**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

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**FORM 10-Q**

 

| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2002 OR** |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                              |
| **o**      |   | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE****SECURITIES  EXCHANGE ACT OF 1934**                                                 |

 

**Commission file number:**

**333-22155**

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**THE WILLIAM CARTER COMPANY**

(Exact name of registrantas specified in charter)

 

 

| **Massachusetts**                                               |   | **04-1156680**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (IRS Employer  Identification No.) |

 

 

| **The Proscenium**                                            |
|---------------------------------------------------------------|
| **1170 Peachtree Street NE, Suite 900**                       |
| **Atlanta, Georgia 30309**                                    |
| (Address of principal  executive offices, including zip code) |

 

|                                                       |
|------------------------------------------------------------|
|                                                       | **(404) 745-2700** |   |
| (Registrant’s telephone  number, including area code) |

 

 

 

        Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yesý     No o

 

        Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).     Yeso     No ý

 

        Applicableonly to corporate issuers:

 

        As ofNovember 12, 2002, there were 1,000 shares of Common Stock outstanding.

 

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**FORM 10-Q**

 

**THE WILLIAM CARTER COMPANY**

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

**INDEX**

 

 
|          |     |                                                                                                                                                                                                                                                               |   |
|---------------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **Part I.**   |     | **Financial Information**                                                                                                                                                                                                                                          |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          | Item 1.  | Financial Statements                                                                                                                                                                                                                                               |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          |     | Condensed Consolidated Balance Sheets as  of September 28, 2002 (Successor) (unaudited) and December 29, 2001  (Successor)                                                                                                                                         |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          |     | Unaudited Condensed  Consolidated Statements of Operations for the three-month period ended  September 28, 2002 (Successor) and for the periods August 15, 2001 through  September 29, 2001 (Successor) and July 1, 2001 through August 14, 2001  (Predecessor)    |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          |     | Unaudited Condensed Consolidated  Statements of Operations for the nine-month period ended September 28, 2002  (Successor) and for the periods August 15, 2001 through September 29, 2001  (Successor) and December 31, 2000 through August 14, 2001 (Predecessor) |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          |     | Unaudited Condensed Consolidated Statements  of Cash Flows for the nine-month period ended September 28, 2002 (Successor)  and for the periods August 15, 2001 through September 29, 2001 (Successor)  and December 31, 2000 through August 14, 2001 (Predecessor) |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          |     | Notes  to the Unaudited Condensed Consolidated Financial Statements                                                                                                                                                                                                |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          | Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                                                                        |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          | Item  3. | Quantitative  and Qualitative Disclosures about Market Risks                                                                                                                                                                                                       |   |
|          |     |                                                                                                                                                                                                                                                               |   |
|          | Item  4. | Disclosure  Controls and Procedures                                                                                                                                                                                                                                |   |
|          |     |                                                                                                                                                                                                                                                               |   |
| **Part  II.** |     | Other Information                                                                                                                                                                                                                                                  |   |

 

 

2

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**THE WILLIAM CARTER COMPANY**

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

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(dollars in thousands,except per share data)

 
|                                                                                                                                                 |   | **Successor,  at**      |    |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|
|                                                                                                                                                 |   | **September  28, 2002** |    | **December  29, 2001** |   |
| **ASSETS**                                                                                                                                           |   | **(unaudited)**         |    |   |   |
| Current assets:                                                                                                                                      |   |                    |    |   |   |
| Cash and cash  equivalents                                                                                                                           |   | $                       | 27,215  |   | $ | 24,692 |   |
| Accounts  receivable, net                                                                                                                            |   | 48,430                  |    | 35,386 |   |
| Inventories, net                                                                                                                                     |   | 96,598                  |    | 89,069 |   |
| Prepaid expenses  and other current assets                                                                                                           |   | 6,919                   |    | 5,585 |   |
| Assets held for  sale                                                                                                                                |   | 250                     |    | 875 |   |
| Deferred income  taxes                                                                                                                               |   | 9,338                   |    | 9,371 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Total current  assets                                                                                                                                |   | 188,750                 |    | 164,978 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Property, plant  and equipment, net                                                                                                                  |   | 45,930                  |    | 46,503 |   |
| Assets held for  sale                                                                                                                                |   | 600                     |    | 600 |   |
| Tradename                                                                                                                                            |   | 220,233                 |    | 220,233 |   |
| Cost in excess  of fair value of net assets acquired                                                                                                 |   | 139,276                 |    | 139,472 |   |
| Licensing  agreements, net of accumulated amortization of $5,625 and $1,875                                                                          |   | 9,375                   |    | 13,125 |   |
| Deferred debt  issuance costs, net                                                                                                                   |   | 11,656                  |    | 12,879 |   |
| Other assets                                                                                                                                         |   | 5,860                   |    | 6,372 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Total assets                                                                                                                                         |   | $                       | 621,680 |   | $ | 604,162 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| **LIABILITIES  AND STOCKHOLDER’S EQUITY**                                                                                                       |   |                    |    |   |   |
| Current  liabilities:                                                                                                                                |   |                    |    |   |   |
| Current maturities  of long-term debt                                                                                                                |   | $                       | 1,250   |   | $ | 1,250 |   |
| Accounts payable                                                                                                                                     |   | 22,461                  |    | 18,765 |   |
| Other current  liabilities                                                                                                                           |   | 34,940                  |    | 34,438 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Total current  liabilities                                                                                                                           |   | 58,651                  |    | 54,453 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Long-term debt                                                                                                                                       |   | 296,653                 |    | 297,492 |   |
| Deferred income  taxes                                                                                                                               |   | 83,187                  |    | 84,375 |   |
| Other long-term  liabilities                                                                                                                         |   | 10,359                  |    | 10,127 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Total  liabilities                                                                                                                                   |   | 448,850                 |    | 446,447 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Commitments and  contingencies                                                                                                                       |   |                    |    |   |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Common  stockholder’s equity:                                                                                                                   |   |                    |    |   |   |
| Common stock,  par value $.01 per share, 200,000 shares authorized, 1,000 shares issued and  outstanding at September 28, 2002 and December 29, 2001 |   | —                  |    | — |   |
| Additional  paid-in capital                                                                                                                          |   | 146,639                 |    | 144,877 |   |
| Retained  earnings                                                                                                                                   |   | 26,191                  |    | 12,838 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Total common  stockholder’s equity                                                                                                              |   | 172,830                 |    | 157,715 |   |
|                                                                                                                                                 |   |                    |    |   |   |
| Total  liabilities and stockholder’s equity                                                                                                     |   | $                       | 621,680 |   | $ | 604,162 |   |

 

See accompanyingnotes to the unaudited condensed consolidated financial statements

 

3

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**THE WILLIAM CARTER COMPANY**

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

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

(dollars inthousands)

(unaudited)

 

 

 
|                                                               |   | **Successor**                                              |    | **Predecessor**                                                         |   |
|--------------------------------------------------------------------|--------|------------------------------------------------------------|---------|-------------------------------------------------------------------------|--------|
|                                                               |   | **For the  three-month  period ended  September 28, 2002** |    | **For the  period from  August 15, 2001  through   September 29, 2001** |   | **For the  period from  July 1, 2001  through  August 14, 2001** |   |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Net sales                                                          |   | $                                                          | 165,779 |                                                                    | $      | 88,343 |   | $ | 65,488 |   |
| Cost of goods  sold                                                |   | 100,642                                                    |    | 55,668                                                                  |   | 41,868 |   |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Gross profit                                                       |   | 65,137                                                     |    | 32,675                                                                  |   | 23,620 |   |
| Selling, general  and administrative expenses                      |   | 43,118                                                     |    | 19,284                                                                  |   | 20,377 |   |
| Acquisition-related  non-recurring charges (Note 1)                |   | —                                                     |    | —                                                                  |   | 11,289 |   |
| Royalty income                                                     |   | (2,461                                                     | )       | (981                                                                    | )      | (1,516 | ) |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Operating income  (loss)                                           |   | 24,480                                                     |    | 14,372                                                                  |   | (6,530 | ) |
| Interest  expense, net                                             |   | 7,268                                                      |    | 3,731                                                                   |   | 2,221 |   |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Income (loss)  before income taxes and extraordinary item          |   | 17,212                                                     |    | 10,641                                                                  |   | (8,751 | ) |
| Provision for  (benefit from) income taxes                         |   | 6,634                                                      |    | 4,276                                                                   |   | (1,041 | ) |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Income (loss)  before extraordinary item                           |   | 10,578                                                     |    | 6,365                                                                   |   | (7,710 | ) |
| Extraordinary  item, net of tax benefit of $4,115                  |   | —                                                     |    | —                                                                  |   | 6,173 |   |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Net income  (loss)                                                 |   | $                                                          | 10,578  |                                                                    | $      | 6,365 |   | (13,883 | ) |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Dividend  requirements and accretion on redeemable preferred stock |   |                                                       |    |                                                                    |   | (345 | ) |
|                                                               |   |                                                       |    |                                                                    |   |   |   |
| Net loss  applicable to common stockholder                         |   |                                                       |    |                                                                    |   | $ | (14,228 | ) |

 

 

 

 

See accompanying notes tothe unaudited condensed consolidated financial statements

 

4

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**THE WILLIAM CARTER COMPANY**

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

**CONDENSEDCONSOLIDATED****STATEMENTS OFOPERATIONS**

(dollars in thousands)

(unaudited)

 

 

 
|                                                               |   | **Successor**                                             |    | **Predecessor**                                                       |   |
|--------------------------------------------------------------------|--------|-----------------------------------------------------------|---------|-----------------------------------------------------------------------|--------|
|                                                               |   | **For the  nine-month  period ended  September 28, 2002** |    | **For the  period from August 15, 2001  through  September 29, 2001** |   | **For the  period from  December 31, 2000 through  August 14, 2001** |   |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Net sales                                                          |   | $                                                         | 409,469 |                                                                  | $      | 88,343 |   | $ | 282,727 |   |
| Cost of goods  sold                                                |   | 250,711                                                   |    | 55,668                                                                |   | 182,863 |   |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Gross profit                                                       |   | 158,758                                                   |    | 32,675                                                                |   | 99,864 |   |
| Selling, general  and administrative expenses                      |   | 122,031                                                   |    | 19,284                                                                |   | 88,895 |   |
| Acquisition-related  non-recurring charges (Note 1)                |   | —                                                    |    | —                                                                |   | 11,289 |   |
| Writedown of  long-lived assets (Note 7)                           |   | —                                                    |    | —                                                                |   | 3,156 |   |
| Non-recurring  charges-plant closure costs (Note 7)                |   | —                                                    |    | —                                                                |   | 1,116 |   |
| Royalty income                                                     |   | (6,236                                                    | )       | (981                                                                  | )      | (4,993 | ) |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Operating income                                                   |   | 42,963                                                    |    | 14,372                                                                |   | 401 |   |
| Interest  expense, net                                             |   | 21,238                                                    |    | 3,731                                                                 |   | 10,060 |   |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Income (loss)  before income taxes and extraordinary item          |   | 21,725                                                    |    | 10,641                                                                |   | (9,659 | ) |
| Provision for  (benefit from) income taxes                         |   | 8,372                                                     |    | 4,276                                                                 |   | (1,404 | ) |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Income (loss)  before extraordinary item                           |   | 13,353                                                    |    | 6,365                                                                 |   | (8,255 | ) |
| Extraordinary  item, net of tax benefit of $4,115                  |   | —                                                    |    | —                                                                |   | 6,173 |   |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Net income  (loss)                                                 |   | $                                                         | 13,353  |                                                                  | $      | 6,365 |   | (14,428 | ) |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Dividend  requirements and accretion on redeemable preferred stock |   |                                                      |    |                                                                  |   | (1,671 | ) |
|                                                               |   |                                                      |    |                                                                  |   |   |   |
| Net loss  applicable to common stockholder                         |   |                                                      |    |                                                                  |   | $ | (16,099 | ) |

 

 

 

 

See accompanying notes tothe unaudited condensed consolidated financial statements

 

5

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**THEWILLIAM CARTER COMPANY**

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

# **CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

(dollars in thousands)

(unaudited)
|                                                                                                 |   | **Successor**                                           |   | **Predecessor**                                                        |   |
|------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|--------|------------------------------------------------------------------------|--------|
|                                                                                                 |   | **For the  nine-month period ended September 28, 2002** |   | **For the  period from  August 15, 2001  through  September 29, 2001** |   | **For the  period from   December 31, 2000  through  August 14, 2001** |   |
| Cash flows from  operating activities:                                                               |   |                                                    |   |                                                                   |   |   |   |
| Net income  (loss)                                                                                   |   | $                                                       | 13,353 |                                                                   | $      | 6,365 |   | $ | (14,428 | ) |
| Extraordinary  loss, net of taxes                                                                    |   | —                                                  |   | —                                                                 |   | 6,173 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |   |                                                    |   |                                                                   |   |   |   |
| Depreciation and  amortization                                                                       |   | 13,202                                                  |   | 2,237                                                                  |   | 12,245 |   |
| Amortization of  debt issuance costs                                                                 |   | 1,223                                                   |   | 185                                                                    |   | 848 |   |
| Accretion of  debt discount                                                                          |   | 98                                                      |   | —                                                                 |   | — |   |
| Non-cash  compensation expense                                                                       |   | 762                                                     |   | —                                                                 |   | 60 |   |
| (Payment of)  provision for Acquisition-related non-recurring charges                                |   | —                                                  |   | (11,289                                                                | )      | 11,289 |   |
| Writedown of  long-lived assets                                                                      |   | —                                                  |   | —                                                                 |   | 3,156 |   |
| Non-recurring  charges-plant closure costs                                                           |   | —                                                  |   | —                                                                 |   | 1,116 |   |
| Gain on sale of  property, plant and equipment                                                       |   | (209                                                    | )      | —                                                                 |   | — |   |
| Deferred tax  (benefit) provision                                                                    |   | (1,261                                                  | )      | 2,795                                                                  |   | (1,659 | ) |
| Effect of  changes in operating assets and liabilities:                                              |   |                                                    |   |                                                                   |   |   |   |
| (Increase)  decrease in assets:                                                                      |   |                                                    |   |                                                                   |   |   |   |
| Accounts  receivable                                                                                 |   | (12,794                                                 | )      | (10,100                                                                | )      | (5,782 | ) |
| Inventories                                                                                          |   | (7,529                                                  | )      | 5,307                                                                  |   | (13,253 | ) |
| Prepaid expenses  and other assets                                                                   |   | (822                                                    | )      | (2,825                                                                 | )      | 1,807 |   |
| Increase  (decrease) in liabilities:                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Accounts payable  and other liabilities                                                              |   | 5,239                                                   |   | 1,577                                                                  |   | (197 | ) |
|                                                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Net cash  provided by (used in) operating activities                                                 |   | 11,262                                                  |   | (5,748                                                                 | )      | 1,375 |   |
|                                                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Cash flows from  investing activities:                                                               |   |                                                    |   |                                                                   |   |   |   |
| Capital  expenditures                                                                                |   | (8,989                                                  | )      | (2,715                                                                 | )      | (9,480 | ) |
| Proceeds from  sale of property, plant and equipment                                                 |   | 313                                                     |   | —                                                                 |   | 10 |   |
| Proceeds from  assets held for sale                                                                  |   | 441                                                     |   | —                                                                 |   | 204 |   |
| Payment of  buyer’s Acquisition costs                                                           |   | —                                                  |   | (3,723                                                                 | )      | — |   |
|                                                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Net cash used in  investing activities                                                               |   | (8,235                                                  | )      | (6,438                                                                 | )      | (9,266 | ) |
|                                                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Cash flows from  financing activities:                                                               |   |                                                    |   |                                                                   |   |   |   |
| Proceeds from  Predecessor revolving line of credit                                                  |   | —                                                  |   | —                                                                 |   | 53,500 |   |
| Payments of  Predecessor revolving line of credit                                                    |   | —                                                  |   | (12,900                                                                | )      | (40,600 | ) |
| Proceeds from  Successor revolving line of credit                                                    |   | —                                                  |   | 30,450                                                                 |   | — |   |
| Payments of  Successor revolving line of credit                                                      |   | —                                                  |   | (25,850                                                                | )      | — |   |
| Proceeds from  Successor term loan                                                                   |   | —                                                  |   | 125,000                                                                |   | — |   |
| Payments of  Successor term loan                                                                     |   | (937                                                    | )      | —                                                                 |   | — |   |
| Payments of  Predecessor term loan                                                                   |   | —                                                  |   | (38,700                                                                | )      | (2,700 | ) |
| Proceeds from issuance  of Successor 10.875% Senior Subordinated Notes                               |   | —                                                  |   | 173,693                                                                |   | — |   |
| Payment of  Predecessor 10 3/8% Senior Subordinated Notes                                            |   | —                                                  |   | (100,000                                                               | )      | — |   |
| Payments of  capital lease obligations                                                               |   | (567                                                    | )      | (163                                                                   | )      | (642 | ) |
| Acquisition-related  dividend to Holdings                                                            |   | —                                                  |   | (128,559                                                               | )      | — |   |
| Proceeds from  contributions from Holdings                                                           |   | 1,000                                                   |   | —                                                                 |   | — |   |
| Payment of other  dividend to Holdings                                                               |   | —                                                  |   | —                                                                 |   | (60 | ) |
| Preferred stock  dividend                                                                            |   | —                                                  |   | —                                                                 |   | (1,207 | ) |
| Payments of  Successor debt issuance costs                                                           |   | —                                                  |   | (13,428                                                                | )      | — |   |
| Other                                                                                                |   | —                                                  |   | 7,181                                                                  |   | (3,573 | ) |
|                                                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Net cash (used  in) provided by financing activities                                                 |   | (504                                                    | )      | 16,724                                                                 |   | 4,718 |   |
|                                                                                                 |   |                                                    |   |                                                                   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                |   | 2,523                                                   |   | 4,538                                                                  |   | (3,173 | ) |
| Cash and cash  equivalents, beginning of period                                                      |   | 24,692                                                  |   | 524                                                                    |   | 3,697 |   |
| Cash and cash  equivalents, end of period                                                            |   | $                                                       | 27,215 |                                                                   | $      | 5,062 |   | $ | 524 |   |

 

See accompanying notes tothe unaudited condensed consolidated financial statements

 

6

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# **THE WILLIAM CARTER COMPANY**

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

**NOTES****TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(unaudited)

 

**NOTE 1 — CHANGE IN OWNERSHIP:**

 

            The William Carter Company(“Carter’s,” “we,” “us,” and “our”) is a wholly-owned subsidiary of CarterHoldings, Inc. (“Holdings”).  Holdingshas no significant assets or investments other than the shares of stock of TheWilliam Carter Company.  On July 12,2001, a special purpose entity formed by Berkshire Partners LLC (“Berkshire”)and affiliates entered into a stock purchase agreement with Holdings and all ofHoldings’ stockholders to acquire substantially all of the stock of Holdingsexcept for some equity interests held by our management (the“Acquisition”).  The Acquisition wasconsummated on August 15, 2001.  Financingfor the Acquisition and related transactions totaled $468.2 million and wasprovided by:  $24.0 million in newrevolving credit facility borrowings; $125.0 million in new term loanborrowings (both the revolver and term loan are part of a $185.0 million newsenior credit facility entered into by us); $173.7 million of borrowings undera new senior subordinated loan facility (issued by us in connection with anAugust 15, 2001 private placement); and $145.5 million of capital invested byaffiliates of Berkshire and other investors, which includes rollover equity byour management of $18.3 million.

 

            Theproceeds of the Acquisition and financing were used to purchase existing equityof Holdings ($252.5 million), pay for selling stockholders transaction expenses($19.1 million, including $0.8 million in debt prepayment penalties recorded onHoldings), pay for buyers’ transaction expenses ($4.0 million), pay debtissuance costs ($13.4 million) and to retire all outstanding balances on ourand Holdings’ previously outstanding long-term debt including accrued interestthereon ($174.8 million).  In addition,$4.4 million of proceeds were held as cash for temporary working capitalpurposes.  Portions of these paymentswere accomplished by an intercompany dividend of $128.6 million from us toHoldings.  Also in connection with theAcquisition, our redeemable preferred stock held by Holdings was cancelled.

 

            Forpurposes of identification and description, we are referred to as the“Predecessor” for the period prior to the Acquisition, the “Successor” forperiods subsequent to the Acquisition and “Carter’s,” “we,” “us,” and “our” forboth periods.

 

            TheAcquisition was accounted for as a purchase and has been reflected in ourfinancial statements using pushdown accounting.  Accordingly, the purchase price for the Acquisition, includingrelated fees and expenses, has been allocated to our tangible and identifiableintangible assets and liabilities based upon their estimated fair values withthe remainder allocated to goodwill.

 

7

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A summary of the total purchase price is as follows ($000):

 
| Total purchase  price                                |   | $       | 468,193 |   |
|------------------------------------------------------|--------|---------|---------|--------|
| Less-amounts  retained at Holdings                   |   | (623    | )       |
|                                                 |   | $       | 467,570 |   |
| Allocated to:                                        |   |    |    |
| Cash and cash  equivalents                           |   | $       | 7,333   |   |
| Accounts  receivable, net                            |   | 39,570  |    |
| Inventories, net                                     |   | 110,219 |    |
| Prepaid expenses  and other current assets           |   | 3,525   |    |
| Property, plant  and equipment                       |   | 42,569  |    |
| Assets held for  sale                                |   | 991     |    |
| Licensing  agreements                                |   | 15,000  |    |
| Tradename                                            |   | 220,233 |    |
| Cost in excess  of fair value of net assets acquired |   | 139,276 |    |
| Deferred debt  issuance costs                        |   | 13,427  |    |
| Other assets                                         |   | 5,432   |    |
| Accounts payable                                     |   | (18,340 | )       |
| Other current  liabilities                           |   | (25,936 | )       |
| Closure and exit  liabilities                        |   | (2,680  | )       |
| Other long-term  liabilities                         |   | (10,850 | )       |
| Net deferred tax  liabilities                        |   | (72,199 | )       |
|                                                 |   |    |    |
|                                                 |   | $       | 467,570 |   |

 

        As aresult of the above, our initial capitalization as of the Acquisition dateconsisted of ($000):

 
| Borrowings on  new revolving credit facility   |   | $       | 24,000  |   |
|------------------------------------------------|--------|---------|---------|--------|
| Borrowings on  new term loan                   |   | 125,000 |    |
| Borrowings under  new senior subordinated note |   | 173,693 |    |
| Additional  paid-in capital                    |   | 144,877 |    |
| Total  capitalization                          |   | $       | 467,570 |   |

 

        Subsequentto the Acquisition, our results of operations will be significantly impacted bychanges in interest expense and amortization of intangibles.

 

        TheAcquisition-related non-recurring charges in the Predecessor period July 1,2001 through August 14, 2001 reflect special compensation of $4.5 million paidto management at the closing of the Acquisition and $6.8 million for sellers’transaction costs and fees.

 

        Theextraordinary charge in the Predecessor period July 1, 2001 through August 14,2001, reflects the write-off of deferred debt issuance costs of approximately$1,991,000, net of a tax benefit of approximately $1,327,000, and a debtprepayment penalty of approximately $4,182,000, net of a tax benefit ofapproximately $2,788,000.

 

8

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        Thefollowing unaudited pro forma operating data presents the results of operationsfor the three-month and nine-month periods ended September 29, 2001 as if theAcquisition had occurred on December 31, 2000, with financing obtained asdescribed above and assumes that there were no other changes in our operations.  The pro forma results are not necessarilyindicative of the financial results that might have occurred had thetransaction actually taken place on December 31, 2000 or of future results ofoperations ($000):

 
|                  |   | **Pro  forma for the three-month period ended September 29, 2001** |    | **Pro  forma for the nine-month period ended September 29, 2001** |   |
|-----------------------|--------|--------------------------------------------------------------------|---------|-------------------------------------------------------------------|--------|
| Net sales             |   | $                                                                  | 153,831 |                                                              | $      | 371,070 |   |
| Operating income      |   | $                                                                  | 20,668  |                                                              | $      | 26,988 |   |
| Interest expense, net |   | $                                                                  | 7,911   |                                                              | $      | 23,073 |   |
| Net income            |   | $                                                                  | 7,972   |                                                              | $      | 2,490 |   |

 

        Excludedfrom the pro forma results for the three and nine-month periods ended September29, 2001, shown above, are the Predecessor's Acquisition-related non-recurringcharges of $4.5 million in special compensation paid to management at theclosing of the Acquisition, $6.8 million for sellers’ transaction costs and anextraordinary charge of $6.2 million (net of tax) related to the Predecessor'swrite-off of deferred debt issuance costs and debt prepayment penalties inconnection with the Acquisition. Included in the pro forma results for the nine-month period endedSeptember 29, 2001, shown above, are approximately $3.1 million related to thewritedown of long-lived assets and $1.1 million related to other non-recurringplant closure costs which were unrelated to the Acquisition.

 

**NOTE 2 —BASIS OF PREPARATION:**

 

        In ouropinion, our accompanying unaudited condensed consolidated financial statementscontain all adjustments necessary to present fairly our financial position asof September 28, 2002 (Successor); the results of our operations for thethree-month and nine-month periods ended September 28, 2002 (Successor), theSuccessor period August 15, 2001 through September 29, 2001, and thePredecessor periods July 1, 2001 through August 14, 2001 and December 31, 2000 throughAugust 14, 2001; and our cash flows for the nine-month period ended September28, 2002 (Successor), the Successor period August 15, 2001 through September29, 2001, and the Predecessor period December 31, 2000 through August 14, 2001.  Operating results for the three-month andnine-month periods ended September 28, 2002 are not necessarily indicative ofthe results that may be expected for the fiscal year ending December 28, 2002(Successor).  Our accompanying condensedconsolidated balance sheet as of December 29, 2001 (Successor) is from ouraudited consolidated financial statements included in our most recently filedannual report on Form 10-K.

 

        Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beencondensed or omitted pursuant to the rules and regulations of the Securitiesand Exchange Commission and the instructions to Form 10-Q.  The accounting policies we follow, except asdescribed in Note 9, are set forth in our most recently filed annual report onForm 10-K in the Notes to our Consolidated Financial Statements for the fiscalyear ended December 29, 2001.

 

        Certainamounts from prior periods have been reclassified to conform to the currentperiod’s presentation.  Thesereclassifications have no effect on net income (loss) as previously reported.

 

**NOTE 3 —THE COMPANY:**

 

        Wedesign, manufacture, source and market premier branded childrenswear under the *Carter’s*and *Tykes*labels.  Our products are sourcedinternationally through internally managed production at plants located inCosta Rica and Mexico and through contractual arrangements with manufacturersthroughout the world.  Our products aresourced for wholesale distribution to major U.S.-based retailers and for our156 retail stores that market our brand name merchandise and certain productsmanufactured by other companies.  Ourretail operations represented approximately 44% of our consolidated net salesin the third quarter of 2002 and 2001, and approximately 44% and 45% in thefirst nine months of 2002 and 2001.

 

9

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**NOTE 4 —INVENTORIES:**

 

        Inventoriesconsisted of the following ($000):

|                        |   | **Successor,  at**      |   |
|-----------------------------|--------|-------------------------|--------|
|                        |   | **September  28, 2002** |   | **December  29, 2001** |   |
| Finished goods              |   | $                       | 87,067 |   | $ | 80,887 |   |
| Work in process             |   | 6,680                   |   | 4,660 |   |
| Raw materials  and supplies |   | 2,851                   |   | 3,522 |   |
|                        |   |                    |   |   |   |
| Total                       |   | $                       | 96,598 |   | $ | 89,069 |   |

 

**NOTE 5 —PARENT COMPANY TRANSACTIONS:**

** **

**        During the nine-month period endedSeptember 28, 2002 (Successor), Holdings sold shares of its common stock to twoof our directors (one during second quarter and one during third quarter) andissued shares of its common stock to an outside consultant as partialconsideration for services rendered.  Inconnection with these transactions, as well as Holdings’ stock option grants tocertain employees, we recorded compensation expense during the three andnine-month periods ended September 28, 2002 in the amounts of approximately$121,000 and $762,000.  Additionally, wereceived cash proceeds of $1.0 million during the nine-month period endedSeptember 28, 2002 and recorded contributions from Holdings to our additionalpaid-in capital in the amount of approximately $1.8 million.**

 

        On August15, 2001, we paid a dividend of approximately $128.6 million to Holdings.  Holdings used these funds to repay debt andpartially fund other payments in connection with the Acquisition, includingpayment to selling stockholders and option holders.

 

        Duringthe Predecessor period from December 31, 2000 through August 14, 2001, we paida dividend on our common stock held by Holdings in the amount of approximately$60,000, the proceeds of which were used by Holdings to repurchase shares ofHoldings’ stock owned by a former employee of Carter’s.  In addition, during the Predecessor periodfrom December 31, 2000 through August 14, 2001, Holdings made a $60,000 capitalcontribution to us in connection with the issuance of shares of Holdings’ stockto an employee of Carter’s.  Thistransaction involved no cash proceeds and we recognized $60,000 as compensationexpense.

 

        Duringthe Predecessor period ended August 14, 2001, we paid a semi-annual dividend ofapproximately $1.2 million on $20.0 million of redeemable preferred stock, whichaccrued annually at 12%.  All of ourredeemable preferred stock held by Holdings was cancelled in connection withthe Acquisition.

 

**NOTE 6 —SEGMENT INFORMATION:**

 

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

 

10

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        Thetable below presents certain segment information for the periods indicated($000):
|                                                                               |   |          |    |       |   |      |   |
|------------------------------------------------------------------------------------|--------|---------------|---------|------------|--------|-----------|--------|
|                                                                               |   | **Wholesale** |    | **Retail** |   | **Total** |   |
| **Successor for the three-month period ended September  28, 2002:**                |   |          |    |       |   |      |   |
| Sales                                                                              |   | $             | 93,604  |       | $      | 72,175    |   | $ | 165,779 |   |
| EBITDA                                                                             |   | $             | 13,166  |       | $      | 15,951    |   | $ | 29,117 |   |
| **Successor for the period from August 15, 2001 through****September 29, 2001:**   |   |          |    |       |   |      |   |
| Sales                                                                              |   | $             | 49,797  |       | $      | 38,546    |   | $ | 88,343 |   |
| EBITDA                                                                             |   | $             | 6,563   |       | $      | 10,046    |   | $ | 16,609 |   |
| **Predecessor for the period from July 1, 2001 through****August 14, 2001:**       |   |          |    |       |   |      |   |
| Sales                                                                              |   | $             | 35,770  |       | $      | 29,718    |   | $ | 65,488 |   |
| EBITDA                                                                             |   | $             | 3,402   |       | $      | 4,178     |   | $ | 7,580 |   |
|                                                                               |   |          |    |       |   |      |   |
| **Successor for the nine-month period ended September  28, 2002:**                 |   |          |    |       |   |      |   |
| Sales                                                                              |   | $             | 228,833 |       | $      | 180,636   |   | $ | 409,469 |   |
| EBITDA                                                                             |   | $             | 26,633  |       | $      | 29,532    |   | $ | 56,165 |   |
| **Successor for the period from August 15, 2001 through****September 29, 2001:**   |   |          |    |       |   |      |   |
| Sales                                                                              |   | $             | 49,797  |       | $      | 38,546    |   | $ | 88,343 |   |
| EBITDA                                                                             |   | $             | 6,563   |       | $      | 10,046    |   | $ | 16,609 |   |
| **Predecessor for the period from December 31, 2000  through****August 14, 2001:** |   |          |    |       |   |      |   |
| Sales                                                                              |   | $             | 155,639 |       | $      | 127,088   |   | $ | 282,727 |   |
| EBITDA                                                                             |   | $             | 12,853  |       | $      | 15,354    |   | $ | 28,207 |   |

* *

* *

* *

*        Areconciliation of total EBITDA for reportable segments to consolidated income(loss) before income taxes is presented below ($000):*

* *
|                                             |   | **Successor**                                            |   | **Predecessor**                                                     |   | **Successor**                                                 |   | **Predecessor**                                         |   |
|--------------------------------------------------|--------|----------------------------------------------------------|--------|---------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                             |   | **For the  three-month period ended September 28, 2002** |   | **For the  period from August 15, 2001 through September 29, 2001** |   | **For the  period from July 1, 2001 through August 14, 2001** |   | **For the  nine-month period ended September 28, 2002** |   | **For the  period from August 15, 2001 through September 29, 2001** |   | **For the  period from December 31, 2000 through August 14, 2001** |   |
|                                             |   |                                                     |   |                                                                |   |                                                          |   |                                                    |   |   |   |   |   |
| Total EBITDA for  reportable segments            |   | $                                                        | 29,117 |                                                                | $      | 16,609                                                        |   | $                                                       | 7,580  |   | $ | 56,165 |   | $ | 16,609 |   | $ | 28,207 |   |
| Depreciation and  amortization expense           |   | (4,637                                                   | )      | (2,237                                                              | )      | (2,821                                                        | )      | (13,202                                                 | )      | (2,237 | ) | (12,245 | ) |
| Acquisition-related  non-recurring charges       |   | —                                                   |   | —                                                              |   | (11,289                                                       | )      | —                                                  |   | — |   | (11,289 | ) |
| Writedown of  long-lived assets                  |   | —                                                   |   | —                                                              |   | —                                                        |   | —                                                  |   | — |   | (3,156 | ) |
| Non-recurring charges-plant closure costs        |   | —                                                   |   | —                                                              |   | —                                                        |   | —                                                  |   | — |   | (1,116 | ) |
| Interest expense, net                            |   | (7,268                                                   | )      | (3,731                                                              | )      | (2,221                                                        | )      | (21,238                                                 | )      | (3,731 | ) | (10,060 | ) |
| Consolidated income (loss)  before income  taxes |   | $                                                        | 17,212 |                                                                | $      | 10,641                                                        |   | $                                                       | (8,751 | ) | $ | 21,725 |   | $ | 10,641 |   | $ | (9,659 | ) |

 

11

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**NOTE 7 —CLOSURE OF MANUFACTURING FACILITIES:**

 

        In thefirst quarter of fiscal 2001, we announced our plans to close our sewingfacility located in Harlingen, Texas, which subsequently closed and ceasedoperations on May 11, 2001.  In thefirst quarter of 2001, we recorded a non-recurring charge of approximately$582,000 for closure costs and involuntary termination benefits and a non-cash charge of approximately $742,000related to the writedown of the asset value of our Harlingen, Texas facility toits estimated net realizable value.  Asof March 30, 2002, all of the costs provided for in the first quarter of 2001for severance and other termination benefits were paid.

 

        Inthe second quarter of fiscal 2001, we announced our plans to close our fabricprinting operations located in Barnesville, Georgia, which subsequently closedand ceased operations on June 29, 2001. In the second quarter of 2001, we recorded a non-recurring charge ofapproximately $534,000 for closure costs and involuntary termination benefitsand a non-cash charge of approximately $2.4 million related to the writedown ofthe asset value of our fabric printing operations in Barnesville, Georgia toits estimated net realizable value.  Asof June 29, 2002, all of the costs provided for in the second quarter of 2001for severance and other termination benefits were paid.

 

**       **In connection with theAcquisition, we evaluated the requirements for certain manufacturingoperations, which we had previously planned to maintain to support our long-termrevenue growth plans.  After a thoroughassessment of alternative sourcing opportunities, we decided to exit certainmanufacturing operations.  We made thisdecision in connection with our new ownership in advance of theAcquisition.  As a result of thisdecision, on October 23, 2001, we announced our plans to close our cutting andfabric warehouse operations located in Griffin, Georgia, our embroideryoperation located in Milner, Georgia, our bed and bath sewing and finishingoperation located in Barnesville, Georgia and our sewing facility located inSan Pedro, Dominican Republic, all of which subsequently closed and ceasedoperations before the end of fiscal 2001. At the time of the Acquisition, we established a liability for theseplant closures.  As of June 29, 2002,all of the severance and other termination costs associated with these plantclosures were paid.

 

        Theassets held for sale related to the embroidery operations at Milner, Georgiawere sold during the first quarter of 2002. During the second and third quarters of 2002, the assets related to ourprinting, sewing and finishing operations located in Barnesville, Georgia weresold.  The remaining assets included in assets held for sale on the accompanyingbalance sheet as of September 28, 2002 represents land and building located inBarnesville, Georgia and land associated with the Harlingen, Texas facility.

 

**NOTE8 — OTHER EXIT COSTS:**

 

        In connection with the Acquisition and our new ownership, weannounced our decision to terminate an initiative to open full-price retailstores.  At Acquisition, we establisheda liability related to terminating three employees, exiting a full-price retailconsulting contract and providing for related lease obligations.  As of June 29, 2002, all of the costs associatedwith exiting the full-price retail initiative were paid.

 

**NOTE9 — RECENT ACCOUNTING PRONOUNCEMENTS:**

 

        In connection with the Acquisition, we adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 141,“Business Combinations” (“SFAS 141”) and applied the required provisions ofSFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).  Accordingly, our tradename and goodwill havenow been deemed to have indefinite lives and are no longer being amortized inthe Successor periods.  Our licensingagreements are being amortized over the average three-year life of suchagreements, as it has been determined that these agreements have finite lives.  Amortization expense for the first ninemonths of 2002 was $3.8 million and is expected to be $5.0 million for fiscal2002, $5.0 million for fiscal 2003 and $3.1 million for 2004.

 

12

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        Thecalculation of reported net income (loss) adjusted for goodwill and tradenameamortization expense, net of taxes is shown below ($000):

** **
|                                                                   |   | **Successor**                                            |   | **Predecessor**                                                     |   | **Successor**                                                 |   | **Predecessor**                                         |    |
|------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|---------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|---------------------------------------------------------|---------|
|                                                                   |   | **For the  three-month period ended September 28, 2002** |   | **For the  period from August 15, 2001 through September 29, 2001** |   | **For the  period from July 1, 2001 through August 14, 2001** |   | **For the  nine-month period ended September 28, 2002** |    | **For the  period from August 15, 2001 through September 29, 2001** |   | **For the  period from December 31, 2000 through August 14, 2001** |   |
|                                                                   |   |                                                     |   |                                                                |   |                                                          |   |                                                    |    |   |   |   |   |
| Reported net income (loss)                                             |   | $                                                        | 10,578 |                                                                | $      | 6,365                                                         |   | $                                                       | (13,883 | ) | $ | 13,353 |   | $ | 6,365 |   | $ | (14,428 | ) |
| Add back:                                                              |   |                                                     |   |                                                                |   |                                                          |   |                                                    |    |   |   |   |   |
| Amortization expense of goodwill                                       |   | —                                                   |   | —                                                              |   | 100                                                           |   | —                                                  |    | — |   | 484 |   |
| Amortization expense of tradename, net of tax benefit of $124 and $598 |   | —                                                   |   | —                                                              |   | 201                                                           |   | —                                                  |    | — |   | 977 |   |
| Adjusted net income (loss)                                             |   | $                                                        | 10,578 |                                                                | $      | 6,365                                                         |   | $                                                       | (13,582 | ) | $ | 13,353 |   | $ | 6,365 |   | $ | (12,967 | ) |

 

        Weadopted the remaining provisions of SFAS 142 as of the beginning of fiscal2002.  In accordance with thisstatement, we have identified our reporting units, completed an assessment forimpairment of goodwill (by comparing the fair values of our reporting units totheir respective carrying values, including allocated goodwill) and ourtradename and found that there was no impairment of either asset.  We are also required to measure our goodwilland tradename for impairment on at least an annual basis or if events orchanges in circumstances so dictate.

 

        InOctober 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No.144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS 144”)which addresses financial accounting and reporting for the impairment ordisposal of long-lived assets.  Weadopted SFAS 144 as of the beginning of fiscal 2002 and it did not have amaterial impact on our financial position or results of operations for thethird quarter or the first nine months of 2002.

 

        InNovember 2001, the Financial Accounting Standards Board’s Emerging Issues TaskForce (“EITF”) issued EITF Issue No. 01-09, “Accounting for Consideration Givenby a Vendor to a Customer/Reseller” (“EITF 01-09”).  EITF 01-09 outlines the presumption that consideration given by avendor to a customer is to be treated as a reduction of revenue, unless certainconditions are met.  Historically, wehave accounted for accommodations and cooperative advertising allowances madeto wholesale customers as selling expenses. We adopted EITF 01-09 as of the beginning of fiscal 2002 and classifiedthese expenses as a reduction of revenue rather than as selling expenses.  Accommodations and cooperative advertisingprovisions of $2.7 million for the Successor period from August 15, 2001through September 29, 2001, $1.2 million for the Predecessor period from July1, 2001 through August 14, 2001 and $5.0 million for the Predecessor periodfrom December 31, 2000 through August 14, 2001 have been reclassified toconform with the current periods’ presentation.  These reclassifications did not impact net income (loss).

 

        In April 2002, the FASB issued SFAS No.145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASBStatement No. 13, and Technical Corrections” (“SFAS 145”).  SFAS 145 rescinds FASB Statement No. 4,which required all gains and losses from extinguishments of debt to beaggregated and, if material, classified as an extraordinary item, net of therelated income tax effect.  As a result,the criteria in Accounting Principles Board Opinion 30 will now be used toclassify those gains and losses.  Theprovisions of SFAS 145, as related to the rescission of FASB Statement No. 4,will be effective for fiscal 2003.  Weare currently evaluating the impact of this statement to determine whether weneed to reclassify a $6.2 million extraordinary item that we recorded in connectionwith the Acquisition.  However, thisreclassification will not impact our reported net loss.

 

13

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        In July 2002, the FASB issued SFAS No.146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS146”).  SFAS 146 sets forth variousmodifications to existing accounting guidance which prescribes the conditionswhich must be met in order for costs associated with contract terminations,facility consolidations, employee relocations and terminations to be accruedand recorded as liabilities in financial statements.  Accordingly, SFAS 146 may affect the timing of recognizing futurerestructuring costs as well as the amount recognized.  SFAS 146 also establishes that the liability should initially bemeasured and recorded at fair value. The provisions of SFAS 146 will be required to be applied prospectivelyto exit or disposal activities initiated after December 31, 2002.

 

**NOTE 10 — RECENT EVENTS:**

 

**       **On August 23, 2002, Holdings filed a registrationstatement with the Securities and Exchange Commission to register an initialpublic offering of up to $100.0 million of its common stock.  That registration statement has not yetbecome effective.  If the initial publicoffering is completed, Holdings intends to contribute to us a portion ofits proceeds from the offering.  Weintend to use these proceeds to redeem a portion of our outstanding10.875% senior subordinated notes due in 2011 at a redemption price of110.875% of the principal amount redeemed plus accrued and unpaid interest,repay a portion of our indebtedness under our senior credit facility and payBerkshire $3.5 million to terminate our future obligations under our managementagreement with Berkshire.  In connectionwith this registration process, we incurred approximately $800,000 of expensesrelated to the offering, which have been deferred and are included in prepaidand other current assets on the accompanying balance sheet as of September 28,2002.

 

**       **During the third quarter of2002, we executed an artwork agreement with Eric Carle, LLC. Under thisagreement, we are obligated to pay $1.5 million in minimum royalty guaranteesfor the initial term which began June 28, 2002 and expires December 31, 2005.

 

14

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**I****TEM 2****.      MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**

**                    AND RESULTS OF OPERATIONS:**

 

        The following is a discussion of the risks relating to ourbusiness, our results of operations and our current financial position.  You should read this discussion inconjunction with our condensed consolidated financial statements and notesincluded elsewhere in this quarterly report. Our discussion of our results of operations and financial conditionincludes various forward-looking statements about our markets, the demand forour products and services and our future results.  We base these statements on certain assumptions that we considerreasonable.  For further informationabout risks and exposures relating to our business and our company, you shouldread Item 3 of this quarterly report entitled “Quantitative and QualitativeDisclosures about Market Risks.”  Actualresults may differ materially from those suggested by our forward-lookingstatements for various reasons including those discussed in Item 2 and Item 3.  These risk factors expressly qualify allsubsequent oral and written forward-looking statements attributable to us orpersons acting on our behalf.  Exceptfor any ongoing obligations to disclose material information as required by thefederal securities laws, we have no intention or obligation to updateforward-looking statements after we file this quarterly report.

 

**RISKSRELATING TO OUR BUSINESS**

 

**The lossof one or more of our key customers could result in a material loss ofrevenues.**

 

        In 2001, we derived approximately 40% of our total net salesfrom our top eight customers.  We expectthat these customers will continue to represent a significant portion of oursales in the future.  A significantdecrease in business from one or more of these customers could have a materialadverse effect on our revenue and results of operations.  We do not enter into formal sales contractswith our wholesale customers, relying instead on long-standing relationshipswith these customers.  As a result, weface the risk that one or more of our key customers may terminate its or theirrelationship with us.  Without contractsestablishing volume commitments from our customers, there is also a risk thatwe will be inaccurate in our forecasting and planning for production requirements.

 

**Retailtrends could result in increased downward pressure on our prices.**

** **

        With the growing trend toward retail trade consolidation, weincreasingly depend upon a reduced number of key retailers whose bargainingstrength is growing.  We may be negativelyaffected by changes in the policies of our retail trade customers, such asinventory de-stocking, limitations on access to shelf space, scan-based tradingand other conditions.  Furtherconsolidations in the retail industry could result in price and othercompetition that could damage our business.

 

**Ourdependence on foreign supply sources may result in disruptions to ouroperations in the event of political instability or foreign regulations.**

 

        We currently source substantially all of our sewing,embroidery and cutting and a substantial portion of our fabric productionthrough our offshore facilities and other offshore productionarrangements.  We expect to source moreof our fabric production offshore over time. We may be adversely affected by:

 

•political instability resulting in the disruption of trade from foreigncountries in which our manufacturing facilities are located; and

 

• theimposition of new regulations relating to imports, duties, taxes and othercharges on imports.

 

        These and other events beyond our control could interruptproduction in offshore facilities or delay receipt of the products in theUnited States, which may have a material adverse effect on our financialcondition and results of operations.

 

**Ourbusiness and reputation may be adversely affected if our brand is associatedwith negative publicity***.*

 

        While our staff and third party compliance auditorsperiodically visit and monitor the operations of our vendors, independentmanufacturers and licensees, we do not control these vendors and independentmanufacturers or their labor practices. The violation of our guidelines or labor or other laws by these vendorsor independent manufacturers could interrupt or otherwise disrupt our sourcingor damage our brand image.  As a result,negative publicity regarding our company, brand or products, including licensedproducts, could adversely affect our reputation and sales.

 

15

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**The loss of one or more of our major suppliers forraw materials may interrupt our supplies.**

 

        Of the fabrics we source in the United States, we purchase amajority from a few vendors of each material. The loss of one or more of these suppliers could interrupt our supply,which could have an adverse effect on our sales and increase our costs.

 

**We operatein a highly competitive market and our business will suffer if we are unable tocompete effectively.**

 

        The baby and young children’s apparel markets are highlycompetitive.  Both branded and privatelabel manufacturers compete in the baby and young children’s apparelmarkets.  Our primary brandedcompetitors include GAP, Gerber, Oshkosh B’Gosh and Disney-licensed products inplayclothes and sleepwear.  Someretailers, including several that are our customers, have significant privatelabel product offerings in playclothes that compete with us.  Because of the fragmented nature of theindustry, we also compete with many small manufacturers and retailers.  Some of our competitors have greaterfinancial resources and larger customer bases than we have and are lessfinancially leveraged than we are.  As aresult, these competitors may be able to:

 

• adapt to changes in customerrequirements more quickly;

 

• take advantage of acquisition and otheropportunities more readily; and

 

•devote greater resources to the marketing and sale of their products and adoptmore aggressive pricing policies than we can.

 

**The lossof key members of our senior management team could adversely affect ourbusiness.**

 

        Our success depends largely on the efforts and abilities ofour senior management team.  Theirexperience and industry contacts significantly benefit us.  If we were to lose the benefit of their experienceand contacts, our business could be adversely affected.

 

**Oursubstantial leverage could adversely affect our financial condition.**

 

        At September 28, 2002, we had total debt of approximately$297.9 million (consisting of $173.8 million of senior subordinated notes and$124.1 million of secured borrowings under our senior credit facility) andcommon stockholder's equity of approximately $172.8 million.  In addition, we and our subsidiaries arepermitted to incur substantial additional indebtedness in the future.

 

        Our substantial indebtedness could have importantconsequences.  For example, it could:

 

• increase our vulnerability to generaladverse economic and industry conditions;

 

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

 

•require us to dedicate a substantial portion of our cash flow from operationsto pay principal of, and interest on, our indebtedness, thereby reducing theavailability of that cash flow to fund working capital, capital expenditures orother general corporate purposes, or to carry out other aspects of our businessplan;

 

•limit our flexibility in planning for, or reacting to, changes in our businessand the industry; and

 

• place us at a competitive disadvantagecompared to our competitors that have less debt.

 

        In addition, the senior credit facility contains financialand other restrictive covenants that limit our ability to engage in activitiesthat may be in our long-term best interests. Our failure to comply with those covenants could result in an event ofdefault which, if not cured or waived, could result in the acceleration of allof our debt.

 

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**The current and future economic downturns mayadversely affect our sales.**

 

        Adownturn in the economy may affect consumer purchases of discretionary items,which could adversely affect our sales. Our success depends on the sustained demand for our products andconsumer confidence.  Consumer purchasesof discretionary items, such as many of our products, tend to decline duringrecessionary periods when disposable income is lower.  These downturns have been characterized by diminished productdemand and subsequent accelerated erosion of average selling prices.  A general slowdown in the economies in whichwe sell our products or even an uncertain economic outlook could adverselyaffect consumer spending on our products and, in turn, our sales and results ofoperations.  Since the third quarter of2000, the U.S. economy has shown signs of a downturn.  If this general economic slowdown continues, it may adverselyimpact our future business and operating results.

 

**Governmentalregulations and environmental risks applicable to our business may require usto take actions which limit our business and increase our costs.**

 

        Ourbusiness is subject to federal, state, provincial, local and foreign laws andregulations, including regulations with respect to air emissions, wastewaterdischarges and the generation, handling, storage, transportation, treatment anddisposal of waste materials.  Althoughwe believe we are in substantial compliance with all applicable laws andregulations, legal requirements are frequently changed and subject tointerpretation, and we are unable to predict the ultimate cost of compliancewith these requirements or their effect on our operations.  We may be required to make significantexpenditures to comply with governmental laws and regulations.  Complying with existing or future laws orregulations may materially limit our business and increase our costs.

 

**Seasonalfluctuations in the children’s apparel market may have an adverse impact on ourbusiness.**

 

        We experience seasonalfluctuations in our sales and profitability, with generally lower sales andgross profit in the first and second quarters of our fiscal year.  We believe that the seasonality of sales andprofitability is a factor that affects the baby and young children’s apparel industrygenerally and is primarily due to retailers’ emphasis on price reductions inthe first quarter, promotional retailers’ and manufacturers’ emphasis oncloseouts of the prior year’s product lines and “back-to-school” and holidayshopping patterns.  Accordingly, ourresults of operations for the first and second quarters of any year are notindicative of the results we expect for the full year.

 

**RESULTSOF OPERATIONS**

 

The 2001 resultssummarized and discussed below for the three and nine-month periods endedSeptember 29, 2001 represent the mathematical addition of the historicalresults for the period from July 1, 2001 through August 14, 2001 (the“Predecessor” period) and the period from August 15, 2001 through September 29,2001 (the “Successor” period) and the mathematical addition of the period fromDecember 31, 2000 through August 14, 2001 (the “Predecessor” period) and theperiod from August 15, 2001 through September 29, 2001 (the “Successor” period)for purpose of the discussion below only. While this approach is not consistent with generally accepted accountingprinciples, due to the new basis of accounting established at the Acquisitiondate, we believe it is the most practical way to comment on the results ofoperations.

 

As a result of theAcquisition, our assets and liabilities were adjusted to their estimated fairvalues as of August 15, 2001.  Inaddition, we entered into new financing arrangements and had a change in ourcapital structure.  The one and one-halfmonth period prior to the Acquisition reflects non-recurring charges,principally sellers' expenses such as management bonuses and professional fees,and an extraordinary charge for debt prepayment penalties and the write-off ofdeferred debt issuance costs on debt retired as a result of the Acquisition andrefinancing.  All periods prior to theAcquisition presented include amortization expense on our tradename andgoodwill.  The periods subsequent to theAcquisition reflect increased interest expense, amortization of licensing agreementsand cessation of amortization on our tradename and goodwill due to the adoptionof Statement of Financial Accounting Standards (“SFAS”) No. 141, “BusinessCombinations” (“SFAS 141”) and SFAS No. 142, “Goodwill and Other IntangibleAssets” (“SFAS 142”).  Accordingly, theresults of operations for the Predecessor and Successor periods are notcomparable.

 

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        Thefollowing table sets forth, for the periods indicated, (i) selected statementof operations data expressed as a percentage of net sales and (ii) the numberof retail stores open at the end of each such period.

 
|                                                    |   | **As a  Percentage of Net Sales** |   |
|---------------------------------------------------------|--------|-----------------------------------|--------|
|                                                    |   |                              |   |   |   |
|                                                    |   | **Three-month  periods ended**    |   | **Nine-month  periods ended** |   |
|                                                    |   |                              |   |   |   |   |   |   |   |
|                                                    |   | **September  28,****2002**        |   | **September  29,****2001** |   | **September  28,****2002** |   | **September  29,****2001** | ** ** |
|                                                    |   |                              |   |   |   |   |   |   |   |
| Wholesale sales                                         |   | 56.5                              | %      | 55.6 | % | 55.9 | % | 55.4 | % |
| Retail sales                                            |   | 43.5                              |   | 44.4 |   | 44.1 |   | 44.6 |   |
| Net sales                                               |   | 100.0                             |   | 100.0 |   | 100.0 |   | 100.0 |   |
| Cost of goods  sold                                     |   | 60.7                              |   | 63.4 |   | 61.2 |   | 64.3 |   |
| Gross profit                                            |   | 39.3                              |   | 36.6 |   | 38.8 |   | 35.7 |   |
| Selling, general  and administrative expenses           |   | 26.0                              |   | 25.8 |   | 29.8 |   | 29.2 |   |
| Non-recurring  charges                                  |   | —                            |   | 7.3 |   | — |   | 4.1 |   |
| Royalty income                                          |   | (1.5                              | )      | (1.6 | ) | (1.5 | ) | (1.6 | ) |
| Operating income                                        |   | 14.8                              |   | 5.1 |   | 10.5 |   | 4.0 |   |
| Interest  expense, net                                  |   | 4.4                               |   | 3.9 |   | 5.2 |   | 3.7 |   |
| Income before  income taxes and extraordinary item      |   | 10.4                              |   | 1.2 |   | 5.3 |   | 0.3 |   |
| Provision for  income taxes                             |   | 4.0                               |   | 2.1 |   | 2.0 |   | 0.8 |   |
| Income (loss)  before extraordinary item                |   | 6.4                               |   | (0.9 | ) | 3.3 |   | (0.5 | ) |
| Extraordinary  item, net of tax benefit of $4.1 million |   | —                            |   | 4.0 |   | — |   | 1.7 |   |
| Net income  (loss)                                      |   | 6.4                               | %      | (4.9 | )% | 3.3 | % | (2.2 | )% |
|                                                    |   |                              |   |   |   |   |   |   |   |
| Number of retail  stores at end of period               |   | 156                               |   | 150 |   | 156 |   | 150 |   |

 

**Threeand nine-month periods ended September 28, 2002 compared to three andnine-month periods ended September 29, 2001**

 

*      NET SALES.*    In thethird quarter of 2002, consolidated net sales increased $11.9 million, or 7.8%,to $165.8 million from $153.8 million in the third quarter of 2001.  Consolidated net sales for the first ninemonths of 2002 were $409.5 million, an increase of $38.4 million, or 10.3%, ascompared with $371.1 million for the first nine months of 2001.  These increases reflect the continuedstrength of our product performance in each of our channels of distribution,which we believe is driven by our focus on core products, the expansion of ourglobal sourcing capabilities, effective merchandising strategies andinvestments in point of sale fixturing.

 

      Totalwholesale sales, excluding discount store channel and off-price sales,increased $6.5 million, or 8.4%, in the third quarter of 2002 to $82.9 millionfrom $76.5 million in the third quarter of 2001.  This revenue growth was driven by an increase in our playclothesproduct line offset by declines in our baby and sleepwear product lines due tothe timing of new product launches and unfavorable market conditions.  Wholesale sales increased in the first ninemonths of 2002 by $20.2 million, or 11.2%, to $200.5 million from $180.3million in the same period in 2001. This revenue growth was driven primarily by an increase in ourplayclothes and baby product lines partially offset by lower sleepwear sales.

 

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      Included intotal wholesale sales are discount store channel sales, which increased $1.5million, or 28.2%, in the third quarter of 2002 to $7.0 million from $5.5million in the third quarter of 2001. In the first nine months of 2002, sales from this channel increased $2.1million, or 14.2%, to $17.0 million from $14.9 million in the first nine monthsof 2001.  We attribute these increasesto strong product performance as well as floor space gained through the openingof additional Target stores.

 

      Our retailstore sales were $72.2 million for the third quarter of 2002, which representedan increase of $3.9 million, or 5.7%, over the third quarter of 2001.  This increase is primarily attributable toincreased sales from our baby and playclothes product lines.  Retail store sales increased $15.0 million,or 9.1%, in the first nine months of 2002 to $180.6 million from $165.6 millionin the first nine months of 2001.  Whileincreases in all of our major product lines contributed to this growth, suchgrowth was led primarily by increases in our baby and playclothes productlines.  Comparable store sales in ourretail store channel increased 1.7% in the third quarter of 2002 and increased2.9% in the third quarter of 2001.  Foreach of the third quarter periods, we opened one store.  During the first nine months of 2002 and2001, comparable store sales increased 5.6%, and 5.4%. We opened five storesduring the first nine months of 2002, and opened five and closed two during thefirst nine months of 2001.  As ofSeptember 28, 2002, we had 156 retail stores compared to 150 stores as ofSeptember 29, 2001. We plan to open seven and close four stores in the fourthquarter of 2002.

 

*      GROSS PROFIT.*   Our gross profit increased $8.8 million, or 15.7%, to $65.1 million inthe third quarter of 2002 from $56.3 million in the third quarter of 2001.Gross profit, as a percentage of net sales, in the third quarter of 2002increased to 39.3% from 36.6% as compared to 2001.  In the first nine months of 2002, our gross profit increased$26.2 million, or 19.8%, to $158.8 million compared to $132.5 million in thefirst nine months of 2001 and as a percentage of net sales increased to 38.8%from 35.7% as compared to 2001.  Theseincreases in gross profit as a percentage of net sales for both periods wereprincipally due to the continued expansion of our global sourcing strategy,which has enabled us to source better quality products with improved fabric andgarment construction at lower costs. These improvements in gross margin also include the impact of a $1.7million charge recorded in the third quarter of 2001 related to theamortization of the step-up in the inventory valuation at Acquisition.

 

*        SELLING, GENERAL AND ADMINISTRATIVEEXPENSES.*    Selling, general and administrativeexpenses for the third quarter of 2002 increased $3.5 million, or 8.7%, to$43.1 million from $39.7 million in the third quarter of 2001.  These costs, as a percentage of net sales,increased to 26.0% in the third quarter of 2002 from 25.8% in the third quarterof 2001 due primarily to increases in distribution and certain productmarketing expenses.  In the first ninemonths of 2002, selling, general and administrative expenses increased $13.9million, or 12.8%, to $122.0 million from $108.2 million in the first ninemonths of 2001.  These expenses,relative to sales, increased to 29.8% in the first nine months of 2002 from29.2% in the first nine months of 2001 due to the factors noted above partiallyoffset by the benefit from leveraging operating expenses against higher levelsof revenue and $1.1 million in non-recurring costs incurred in connection withactivities leading up to the Acquisition in the first nine months of 2001.

 

        *NON-RECURRING CHARGES / WRITEDOWN OF LONG-LIVEDASSETS.   *As described inNote 1 to the accompanying condensed consolidated financial statements, weincurred Acquisition-related non-recurring charges including $4.5 million ofspecial compensation paid to management at the closing of the Acquisition and$6.8 million in sellers’ transaction costs and fees paid during the one andone-half month period ended August 14, 2001.  As described in Note 7 to the accompanying condensed consolidatedfinancial statements, in the first quarter of 2001, we recognized anon-recurring charge of approximately $582,000 for certain closure costs andinvoluntary termination benefits related to our sewing facility in Harlingen,Texas.  Additionally, we recorded anon-cash charge of approximately $742,000 for the writedown of the asset valueto its estimated net realizable value. In the second quarter of fiscal 2001, we closed our fabric printingoperations located in Barnesville, Georgia and recognized a non-recurringcharge of approximately $534,000 related to certain closure costs andinvoluntary termination benefits.  Allof the costs for these plant closures provided for in fiscal 2001 were paid.  Additionally, we recorded a non-cash chargeof approximately $2.4 million for the writedown of the related asset value toits estimated net realizable value.

 

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*        ROYALTY INCOME.*   We license the use of the *Carter’s*and*Tykes*names to certain licensees.  Our royalty income in the third quarter of2002 and 2001 was approximately $2.5 million. During the first nine months of 2002, royalty income was approximately$6.2 million compared to approximately $6.0 million during the first ninemonths of 2001.

 

*        OPERATING INCOME.   *Operating income for the third quarter of 2002increased $16.6 million to $24.5 million compared to $7.8 million in the thirdquarter of 2001.  Operating income forthe first nine months of 2002 increased $28.2 million to $43.0 million from$14.8 million in the first nine months of 2001.  These increases reflect the effect of higher levels of revenueand gross profit and the impact of the non-recurring charges incurred in2001.  Excluding the non-recurringcharges in 2001, operating income for the third quarter and first nine monthsof 2002 would have increased approximately $5.3 million, or 28.0%, andapproximately $12.6 million, or 41.6%, over the third quarter and first ninemonths of 2001.

 

        *INTEREST EXPENSE*, *NET*.   Net interest expense for the third quarter of 2002 increased $1.3million to $7.3 million from $6.0 million in the third quarter of 2001.  In the first nine months of 2002, interestexpense increased $7.4 million to $21.2 million from $13.8 million in the firstnine months of 2001.  This increase is aresult of additional borrowings from the Acquisition and refinancing asdiscussed in Note 1 to the accompanying condensed consolidated financialstatements.

 

*        INCOME TAXES.   *Werecorded a provision for income taxes of $6.6 million in the third quarter of2002 compared to $3.2 million in the third quarter of 2001.  In the first nine months of 2002, werecorded a provision for income taxes of $8.4 million compared to $2.9 in thefirst nine months of 2001.  Oureffective tax rate was approximately 38.5% during the first nine months of2002; 40.2% for the one and one-half month period ended September 29, 2001; and14.5% for the seven and one-half month period ended August 14, 2001.  The 14.5% tax benefit for the seven andone-half month period ended August 14, 2001 is primarily a result of certainseller’s expenses incurred in connection with the Acquisition and goodwillamortization that are not deductible for tax purposes.

 

        *EXTRAORDINARY ITEM*.    As described in Note 1 to the accompanyingcondensed consolidated financial statements, we incurred an extraordinarycharge of $6.2 million, net of a tax benefit of $4.1 million, during the oneand one-half month period ended August 14, 2001 in connection with theAcquisition and refinancing due to the write off of deferred debt issuancecosts and debt prepayment penalties.

 

*        NET INCOME (LOSS).   *Our third quarter 2002 net income was approximately$10.6 million compared to a net loss of approximately $7.5 million in the thirdquarter of 2001.  Net income for thefirst nine months of 2002 was approximately $13.4 million compared to a netloss of approximately $8.1 million in the first nine months of 2001.  As noted above, our 2001 results include non-recurring charges and an extraordinaryitem.  Excluding these items, our netincome for the three and nine-month periods ended September 28, 2002 would haveincreased approximately $2.4 million, or 29.0%, and approximately $3.0 million,or 29.6%, as compared to the three and nine-month periods ended September 29,2001.

 

**FINANCIALCONDITION, CAPITAL RESOURCES AND LIQUIDITY**

 

        Our primary cash needs are working capital, capitalexpenditures and debt service. Historically, we have financed these needs primarily through internallygenerated cash flow and funds borrowed under senior credit facilities.  Our primary source of liquidity willcontinue to be cash flow from operations and borrowings under our creditfacilities, and we expect that these sources will fund our ongoing requirementsfor debt service and capital expenditures. These sources of liquidity may be impacted by continued demand for ourproducts and our ability to meet debt covenants under our credit facility.

 

        On August23, 2002, Holdings filed a registration statement with the Securities andExchange Commission to register an initial public offering of up to $100.0million of its common stock.  Thatregistration statement has not yet become effective.  If the initial public offering is completed, Holdings intends tocontribute to us a portion of its proceeds from the offering.  We intend to use these proceeds to redeem aportion of our outstanding 10.875% senior subordinated notesdue in 2011 (the “Notes”) at a

 

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redemption price of 110.875% of the principal amountredeemed plus accrued and unpaid interest, repay a portion of our indebtednessunder our senior credit facility and pay Berkshire Partners LLC $3.5 million toterminate our future obligations under our management agreement with Berkshire.

 

        Net cashprovided by operating activities for the first nine months of 2002 was $11.3million compared to net cash used in operating activities of $4.4 million forthe first nine months of 2001.  Thisincrease is primarily attributable to the increase in net income.

 

        Netaccounts receivable at September 28, 2002 were $48.4 million compared to $49.7million at September 29, 2001 and $35.4 million at December 29, 2001.  The decrease over the third quarter 2001reflects a higher level of wholesale shipments in the latter part of the thirdquarter ended September 29, 2001.  Dueto the seasonal nature of our operations, the net accounts receivable balanceat September 28, 2002 is not comparable to the net accounts receivable balanceat December 29, 2001.

 

        Netinventories at September 28, 2002 were $96.6 million compared to $104.9 millionat September 29, 2001 and $89.1 million at December 29, 2001.  This reduction compared to September 29, 2001reflects the favorable impact of our forecasting and sourcing strategies inaddition to an Acquisition-related valuation adjustment of $2.9 million whichincreased inventories as of September 29, 2001.  Due to the seasonal nature of our operations, net inventories atSeptember 28, 2002 are not comparable to net inventories at December 29, 2001.

 

        We haveinvested $9.0 million in capital expenditures during the first nine months of2002 compared to $12.2 million during the first nine months of 2001.  We plan to invest a total of approximately$21.0 million in capital expenditures in 2002. Major investments include retail store openings and remodeling,fixturing programs for wholesale customers and the expansion of ourdistribution centers to support increased revenue growth.

 

        At September 28, 2002, we hadapproximately $297.9 million of debt outstanding, consisting of $173.8 millionof Notes, $124.1 million in term loan borrowings and no revolver borrowingsunder the senior credit facility, exclusive of approximately $11.6 million ofoutstanding letters of credit.  AtSeptember 28, 2002, we invested our available cash of $29.5 million in moneymarket mutual funds at a tax-exempt interest rate of 1.39%, compared to borrowingsof $4.6 million under the revolving portion of our senior credit facility atSeptember 29, 2001.  At September 28,2002, we had approximately $48.4 million of financing available under ourrevolving loan facility.  At December29, 2001, we had approximately $298.7 million of debt outstanding, consistingof $173.7 million of Notes, $125.0 million in term loan borrowings and norevolver borrowings under the senior credit facility, exclusive ofapproximately $6.5 million of outstanding letters of credit.  The borrowings under the revolving creditfacility will be available to fund our working capital requirements, capitalexpenditures and other general corporate purposes.

 

        Principalborrowings under the term loan are due and payable in twenty-four quarterlyinstallments of $312,500 beginning December 31, 2001 through September 30, 2007and four quarterly payments of approximately $29.4 million from December 31,2007 through September 30, 2008. Interest on the term loan is payable at the end of interest rate resetperiods, which vary in length but in no case exceed six months.  The outstanding balance of the revolvingcredit facility is payable in full on August 15, 2006, and interest is payablequarterly.  No principal payments arerequired on the Notes prior to their scheduled maturity in August 2011.  Interest is payable semi-annually on theNotes in February and August of each year, commencing February 15, 2002, in theamount of approximately $9.5 million for each payment.

 

        Thesenior credit facility contains mandatory and optional prepayments as definedunder the agreement, including 50% of the net cash proceeds from Carter’s orHoldings issuance of equity, excluding, among other things, proceeds from anyissuance of equity that arise in connection with employee stock plans or areinvested in connection with a permitted acquisition and; 75% or 50% of excesscash flow, depending on the applicable leverage ratio, as both terms aredefined in the senior credit facility. The excess cash flow requirement is effective for fiscal 2002 and couldrequire us to make such mandatory prepayments, if applicable, on the seniorcredit facility within 90 days of the end of fiscal 2002.  The lenders will apply such prepaymentsfirst to the term loan and, second, to reduce permanently the revolving creditcommitments.

 

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Subject to certain conditions, we may make optionalprepayments of loans without premium or penalty.  The lenders will apply such optional prepayments according to ourinstruction.

 

        Basedon our current level of operations, we believe that cash generated from operations andavailable cash, together with amounts available under the revolving creditportion of our new senior credit 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.

 

        Thesenior credit facility imposes certain covenants, requirements and restrictionson our actions and our subsidiaries that, among other things, restrict thepayment of dividends.

 

**EFFECTSOF INFLATION**

 

        We areaffected by inflation and changing prices primarily through the purchase of rawmaterials, increased operating costs and higher interest rates.  The effects of inflation in changing priceson our net sales, revenues and operations have not been material in recentyears.

 

**SEASONALITY**

 

        Weexperience seasonal fluctuations in our sales and profitability, with generallylower sales and gross profit in the first and second quarters of our fiscalyear.  Over the past five years,approximately 58% of our consolidated net sales have been generated in thesecond half of our fiscal year.  Webelieve that the seasonality of sales and profitability is a factor thatgenerally affects the baby and young children’s apparel industry and isprimarily due to retailers’ emphasis on price reductions in the first quarter,promotional retailers’ and manufacturers’ emphasis on closeouts of the prioryear’s product lines and “back-to-school” and holiday shopping patterns.  Accordingly, the results of operations forthe three and nine-month periods ended September 28, 2002 are not indicative ofthe results we expect for the full year.

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

        Our discussion and analysis of ourfinancial condition and results of operations are based upon our condensedconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these requires us to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses and relateddisclosure of contingent assets and liabilities. On an ongoing basis, weevaluate our estimates, including those related to bad debts, inventories,intangible assets, income taxes, restructuring, pensions and otherpost-retirement benefits and contingencies and litigation. 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. Actualresults may differ from these estimates under different assumptions orconditions.

 

        A summaryof the significant accounting policies and methods used in the preparation ofour consolidated financial statements is included in Note 2 to the ConsolidatedFinancial Statements, included in our most recently filed annual report on Form10-K.  The following is a briefdiscussion of the more significant accounting policies and methods we use.

 

*Revenuerecognition:*****We recognize wholesale revenue aftershipment of products to customers, when title passes and when all risks andrewards of ownership have transferred. In certain cases, this does not occur until the goods reach thespecified customer.  We consider revenuerealized or realizable and earned when the product has been shipped, the salesprice is fixed or determinable and collectibility is reasonably assured.

 

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In the normal course of business,we grant certain accommodations and allowances to our wholesale customers.  As a result of our recent adoption of theFinancial Accounting Standards Board’s Emerging Issues Task Force (“EITF”)Issue No. 01-09, “Accounting for Consideration Given by a Vendor to aCustomer/Reseller,” (“EITF 01-09”) these amounts are classified as a reductionof revenue.  We also reduce revenue forcustomer returns and deductions and maintain an allowance for doubtful accountsfor estimated losses resulting from the inability of our customers to makepayments.  If the financial condition ofour customers were to deteriorate, resulting in an impairment of their abilityto make payments, an additional allowance could be required.  Retail store revenues are recognized at thepoint of sale.

 

*Inventory:*We write down ourinventory for estimated excess and obsolescence equal to the difference betweenthe cost of inventory and the estimated market value based upon assumptionsabout future demand and market conditions. If actual market conditions are less favorable than those projected byus, additional write-downs may be required.

 

*Goodwilland tradename:* Asof September 28, 2002, we have approximately $359.5 million in goodwill andtradename assets on our balance sheet. At Acquisition, we estimated the fair value of the *Carter’s* tradename to be approximately$220.2 million using a discounted cash flow analysis, which examined thehypothetical cost savings that accrue as a result of our ownership of thetradename.  The cash flows, whichincorporated both historical and projected financial performance, werediscounted using a discount rate of ten percent.  We determined that the tradename has an indefinite life.  The carrying value of these assets will besubject to annual impairment reviews based on the estimated fair values of theunderlying businesses.  These estimatedfair values are based on estimates of the future cash flows of thebusinesses.  Factors affecting thesefuture cash flows include the continued market acceptance of our offeredproducts and our development of new products. Impairment reviews may also be triggered by any significant events orchanges in circumstances.

 

### **RECENT ACCOUNTINGPRONOUNCEMENTS**

 

          Inconnection with the Acquisition, we adopted the provisions of SFAS 141,“Business Combinations” and applied the required provisions of SFAS 142,“Goodwill and Other Intangible Assets.” Accordingly, our tradename and goodwill have now been deemed to haveindefinite lives and are no longer being amortized in the Successorperiods.  Our licensing agreements arebeing amortized over the average three-year life of such agreements, as it hasbeen determined that these agreements have finite lives.  Amortization expense for the first ninemonths of 2002 was $3.8 million and is expected to be $5.0 million for fiscal2002, $5.0 million for fiscal 2003 and $3.1 million for 2004.

 

        Thecalculation of reported net income (loss) adjusted for goodwill and tradenameamortization expense, net of taxes is shown below ($000):

 
|                                                                   |   | **Successor**                                            |   | **Predecessor**                                                     |   | **Successor**                                                 |   | **Predecessor**                                         |    |
|------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|---------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|---------------------------------------------------------|---------|
|                                                                   |   | **For the  three-month period ended September 28, 2002** |   | **For the  period from August 15, 2001 through September 29, 2001** |   | **For the  period from July 1, 2001 through August 14, 2001** |   | **For the  nine-month period ended September 28, 2002** |    | **For the  period from August 15, 2001 through September 29, 2001** |   | **For the  period from December 31, 2000 through August 14, 2001** |   |
|                                                                   |   |                                                     |   |                                                                |   |                                                          |   |                                                    |    |   |   |   |   |
| Reported net income (loss)                                             |   | $                                                        | 10,578 |                                                                | $      | 6,365                                                         |   | $                                                       | (13,883 | ) | $ | 13,353 |   | $ | 6,365 |   | $ | (14,428 | ) |
| Add back:                                                              |   |                                                     |   |                                                                |   |                                                          |   |                                                    |    |   |   |   |   |
| Amortization expense of goodwill                                       |   | —                                                   |   | —                                                              |   | 100                                                           |   | —                                                  |    | — |   | 484 |   |
| Amortization expense of tradename, net of tax benefit of $124 and $598 |   | —                                                   |   | —                                                              |   | 201                                                           |   | —                                                  |    | — |   | 977 |   |
| Adjusted net income (loss)                                             |   | $                                                        | 10,578 |                                                                | $      | 6,365                                                         |   | $                                                       | (13,582 | ) | $ | 13,353 |   | $ | 6,365 |   | $ | (12,967 | ) |

 

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        Weadopted the remaining provisions of SFAS 142 as of the beginning of fiscal2002.  In accordance with thisstatement, we have identified our reporting units, completed an assessment forimpairment of goodwill (by comparing the fair values of our reporting units totheir respective carrying values, including allocated goodwill) and ourtradename and found that there was no impairment of either asset.  We are also required to measure our goodwilland tradename for impairment on at least an annual basis or if events orchanges in circumstances so dictate.

 

        InOctober 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No.144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS 144”)which addresses financial accounting and reporting for the impairment ordisposal of long-lived assets.  Weadopted SFAS 144 as of the beginning of fiscal 2002 and it did not have amaterial impact on our financial position or results of operations for thethird quarter or the nine months of 2002.

 

        InNovember 2001, the EITF issued EITF 01-09, “Accounting for Consideration Givenby a Vendor to a Customer/Reseller.” EITF 01-09 outlines the presumption that consideration given by a vendorto a customer is to be treated as a reduction of revenue, unless certainconditions are met.  Historically, wehave accounted for accommodations and cooperative advertising allowances madeto wholesale customers as selling expenses at the point at which we enter intosuch commitments.  We adopted EITF 01-09as of the beginning of fiscal 2002 and classified these expenses as a reductionof revenue rather than as selling expenses. Accommodations and cooperative advertising provisions of $2.7 millionfor the Successor period from August 15, 2001 through September 29, 2001, $1.2million for the Predecessor period from July 1, 2001 through August 14, 2001and $5.0 million for the Predecessor period from December 31, 2000 throughAugust 14, 2001 have been reclassified to conform with the current periods'presentation.  These reclassificationsdid not impact net income (loss).

 

        In April 2002, the FASB issued SFAS No.145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASBStatement No. 13, and Technical Corrections” (“SFAS 145”).  SFAS 145 rescinds FASB Statement No. 4,which required all gains and losses from extinguishments of debt to beaggregated and, if material, classified as an extraordinary item, net of therelated income tax effect.  As a result,the criteria in Accounting Principles Board Opinion 30 will now be used toclassify those gains and losses.  Theprovisions of SFAS 145, as related to the rescission of FASB Statement No. 4,will be effective for fiscal 2003.  Weare currently evaluating the impact of this statement to determine whether weneed to reclassify a $6.2 million extraordinary item that we recorded inconnection with the Acquisition. However, this reclassification will not impact our reported net loss.

 

        In July 2002, the FASB issued SFAS No.146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS146”).  SFAS 146 sets forth variousmodifications to existing accounting guidance which prescribes the conditionswhich must be met in order for costs associated with contract terminations,facility consolidations, employee relocations and terminations to be accruedand recorded as liabilities in financial statements.  Accordingly, SFAS 146 may affect the timing of recognizing futurerestructuring costs as well as the amount recognized.  SFAS 146 also establishes that the liability should initially bemeasured and recorded at fair value. The provisions of SFAS 146 will be required to be applied prospectivelyto exit or disposal activities initiated after December 31, 2002.

 

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

        In the operation of our business, we have market riskexposures to global sourcing, raw material prices and interest rates.  Each of these risks and our strategies tomanage the exposure are discussed below.

 

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

 

        Additionally,we enter into various purchase order commitments with full packagesuppliers.  We can cancel thesearrangements, although in some instances, we may be subject to a terminationcharge reflecting a percentage of work performed prior to cancellation.  Historically, such cancellations and relatedtermination charges have not had a material impact on our business.

 

        Theprincipal raw materials we use are finished fabrics and trim materials.  Prices for these materials are affected bychanges in market demand and there can be no assurance that prices for theseand other raw materials will not increase in the near future.  Most of these materials are available frommore than one supplier, which enables us to negotiate pricing.

 

        Ouroperating results are subject to risk from interest rate fluctuations on debt,which carries variable interest rates.  At September 28, 2002, outstanding debtaggregated $297.9 million, of which $124.1 million bore interest at a variablerate.  An increase of 1% in theapplicable rate would increase our annual interest cost by $1,241,000 and couldhave an adverse effect on our net income and cash flow.  Pursuant to the provisions of oursenior credit facility, we purchased an interest rate cap as an economic hedgeagainst approximately $31.3 million of variable rate debt.  The cap rate is 7.0% and the arrangementexpires on December 7, 2004.

 

### **ITEM 4**.      DISCLOSURE CONTROLS AND PROCEDURES

 

        Based onan evaluation of our disclosure controls and procedures as of a date within 90days of the filing date of this quarterly report, our Chief Executive Officerand Chief Financial Officer have concluded that our disclosure controls andprocedures are effective in connection with our filing of this quarterly reporton Form 10-Q for the period ended September 28, 2002.

 

        Therewere no significant changes in our internal controls or in any other factorswhich could significantly affect those controls, subsequent to the date of ourmost recent evaluation of our internal controls, including any correctiveactions with regard to any significant deficiencies or material weakness.

 

25

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**PARTII—OTHER INFORMATION****:**

 

**ITEM 1.LEGAL PROCEEDINGS:**

 

            Fromtime to time, we have been involved in various legal proceedings.  We believe that all such litigation isroutine in nature and incidental to the conduct of our business, and we believethat no such litigation will have a material adverse effect on our financialcondition 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 OF SECURITY HOLDERS:**

 

None

 

**ITEM 5.OTHER INFORMATION:**

 

None

 

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

 

(a) Exhibits:    None

 

(b) Reports on Form 8-K

 

On August 23, 2002, wefiled a current report on Form 8-K with the Securities and Exchange Commission(“SEC”).  Under Item 5 of the report, weannounced that Holdings had filed a registration statement with the SEC toregister an initial public offering of up to $100.0 million of Holdings’ commonstock.

 

26

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**SIGNATURES**

 

        Pursuantto the requirements of the Securities and Exchange Act of 1934, the Registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
| THE WILLIAM  CARTER COMPANY    |
|--------------------------------|
|                           |   |   |
| Date:   November 12, 2002 | /s/ FREDERICK J.  ROWAN, II |   |
|                           |   |   |
|                           |   |   |
|                           | Frederick J.  Rowan, II |   |
|                           | *Chief Executive Officer* |   |
|                           |   |   |
| Date:   November 12, 2002 | /s/ MICHAEL D.  CASEY |   |
|                           |   |   |
|                           |   |   |
|                           | Michael D. Casey |   |
|                           | *Chief Financial Officer* |   |

#### * *

 

 

27

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**CERTIFICATION**

 

I, Frederick J.Rowan, II, certify that:

 

1. I have reviewedthis quarterly report on Form 10-Q of The William Carter Company;

 

2. Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3. Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for,the periods presented in this quarterly report;

 

4. Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5. Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or otheremployees who have a significant role in the registrant’s internal controls;and

 

6. Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date: November  12, 2002 |                        |   |
|--------------------------|-----------------------------|--------|
|                     | /s/ FREDERICK J.  ROWAN, II |   |
|                     |                        |   |
|                     |                        |   |
|                     | Frederick J.  Rowan, II     |   |
|                     | *Chief Executive Officer*   |   |

#### * *

 

28

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**CERTIFICATION**

 

I, Michael D.Casey, certify that:

 

1. I have reviewedthis quarterly report on Form 10-Q of The William Carter Company;

 

2. Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3. Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5. Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6. Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date: November  12, 2002 |                      |   |
|--------------------------|---------------------------|--------|
|                     | /s/ MICHAEL D.  CASEY     |   |
|                     |                      |   |
|                     |                      |   |
|                     | Michael D. Casey          |   |
|                     | *Chief Financial Officer* |   |

#### * *

 

 

29

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**CERTIFICATION**

 

*        Eachof the undersigned in the capacity indicated hereby certifies that, to hisknowledge, this Report on Form 10-Q for the quarter ended September 28, 2002fully complies with the requirements of Section 13(a) or 15(d) of theSecurities Exchange Act of 1934, and the information contained in this Reportfairly presents, in all material respects, the financial condition and resultsof operations of The William Carter Company.*

 

 

 

 

 
| Date:   November 12, 2002 | /s/ FREDERICK J.  ROWAN, II |   |
|--------------------------------|-----------------------------|--------|
|                           |                        |   |
|                           |                        |   |
|                           | Frederick J.  Rowan, II     |   |
|                           | *Chief  Executive Officer*  |   |
|                           |                        |   |
| Date:  November  12, 2002 | /s/ MICHAEL D.  CASEY       |   |
|                           |                        |   |
|                           |                        |   |
|                           | Michael D. Casey            |   |
|                           | *Chief Financial Officer*   |   |

 

 

 

30

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