiple to Adjusted EBITDA.  Adjusted EBITDA represents earnings beforeinterest, income tax expense, depreciation and amortization, and also excludesAcquisition-related charges, write-downs of long-lived assets, closure costs,and a deferred charge write-off. Adjusted EBITDA is not a measurement under accounting principlesgenerally accepted in the United States of America.

 

**FORWARD LOOKING STATEMENTS**

 

        Statements contained herein that relate to our futureperformance, including, without limitation, statements with respect to ouranticipated results of operations or level of business for fiscal 2004 or anyother future period, are forward-looking statements within the meaning of thesafe harbor provisions of the Private Securities Litigation Reform Act of1995.  Such statements are based oncurrent expectations only and are subject to certain risks, uncertainties, andassumptions.  Should one or more of theserisks or uncertainties materialize, or should underlying assumptions proveincorrect, actual results may vary materially from those anticipated,estimated, or projected.  Among thefactors that could cause actual results to materially differ include a decreasein sales to or the loss of one or more of our key customers, downward pressureon our prices, disruptions in foreign supply sources, negative publicity, theloss of one or more of our major suppliers for raw materials, increased competitionin the baby and young children’s apparel market, our substantial leverage whichincreases our exposure to interest rate risk and could require us to dedicate asubstantial portion of our cash flow to repay principal, the impact ofgovernmental regulations and environmental risks applicable to our business,and seasonal fluctuations in the children’s apparel business.  These risks are described in our finalprospectus dated September 23, 2004 under the headings “Risk Factors,”  “Business-Competition; Certain Risks,” and “StatementRegarding Forward-Looking Statements.” We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents, or otherwise.

 

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

 

        In the operation of our business, we have market riskexposures including those related to foreign currency risk and interestrates.  These risks and our strategies tomanage our exposure to them are discussed below.

 

        We contract for production with third parties primarily inthe Far East and South and Central America. While these contracts are stated in United States dollars, there can beno assurance that the cost for the future production of our products will notbe affected by exchange rate fluctuations between the United States dollar andthe local currencies of these contractors. Due to the number of currencies involved, we cannot quantify thepotential impact of future currency fluctuations on net income in future years. Inorder to manage this risk, we source products from approximately 100 vendorsworldwide, providing us with flexibility in our production should significantfluctuations occur between the United States and various local currencies.  To date, such exchange fluctuationshave not had a material impact on our financial condition or results ofoperations.  We do not hedge foreigncurrency exchange rate risk.

 

        Our operating results are subject to risk from interest ratefluctuations on our debt, which carries variable interest rates.  At October 2, 2004, our outstanding debtaggregated $214.7 million, of which $101.6 million bore interest at a variablerate, so that an increase of 1% in the applicable rate would increase ourannual interest cost by $1,016,000 and could have an adverse effect on our netincome and cash flow.  Pursuant to theprovisions of our senior credit facility, we purchased an interest rate cap asan economic hedge against approximately $31.3 million of variable ratedebt.  The cap rate is 7.0%, and thearrangement expires on December 7, 2004.

 

**OTHER RISKS**

 

        There also are other risks in the operation of our businessspecifically related to raw material pricing and our global sourcing network.

 

        The principal raw materials we use are finished fabrics andtrim materials.  Prices for thesematerials are affected by changes in market demand, and there can be noassurance that prices for these and other raw materials will not increase inthe near future.  These materials areavailable from more than one supplier, which enables us to negotiatepricing.  However, the loss of one ormore of these suppliers could temporarily interrupt our supply, which couldhave an adverse effect on our sales and increase our costs.

 

        We currently source substantially all of our production fromour offshore operations and third-party manufacturers located in foreigncountries.  As a result, we may beadversely affected by political instability resulting in the disruption oftrade from foreign countries, the imposition of new regulations relating toimports, duties, taxes, and other charges on imports, any significant decreasesin the value of the dollar against foreign currencies, and restrictions on the transferof funds.  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 to suchfactors, which are beyond our control, and there can be no assurance that suchfactors would not have a material adverse effect on our financial condition andresults of operations.  We carefullyselect 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.

 

        Wecontinually evaluate opportunities to improve our products and reduce ourcosts.  Our remaining sewing facilities,located in Mexico, currently provide us with an advantageous coststructure.  If we determine in the futurethat we are able to source products currently sewn in Mexico at a significantlylower cost with superior quality elsewhere, we would develop a plan to exitsuch facilities and incur substantial closure-related costs.

 

        We enter into various purchase ordercommitments with full-package suppliers. We can cancel these arrangements, although in some instances, we may besubject to a termination charge reflecting a percentage of work performed priorto cancellation.  Historically, suchcancellations and related termination charges have occurred infrequently andhave not had a material impact on our business. However,as we rely more heavily on our full-package global sourcing network, we expectto incur more of these termination charges, which could increase our cost ofgoods sold.

 

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**ITEM 4.****                            ****CONTROLS AND PROCEDURES**

 

        The Chief Executive Officer and Chief Financial Officer ofCarter’s, Inc. and TWCC have evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined under Rules13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934,as amended) as of the end of the period covered by this report.  Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer of Carter’s, Inc. and TWCC haveconcluded that our disclosure controls and procedures are adequate andeffective.

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.          LEGAL PROCEEDINGS:**

 

        From time to time, we have been involved in various legalproceedings.  We believe that all suchlitigation is routine in nature and incidental to the conduct of ourbusiness.  We believe that no suchlitigation will have a material adverse effect on our financial condition, cashflows, or results of operations.

 

**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

 

 

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

 

        (a)   Exhibits:

 
| **Exhibit Number** | ** ** | **Description of Exhibits**            |
|--------------------|------------|----------------------------------------|
|               |       |                                   |
| 31.1               |       | Rule 13a-14(a)/15d-14(a) Certification |
|               |       |                                   |
| 31.2               |       | Rule 13a-14(a)/15d-14(a) Certification |
|               |       |                                   |
| 31.3               |       | Rule 13a-14(a)/15d-14(a) Certification |
|               |       |                                   |
| 31.4               |       | Rule 13a-14(a)/15d-14(a) Certification |
|               |       |                                   |
| 32                 |       | Section 1350 Certification             |
|               |       |                                   |

 

 

        (b)   Reports on Form 8-K:

 

                                                     OnJuly 29, 2004, Carter’s, Inc. filed a current report on Form 8-K with theSecurities and Exchange Commission. Under Item 12 of the report, we reported that on July 28, 2004,Carter’s, Inc. issued a press release announcing its financial results for thesecond quarter ended July 3, 2004.

 

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**SIGNATURES**

 

        Pursuant to the requirements of the Securities and ExchangeAct of 1934, the Registrants have duly caused this report to be signed on theirbehalf by the undersigned thereunto duly authorized.

 

 
|                    | CARTER’S, INC.         |
|-------------------------|-----------------------------|
|                    | THE WILLIAM  CARTER COMPANY |
|                    |                        |   |
| Date: November 12, 2004 |                        | /s/ FREDERICK J.  ROWAN, II |
|                    |                        | Frederick J.  Rowan, II |
| * *                | * *                    | *Chairman of the Board of Directors**and* |
| * *                | * *                    | *Chief Executive Officer* |
|                    |                        |   |
| Date: November 12, 2004 |                        | /s/ MICHAEL D.  CASEY |
|                    |                        | Michael D. Casey |
| * *                | * *                    | *Executive Vice President and* |
| * *                | * *                    | *Chief Financial Officer* |

 

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