Edgar Filing: CARTERS INC

form10_q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 2, 2010 OR

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____

Commission file number:

001-31829

CARTER’S, INC.

(Exact name of Registrant as specified in its charter)

Delaware	13-3912933
(state or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

The Proscenium

1170 Peachtree Street NE, Suite 900

Atlanta, Georgia 30309

(Address of principal executive offices, including zip code)

(404) 745-2700

(Registrant's telephone number, including area code)

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes (X) No ( )

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer, accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

Large Accelerated Filer (X) Accelerated Filer ( ) Non-Accelerated Filer ( ) Smaller Reporting Company ( )

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock		Outstanding Shares at October 29, 2010
Common stock, par value $0.01 per share		57,474,937

CARTER’S, INC.

INDEX

		Page
Part I. Financial Information

Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of October 2, 2010, January 2, 2010, and October 3, 2009		1

	Unaudited Condensed Consolidated Statements of Operations for the three and nine-month periods ended October 2, 2010 and October 3, 2009		2

	Unaudited Condensed Consolidated Statements of Cash Flows for the nine-month periods ended October 2, 2010 and October 3, 2009		3

	Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity for the nine-month period ended October 2, 2010		4

	Notes to the Unaudited Condensed Consolidated Financial Statements		5
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		31
Item 4.	Controls and Procedures		32

Part II. Other Information

Item 1.	Legal Proceedings		33
Item 1A.	Risk Factors		33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		39
Item 3.	Defaults upon Senior Securities		39
Item 4.	Removed and Reserved		39
Item 5.	Other Information		39
Item 6.	Exhibits		39
Signatures			40
Certifications			41

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARTER’S, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except for share data)

(unaudited)

	October 2, 2010			January 2, 2010			October 3, 2009

ASSETS
Current assets:
Cash and cash equivalents	$	182,329		$	335,041		$	214,339
Accounts receivable, net		171,501			82,094			127,879
Finished goods inventories, net		263,782			214,000			223,510
Prepaid expenses and other current assets		12,369			11,114			11,845
Deferred income taxes		25,701			33,419			32,005

Total current assets		655,682			675,668			609,578
Property, plant, and equipment, net		92,558			86,077			84,430
Tradenames		305,733			305,733			305,733
Goodwill		136,570			136,570			136,570
Deferred debt issuance costs, net		1,237			2,469			2,750
Licensing agreements, net		--			1,777			2,597
Other assets		305			305			405

Total assets	$	1,192,085		$	1,208,599		$	1,142,063

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	2,450		$	3,503		$	3,503
Accounts payable		94,440			97,546			68,009
Other current liabilities		62,502			69,568			69,808

Total current liabilities		159,392			170,617			141,320
Long-term debt		229,709			331,020			331,896
Deferred income taxes		109,855			110,676			106,646
Other long-term liabilities		45,626			40,262			43,628

Total liabilities		544,582			652,575			623,490

Commitments and contingencies
Stockholders’ equity:
Preferred stock; par value $.01 per share; 100,000 shares authorized; none issued or outstanding at October 2, 2010, January 2, 2010, and October 3, 2009		--			--			--
Common stock, voting; par value $.01 per share; 150,000,000 shares authorized; 57,696,317, 58,081,822, and 58,037,018 shares issued and outstanding at October 2, 2010, January 2, 2010, and October 3, 2009, respectively		577			581			580
Additional paid-in capital		214,547			235,330			233,565
Accumulated other comprehensive loss		(3,378	)		(4,066	)		(6,755	)
Retained earnings		435,757			324,179			291,183

Total stockholders’ equity		647,503			556,024			518,573

Total liabilities and stockholders’ equity	$	1,192,085		$	1,208,599		$	1,142,063

See accompanying notes to the unaudited condensed consolidated financial statements.

CARTER’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except per share data)

(unaudited)

	For the three-month periods ended						For the nine-month periods ended
	October 2, 2010			October 3, 2009			October 2, 2010			October 3, 2009

Net sales	$	517,928		$	481,506		$	1,253,986		$	1,164,997
Cost of goods sold		325,125			295,942			764,122			727,001

Gross profit		192,803			185,564			489,864			437,996
Selling, general, and administrative expenses		123,321			115,225			333,084			314,198
Workforce reduction and facility write-down and closure costs		--			--			--			11,400
Royalty income		(10,396	)		(10,637	)		(27,690	)		(26,871	)

Operating income		79,878			80,976			184,470			139,269
Interest expense, net		1,568			2,688			6,674			8,571

Income before income taxes		78,310			78,288			177,796			130,698
Provision for income taxes		28,653			28,882			66,218			48,054

Net income	$	49,657		$	49,406		$	111,578		$	82,644

Basic net income per common share (Note 13)	$	0.84		$	0.86		$	1.89		$	1.45
Diluted net income per common share (Note 13)	$	0.83		$	0.84		$	1.86		$	1.41

See accompanying notes to the unaudited condensed consolidated financial statements.

CARTER’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(unaudited)

	For the nine-month periods ended
	October 2, 2010			October 3, 2009
Cash flows from operating activities:
Net income	$	111,578		$	82,644
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		22,730			24,396
Amortization of debt issuance costs		1,232			848
Non-cash stock-based compensation expense		5,397			5,200
Income tax benefit from exercised stock options		(8,973	)		(11,374	)
Non-cash asset impairment and facility write-down charges		--			3,662
(Gain) loss on sale of property, plant, and equipment		(3	)		96
Deferred income taxes		6,974			1,310
Effect of changes in operating assets and liabilities:
Accounts receivable		(89,407	)		(42,427	)
Inventories		(49,782	)		(20,024	)
Prepaid expenses and other assets		(1,255	)		(1,876	)
Accounts payable and other liabilities		6,710			18,679

Net cash provided by operating activities		5,201			61,134

Cash flows from investing activities:
Capital expenditures		(29,483	)		(25,783	)
Proceeds from sale of property, plant, and equipment		286			2,805

Net cash used in investing activities		(29,197	)		(22,978	)

Cash flows from financing activities:
Payments on Term Loan (See Note 4)		(102,364	)		(2,627	)
Repurchases of common stock		(44,090	)		--
Income tax benefit from exercised stock options		8,973			11,374
Proceeds from exercised stock options		8,765			5,087

Net cash (used in) provided by financing activities		(128,716	)		13,834

Net (decrease) increase in cash and cash equivalents		(152,712	)		51,990
Cash and cash equivalents, beginning of period		335,041			162,349

Cash and cash equivalents, end of period	$	182,329		$	214,339

See accompanying notes to the unaudited condensed consolidated financial statements.

CARTER’S, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(dollars in thousands)

(unaudited)

	Common stock			Additional paid-in capital			Accumulated other comprehensive (loss) income			Retained earnings		Total stockholders’ equity

Balance at January 2, 2010	$	581		$	235,330		$	(4,066	)	$	324,179	$	556,024
Exercise of stock options (1,298,795 shares)		13			8,752			--			--		8,765
Income tax benefit from exercised stock options		--			8,973			--			--		8,973
Restricted stock activity		1			(1	)		--			--		--
Stock-based compensation expense		--			4,715			--			--		4,715
Issuance of common stock (26,147 shares)		--			850			--			--		850
Repurchases of common stock (1,837,450 shares)		(18	)		(44,072	)		--			--		(44,090	)
Comprehensive income:
Net income		--			--			--			111,578		111,578
Unrealized gain on interest rate swap agreements, net of tax of $379		--			--			688			--		688
Total comprehensive income		--			--			688			111,578		112,266
Balance at October 2, 2010	$	577		$	214,547		$	(3,378	)	$	435,757	$	647,503

See accompanying notes to the unaudited condensed consolidated financial statements.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1 – THE COMPANY:

Carter’s, Inc. and its wholly owned subsidiaries (collectively, the “Company,” “we,” “us,” “its,” and “our”) design, source, and market branded childrenswear under the Carter’s, Child of Mine, Just One You (formerly Just One Year), Precious Firsts, OshKosh, and related brand names. Our products are sourced through contractual arrangements with manufacturers worldwide for wholesale distribution to major domestic retailers, including the mass channel, and for our 297 Carter’s and 177 OshKosh retail stores that market our brand name merchandise and other licensed products manufactured by other companies.

NOTE 2 – BASIS OF PREPARATION:

The accompanying unaudited condensed consolidated financial statements include the accounts of Carter’s, Inc. and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

In our opinion, the Company’s accompanying unaudited condensed consolidated financial statements contain all adjustments necessary for a fair presentation of our financial position as of October 2, 2010 and October 3, 2009, the results of our operations for the three and nine-month periods ended October 2, 2010 and October 3, 2009, cash flows for the nine-month periods ended October 2, 2010 and October 3, 2009 and changes in stockholders’ equity for the nine-month period ended October 2, 2010. Operating results for the three and nine-month periods ended October 2, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending January 1, 2011. Our accompanying condensed consolidated balance sheet as of January 2, 2010 is from our audited consolidated financial statements included in our most recently filed Annual Report on Form 10-K, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”).

Certain information and footnote disclosure normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and the instructions to Form 10-Q. The accounting policies we follow are set forth in our most recently filed Annual Report on Form 10-K in the notes to our audited consolidated financial statements for the fiscal year ended January 2, 2010.

Our fiscal year ends on the Saturday, in December or January, nearest the last day of December. The accompanying unaudited condensed consolidated financial statements for the third quarter and first nine months of fiscal 2010 reflect our financial position as of October 2, 2010. The third quarter and first nine months of fiscal 2009 ended on October 3, 2009.

Certain prior year amounts have been reclassified to facilitate comparability with current year presentation.

NOTE 3 – COMPREHENSIVE INCOME:

Comprehensive income is summarized as follows:

	For the three-month periods ended				For the nine-month periods ended
(dollars in thousands)	October 2, 2010		October 3, 2009		October 2, 2010		October 3, 2009

Net income	$	49,657	$	49,406	$	111,578	$	82,644
Unrealized gain on interest rate swap agreements, net of tax of $107, $93, $379, and $91, respectively		225		159		688		156
Settlement of interest rate collar agreement, net of tax of $216		--		--		--		407
Total comprehensive income	$	49,882	$	49,565	$	112,266	$	83,207

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 4 – LONG TERM DEBT:

Long-term debt consisted of the following:

(dollars in thousands)	October 2, 2010			January 2, 2010			October 3, 2009
Term Loan	$	232,159		$	334,523		$	335,399
Current maturities		(2,450	)		(3,503	)		(3,503	)
Total long-term debt	$	229,709		$	331,020		$	331,896

The Company’s senior credit facility is comprised of a $232.2 million term loan (the “Term Loan”) and a $125 million revolving credit facility (the “Revolver”) (including a sub-limit for letters of credit of $80 million). The Revolver expires on July 14, 2011 and the Term Loan expires July 14, 2012. There were no borrowings outstanding under the Revolver, exclusive of approximately $8.6 million of outstanding letters of credit at October 2, 2010, January 2, 2010, and October 3, 2009, respectively. Principal borrowings under our Term Loan are due and payable in quarterly installments of $0.6 million through June 30, 2012 with the remaining balance of $227.9 million due on July 14, 2012.

Amounts borrowed under the Term Loan have an applicable rate of LIBOR + 1.50%, regardless of the Company’s overall leverage level. Interest is payable at the end of interest rate reset periods, which vary in length but in no case exceed 12 months for LIBOR rate loans and quarterly for prime rate loans. The effective interest rates on Term Loan borrowings as of October 2, 2010, January 2, 2010, and October 3, 2009 were 1.8%, 1.7%, and 1.8% respectively.

During the second quarter of fiscal 2010, the Company prepaid approximately $100 million in Term Loan borrowings, or approximately 30% of its outstanding debt, in addition to a regularly scheduled amortization payment of approximately $0.9 million. In addition, the Company expensed $0.5 million of debt issuance costs related to the prepayment of a portion of our Term Loan debt.

On October 15, 2010, the Company entered into a new revolving credit facility and paid off the Term Loan. See Note 15 for additional detail.

NOTE 5 –GOODWILL AND OTHER INTANGIBLE ASSETS:

Goodwill as of October 2, 2010 represents the excess of the cost of the acquisition of Carter’s, Inc. by Berkshire Partners LLC which was consummated on August 15, 2001 over the fair value of the net assets acquired. Our goodwill is not deductible for tax purposes. Our Carter’s goodwill and Carter’s and OshKosh tradenames are deemed to have indefinite lives and are not being amortized.

The Company’s intangible assets were as follows:

		October 2, 2010						January 2, 2010
(dollars in thousands)	Weighted-average useful life	Gross amount		Accumulated amortization		Net amount		Gross amount		Accumulated amortization		Net amount

Carter’s goodwill (1)	Indefinite	$	136,570	$	--	$	136,570	$	136,570	$	--	$	136,570
Carter’s tradename	Indefinite	$	220,233	$	--	$	220,233	$	220,233	$	--	$	220,233
OshKosh tradename	Indefinite	$	85,500	$	--	$	85,500	$	85,500	$	--	$	85,500
OshKosh licensing agreements	4.7 years	$	19,100	$	19,100	$	--	$	19,100	$	17,323	$	1,777

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 5 – GOODWILL AND OTHER INTANGIBLE ASSETS: (Continued)

		October 3, 2009
(dollars in thousands)	Weighted-average useful life	Gross amount		Accumulated amortization		Net amount

Carter’s goodwill (1)	Indefinite	$	136,570	$	--	$	136,570
Carter’s tradename	Indefinite	$	220,233	$	--	$	220,233
OshKosh tradename	Indefinite	$	85,500	$	--	$	85,500
OshKosh licensing agreements	4.7 years	$	19,100	$	16,503	$	2,597

(1) $51.8 million of which relates to Carter’s wholesale segment, $82.0 million of which relates to Carter’s retail segment, and

$2.7 million of which relates to Carter’s mass channel segment.

Amortization expense for intangible assets was approximately $0.2 million for the three-month period ended October 2, 2010 and $0.9 million for the three-month period ended October 3, 2009. Amortization expense for intangible assets was approximately $1.8 million and $2.9 million for the nine-month periods ended October 2, 2010 and October 3, 2009, respectively.

NOTE 6 – INCOME TAXES:

The Company and its subsidiaries file income tax returns in the United States and in various states and local jurisdictions. During fiscal 2009, the Internal Revenue Service completed an income tax audit for fiscal 2006 and 2007. In most cases, the Company is no longer subject to state and local tax authority examinations for years prior to fiscal 2006.

During the first nine months of fiscal 2010, we reversed approximately $0.5 million of reserves for which the statute of limitations expired in the third quarter of fiscal 2010. During the first nine months of fiscal 2009, we reversed approximately $1.4 million in tax benefits consisting of $1.0 million due to the completion of the Internal Revenue Service audit for fiscal 2006 and approximately $0.4 million due to various statute closures.

As of October 2, 2010, the Company had gross unrecognized tax benefits of approximately $8.3 million. Substantially all of the Company’s reserve for unrecognized tax benefits as of October 2, 2010, if ultimately recognized, will impact the Company’s effective tax rate in the period settled, net of applicable federal income tax affect. The Company has recorded tax positions for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductions. Because of deferred tax accounting, changes in the timing of these deductions would not impact the annual effective tax rate, but would accelerate the payment of cash to the taxing authorities.

Included in the reserves for unrecognized tax benefits as of October 2, 2010, are approximately $1.6 million of reserves for which the statute of limitations is expected to expire within the next fiscal year. If these tax benefits are ultimately recognized, such recognition may impact our annual effective tax rate for fiscal 2011 and the effective tax rate in the quarter in which the benefits are recognized.

We recognize interest related to unrecognized tax benefits as a component of interest expense and penalties related to unrecognized tax benefits as a component of income tax expense. The Company had approximately $0.6 million of interest accrued as of October 2, 2010 and January 2, 2010. As of October 3, 2009, the Company had approximately $0.5 million of interest accrued.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 7 – FAIR VALUE MEASUREMENTS:

The Company reports its fair value measurements in accordance with accounting guidance, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The fair value hierarchy for disclosure of fair value measurements is as follows:

Level 1	- Quoted prices in active markets for identical assets or liabilities

Level 2	- Quoted prices for similar assets and liabilities in active markets or inputs that are observable

Level 3	- Inputs that are unobservable (for example, cash flow modeling inputs based on assumptions)

The following table summarizes assets and liabilities measured at fair value on a recurring basis:

	October 2, 2010						January 2, 2010						October 3, 2009
(dollars in millions)	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3		Level 1		Level 2		Level 3

Assets
Investments	$	150.4	$	13.0	$	--	$	--	$	130.0	$	--	$	--	$	190.0	$	--
Interest rate swaps	$	--	$	--	$	--	$	--	$	--	$	--	$	--	$	0.1	$	--

Liabilities
Interest rate swaps	$	--	$	0.3	$	--	$	--	$	1.3	$	--	$	--	$	1.9	$	--

At October 2, 2010, we had approximately $110.4 million invested in money market deposit accounts, $40.0 million in U.S. Treasury Bills, and $13.0 million invested in a Black Rock Treasury fund, which invests only in U.S. Treasury Bills and U.S. Government securities.

At January 2, 2010, we had approximately $130.0 million of cash invested in two Dreyfus Cash Management Funds. These funds consisted of the Dreyfus Treasury Prime Cash Management fund ($87.9 million) which invests only in U.S. Treasury Bills or U.S. Treasury Notes and the Dreyfus Tax Exempt Cash Management fund ($42.1 million) which invests in short-term, high quality municipal obligations that provide income exempt from federal taxes.

At October 3, 2009, we had approximately $190.0 million invested in two Dreyfus Cash Management Funds and U.S. Treasury Bills, which are included in cash and cash equivalents on the accompanying unaudited condensed consolidated balance sheet. The funds consisted of the Dreyfus Treasury Prime Cash Management Fund ($87.9 million), which invests only in U.S. Treasury Bills or U.S. Treasury Notes, and the Dreyfus Tax Exempt Cash Management Fund ($42.1 million), which invests in short-term, high quality municipal obligations that provide income exempt from federal taxes. We also invested $60.0 million in U.S. Treasury Bills that mature in the fourth quarter of fiscal 2009.

Our senior credit facility requires us to hedge at least 25% of our variable rate debt under this facility. The Company enters into interest rate swap agreements in order to hedge the risk of interest rate fluctuations. These interest rate swap agreements are designated as cash flow hedges of the variable interest payments on a portion of our variable rate Term Loan debt. Our interest rate swap agreements are traded in the over-the-counter market. Fair values are based on quoted market prices for similar assets or liabilities or determined using inputs that use as their basis readily observable market data that are actively quoted and can be validated through external sources, including third-party pricing services, brokers, and market transactions. Our interest rate swap agreements are classified as current as their terms span less than one year.

As of October 2, 2010, approximately $100.0 million of our $232.2 million of outstanding debt was hedged under interest rate swap agreements. These interest rate swap agreements mature January 2011. On July 30, 2010, an interest rate swap agreement of $30.7 million matured. As of January 2, 2010, approximately $238.9 million of our $334.5 million of outstanding debt was hedged under interest rate swap agreements. As of October 3, 2009, approximately $243.0 million of our $335.4 million of outstanding debt was hedged under interest rate swap agreements. As of October 2, 2010, we continue to be in compliance with the 25% hedging requirement under our senior credit facility.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 7 – FAIR VALUE MEASUREMENTS: (Continued)

In fiscal 2006, the Company entered into an interest rate collar agreement which covered $100 million of our variable rate Term Loan debt and was designated as a cash flow hedge of the variable interest payments on such debt. The interest rate collar agreement matured on January 31, 2009.

The fair value of our derivative instruments in our accompanying unaudited condensed consolidated balance sheets were as follows:

	Asset Derivatives			Liability Derivatives

(dollars in millions)	Balance sheet location	Fair value		Balance sheet location	Fair value

October 2, 2010	Prepaid expenses and other current assets	$	--	Other current liabilities	$	0.3
January 2, 2010	Prepaid expenses and other current assets	$	--	Other current liabilities	$	1.3
October 3, 2009	Prepaid expenses and other current assets	$	0.1	Other current liabilities	$	1.9

The effect of derivative instruments designated as cash flow hedges on our accompanying unaudited condensed consolidated financial statements was as follows:

	For the three-month period ended October 2, 2010					For the nine-month period ended October 2, 2010
(dollars in thousands)	Amount of gain recognized in accumulated other comprehensive income (loss) on effective hedges (1)		Amount of loss reclassified from accumulated other comprehensive income (loss) into interest expense			Amount of gain recognized in accumulated other comprehensive income (loss) on effective hedges (1)		Amount of loss reclassified from accumulated other comprehensive income (loss) into interest expense

Interest rate hedge agreements	$	225	$	(291	)	$	688	$	(1,440	)

(1) Amount recognized in accumulated other comprehensive income (loss), net of tax of $107,000 and $379,000 for the three and nine-month periods ended October 2, 2010, respectively.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 7 – FAIR VALUE MEASUREMENTS: (Continued)

	For the three-month period ended October 3, 2009					For the nine-month period ended October 3, 2009
(dollars in thousands)	Amount of gain recognized in accumulated other comprehensive income (loss) on effective hedges (1)		Amount of loss reclassified from accumulated other comprehensive income (loss) into interest expense			Amount of gain recognized in accumulated other comprehensive income (loss) on effective hedges (1)		Amount of loss reclassified from accumulated other comprehensive income (loss) into interest expense

Interest rate hedge agreements	$	159	$	(720	)	$	156	$	(2,134	)

(1) Amount recognized in accumulated other comprehensive income (loss), net of tax of $93,000 and $91,000 for the three and nine-month periods ended October 3, 2009, respectively.

NOTE 8 – EMPLOYEE BENEFIT PLANS:

Under a defined benefit plan frozen in 1991, we offer a comprehensive post-retirement medical plan to current and certain future retirees and their spouses until they become eligible for Medicare or a Medicare Supplement Plan. We also offer life insurance to current and certain future retirees. Employee contributions are required as a condition of participation for both medical benefits and life insurance and our liabilities are net of these expected employee contributions. See Note 7 “Employee Benefit Plans” to our audited consolidated financial statements in our most recently filed Annual Report on Form 10-K for further information.

The components of post-retirement benefit expense charged to operations are as follows:

	For the three-month periods ended						For the nine-month periods ended
(dollars in thousands)	October 2, 2010			October 3, 2009			October 2, 2010			October 3, 2009

Service cost – benefits attributed to service during the period	$	23		$	23		$	69		$	69
Interest cost on accumulated post-retirement benefit obligation		133			113			399			339
Amortization net actuarial gain		(7	)		(7	)		(21	)		(21	)
Total net periodic post-retirement benefit cost	$	149		$	129		$	447		$	387

We have an obligation under a defined benefit plan covering certain former officers and their spouses. The component of pension expense charged to operations is as follows:

	For the three-month periods ended				For the nine-month periods ended
(dollars in thousands)	October 2, 2010		October 3, 2009		October 2, 2010		October 3, 2009

Interest cost on accumulated pension benefit obligation	$	12	$	12	$	36	$	38

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 8 – EMPLOYEE BENEFIT PLANS: (Continued)

Under a defined benefit pension plan frozen as of December 31, 2005, certain current and former employees of OshKosh are eligible to receive benefits. The net periodic pension (benefit) expense associated with this pension plan and included in the statement of operations was comprised of:

	For the three-month periods ended						For the nine-month periods ended
(dollars in thousands)	October 2, 2010			October 3, 2009			October 2, 2010			October 3, 2009

Interest cost on accumulated pension benefit obligation	$	598		$	567		$	1,794		$	1,702
Expected return on assets		(718	)		(651	)		(2,156	)		(1,951	)
Amortization of actuarial loss		34			103			101			308
Total net periodic pension (benefit) expense	$	(86	)	$	19		$	(261	)	$	59

NOTE 9 – COMMON STOCK:

During the first nine months of fiscal 2010, the Company issued 24,032 and 2,115 shares of common stock at a fair market value of $33.29 and $23.65 per share, respectively, to its non-management board members. In connection with these issuances, we recognized approximately $850,000 in stock-based compensation expense. During the first nine months of fiscal 2009, the Company issued 33,656 shares of common stock at a fair market value of $20.80 per share to its non-management board members. In connection with this issuance, we recognized approximately $700,000 in stock-based compensation expense. We received no proceeds from the issuance of these shares.

On February 16, 2007, the Company’s Board of Directors approved a share repurchase authorization, pursuant to which the Company is authorized to purchase up to $100 million of its outstanding common shares. The Company did not repurchase any shares of its common stock during the three or nine-month periods ended October 3, 2009 pursuant to the Company’s share repurchase authorization. As of January 2, 2010, approximately $8.9 million was still remaining under the February 16, 2007 authorization.

On June 15, 2010, the Company’s Board of Directors approved a share repurchase authorization, pursuant to which the Company is authorized to purchase up to an additional $100 million of its outstanding common shares.

Neither of the current share repurchase authorizations have expiration dates. Purchases may be made in the open market or in privately negotiated transactions, with the level and timing of activity being at the discretion of the Company’s management depending on market conditions, stock price, other investment priorities, and other factors.

During the first nine months of fiscal 2010, beginning in the third quarter, the Company repurchased and retired 1,837,450 shares of its common stock at an average price of $24.00 per share, leaving approximately $64.8 million available for repurchase under these authorizations as of October 2, 2010. We have reduced common stock by the par value of such shares repurchased and have deducted the remaining excess repurchase price over par value from additional paid-in capital.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 10 – STOCK-BASED COMPENSATION:

Under the Company’s Amended and Restated 2003 Equity Incentive Plan, the compensation committee of our Board of Directors may award incentive stock options (ISOs and non-ISOs), stock appreciation rights (SARs), restricted stock, unrestricted stock, stock deliverable on a deferred basis, performance-based stock awards, and cash payments intended to help defray the cost of awards. The fair value of time-based or performance-based stock option grants are estimated on the date of grant using the Black-Scholes option pricing method with the following weighted-average assumptions used for grants issued during the nine-month period ended October 2, 2010.

	Assumptions

Volatility		34.58	%
Risk-free interest rate		3.03	%
Expected term (years)		7
Dividend yield		--

The fair value of restricted stock is determined based on the quoted closing price of our common stock on the date of grant.

The following table summarizes our stock option and restricted stock activity during the nine-month period ended October 2, 2010:

	Time-based stock options			Restricted stock

Outstanding, January 2, 2010		3,512,385			449,844

Granted		414,500			190,733
Exercised		(1,298,795	)		--
Vested restricted stock		--			(95,189	)
Forfeited		(105,600	)		(39,400	)
Expired		(17,800	)		--

Outstanding, October 2, 2010		2,504,690			505,988

Exercisable, October 2, 2010		1,528,265			--

During the three-month period ended October 2, 2010, we granted 20,000 time-based stock options with a weighted-average Black-Scholes fair value of $9.14 per share and a weighted-average exercise price of $23.12 per share. In connection with this grant, we recognized approximately $6,000 in stock-based compensation expense during the three-month period ended October 2, 2010.

During the nine-month period ended October 2, 2010, we granted 414,500 time-based stock options with a weighted-average Black-Scholes fair value of $11.80 per share and a weighted-average exercise price of $27.92 per share. In connection with these grants, we recognized approximately $680,000 in stock-based compensation expense during the nine-month period ended October 2, 2010.

During the three-month period ended October 2, 2010, we granted 14,229 shares of restricted stock to employees and a director with a weighted-average fair value on the date of grant of $23.28 per share. In connection with these grants, we recognized approximately $12,000 in stock-based compensation expense during the three-month period ended October 2, 2010.

During the nine-month period ended October 2, 2010, we granted 190,733 shares of restricted stock to employees and directors with a weighted-average fair value on the date of grant of $27.89 per share. In connection with these grants, we recognized approximately $730,000 in stock-based compensation expense during the nine-month period ended October 2, 2010.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 10 – STOCK-BASED COMPENSATION: (Continued)

Unrecognized stock-based compensation expense related to outstanding unvested stock options and unvested restricted stock awards is expected to be recorded as follows:

(dollars in thousands)	Time-based stock options		Restricted Stock		Total

2010 (period from October 3 through January 1, 2011)	$	752	$	865	$	1,617
2011		2,722		3,133		5,855
2012		2,113		2,424		4,537
2013		1,283		1,403		2,686
Total	$	6,870	$	7,825	$	14,695

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 11 – SEGMENT INFORMATION:

We report segment information in accordance with accounting guidance on segment reporting, which requires segment information to be disclosed based upon a “management approach.” The management approach refers to the internal reporting that is used by management for making operating decisions and assessing the performance of our reportable segments. We report our corporate expenses, workforce reduction, and facility write-down and closure costs separately as they are not included in the internal measures of segment operating performance used by the Company in order to measure the underlying performance of our reportable segments.

The table below presents certain segment information for the periods indicated:

	For the three-month periods ended												For the nine-month periods ended
(dollars in thousands)	October 2, 2010			% of Total			October 3, 2009			% of Total			October 2, 2010			% of Total			October 3, 2009			% of Total
Net sales:

Carter’s:
Wholesale	$	186,396			36.0	%	$	165,672			34.4	%	$	443,902			35.4	%	$	395,550			34.0	%
Retail (a)		150,838			29.1	%		137,708			28.6	%		382,570			30.5	%		349,765			30.0	%
Mass Channel		75,050			14.5	%		78,584			16.3	%		181,808			14.5	%		181,690			15.6	%
Carter’s total net sales		412,284			79.6	%		381,964			79.3	%		1,008,280			80.4	%		927,005			79.6	%

OshKosh:
Retail (a)		77,946			15.0	%		74,103			15.4	%		185,050			14.8	%		178,091			15.3	%
Wholesale		27,698			5.4	%		25,439			5.3	%		60,656			4.8	%		59,901			5.1	%
OshKosh total net sales		105,644			20.4	%		99,542			20.7	%		245,706			19.6	%		237,992			20.4	%

Total net sales	$	517,928			100.0	%	$	481,506			100.0	%	$	1,253,986			100.0	%	$	1,164,997			100.0	%

Operating income (loss):				% of segment net sales						% of segment net sales						% of segment net sales						% of segment net sales

Carter’s:
Wholesale	$	39,843			21.4	%	$	37,698			22.8	%	$	103,482			23.3	%	$	81,122			20.5	%
Retail (a)		31,579			20.9	%		31,381			22.8	%		76,405			20.0	%		64,544			18.5	%
Mass Channel		8,356			11.1	%		13,738			17.5	%		28,006			15.4	%		30,557			16.8	%

Carter’s operating income		79,778			19.4	%		82,817			21.7	%		207,893			20.6	%		176,223			19.0	%

OshKosh:
Retail (a)		9,420			12.1	%		10,765			14.5	%		10,475			5.7	%		11,220			6.3	%
Wholesale		4,955			17.9	%		4,124			16.2	%		6,185			10.2	%		3,607			6.0	%
Mass Channel (b)		764			--			709			--			2,003			--			1,853			--

OshKosh operating income		15,139			14.3	%		15,598			15.7	%		18,663			7.6	%		16,680			7.0	%

Segment operating income		94,917			18.3	%		98,415			20.4	%		226,556			18.1	%		192,903			16.6	%

Corporate expense (c)		(15,039	)		(2.9	%)		(17,439	)		(3.6	%)		(42,086	)		(3.4	%)		(41,269	)		(3.5	%)
Workforce reduction and facility write-down and closure costs (d)		--			--			--			--			--			--			(12,365	)		(1.1	%)

Net corporate expenses		(15,039	)		(2.9	%)		(17,439	)		(3.6	%)		(42,086	)		(3.4	%)		(53,634	)		(4.6	%)

Total operating income	$	79,878			15.4	%	$	80,976			16.8	%	$	184,470			14.7	%	$	139,269			12.0	%

(a)	Includes eCommerce results.

(b)	OshKosh mass channel consists of a licensing agreement with Target Stores. Operating income consists of royalty income, net of related expenses.

(c)	Corporate expenses generally include expenses related to incentive compensation, stock-based compensation, executive management, severance and relocation, finance, building occupancy, information technology, certain legal fees, consulting, and audit fees.

(d)	Includes closure costs associated with our Barnesville, Georgia distribution facility and our Oshkosh, Wisconsin facility, write-down of the White House, Tennessee facility, and severance and other benefits related to the corporate workforce reduction.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 12 – WORKFORCE REDUCTION AND FACILITY CLOSURE COSTS:

Corporate Workforce Reduction

On April 21, 2009, the Company announced to affected employees a plan to reduce its corporate workforce (defined as excluding retail district managers, hourly retail store employees, and distribution center employees). Approximately 150 employees were affected under the plan. The plan included consolidating the majority of our operations performed in our Oshkosh, Wisconsin office into other Company locations. This consolidation has resulted in the addition of resources in our other locations.

As a result of this corporate workforce reduction, during the first nine months of fiscal 2009, we recorded charges of $7.3 million consisting of $5.5 million in severance charges and other benefits, and approximately $1.8 million in asset impairment charges related to the closure of our Oshkosh, Wisconsin office. The majority of the remaining severance payments will be paid by the end of fiscal 2010.

The following table summarizes restructuring reserves related to the corporate workforce reduction which are included in other current liabilities on the accompanying unaudited condensed consolidated balance sheet:

(dollars in thousands)	Severance and other one-time benefits

Balance at April 4, 2009	$	3,300
Provision		2,200
Payments		(900	)
Balance at July 4, 2009		4,600
Provision		--
Payments		(1,300	)
Balance at October 3, 2009		3,300
Provision		--
Payments		(800	)
Balance at January 2, 2010		2,500
Provision		--
Payments		(1,000	)
Balance at April 3, 2010		1,500
Provision		--
Payments		(600	)
Balance at July 3, 2010		900
Provision		--
Adjustment		(300	)
Payments		(300	)
Balance at October 2, 2010	$	300

Barnesville Distribution Facility Closure

On April 2, 2009, the Company announced to affected employees a plan to close its Barnesville, Georgia distribution center. Approximately 210 employees were affected by this closure. Operations at the Barnesville facility ceased on June 1, 2009.

In accordance with accounting guidance on accounting for the impairment or disposal of long-lived assets, under a held and used model, it was determined that the distribution facility assets became impaired during March 2009, when it became “more likely than not” that the expected life of the Barnesville, Georgia distribution facility would be significantly shortened. Accordingly, we wrote down the assets to their estimated recoverable fair value in March 2009. The adjusted asset values were subject to accelerated depreciation over their remaining estimated useful life.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 12 – WORKFORCE REDUCTION AND FACILITY CLOSURE COSTS: (Continued)

In conjunction with the plan to close the Barnesville, Georgia distribution center, the Company recorded approximately $4.3 million during the first nine months of fiscal 2009, consisting of severance of $1.7 million, asset impairment charges of $1.1 million related to the write-down of the related land, building, and equipment, $1.0 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.5 million of other closure costs.

The following table summarizes restructuring reserves related to the closure of the Barnesville, Georgia distribution center which are included in other current liabilities on the accompanying unaudited condensed consolidated balance sheet:

(dollars in thousands)	Severance			Other closure costs			Total

Balance at April 4, 2009	$	1,700		$	500		$	2,200
Provision		--			--			--
Payments		(700	)		--			(700	)
Balance at July 4, 2009		1,000			500			1,500
Provision		--			--			--
Payments		(500	)		--			(500	)
Adjustments		(400	)		--			(400	)
Balance at October 3, 2009		100			500			600
Provision		--			--			--
Payments		(50	)		--			(50	)
Balance at January 2, 2010		50			500			550
Provision		--			--			--
Payments		--			--			--
Balance at April 3, 2010		50			500			550
Provision		--			--			--
Payments		--			(50	)		(50	)
Balance at July 3, 2010		50			450			500
Provision		--			--			--
Adjustment		(50	)		--			(50	)
Payments		--			--			--
Balance at October 2, 2010	$	--		$	450		$	450

White House Distribution Facility

During the first nine months of fiscal 2009, the Company wrote down the carrying value of its White House, Tennessee distribution facility by approximately $0.7 million to $2.8 million to reflect the decrease in the fair market value of the facility at that time. During the third quarter of fiscal 2009, the Company sold the facility for net proceeds of approximately $2.8 million.

NOTE 13 – EARNINGS PER SHARE:

The Company calculates basic and diluted net income per common share in accordance with accounting guidance which requires earnings per share to be calculated pursuant to the two-class method for unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid).

Basic net income per share is calculated by dividing net income for the period by the weighted-average common shares outstanding for the period. Diluted net income per share includes the effect of dilutive instruments, such as stock options and restricted stock, and uses the average share price for the period in determining the number of shares that are to be added to the weighted-average number of shares outstanding.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 13 – EARNINGS PER SHARE: (Continued)

The following is a reconciliation of basic common shares outstanding to diluted common and common equivalent shares outstanding:

	For the three-month periods ended						For the nine-month periods ended
	October 2, 2010			October 3, 2009			October 2, 2010			October 3, 2009

Weighted-average number of common and common equivalent shares outstanding:
Basic number of common shares outstanding		58,325,162			56,825,229			58,513,228			56,334,860
Dilutive effect of unvested restricted stock		89,931			112,370			111,110			116,483
Dilutive effect of stock options		599,598			1,622,531			781,849			1,684,897
Diluted number of common and common equivalent shares outstanding		59,014,691			58,560,130			59,406,187			58,136,240

Basic net income per common share:
Net income	$	49,657,000		$	49,406,000		$	111,578,000		$	82,644,000
Income allocated to participating securities		(427,084	)		(411,426	)		(956,589	)		(694,154	)
Net income available to common shareholders	$	49,229,916		$	48,994,574		$	110,621,411		$	81,949,846

Basic net income per common share	$	0.84		$	0.86		$	1.89		$	1.45

Diluted net income per common share:
Net income	$	49,657,000		$	49,406,000		$	111,578,000		$	82,644,000
Income allocated to participating securities		(422,775	)		(400,097	)		(944,082	)		(674,160	)
Net income available to common shareholders	$	49,234,225		$	49,005,903		$	110,633,918		$	81,969,840

Diluted net income per common share	$	0.83		$	0.84		$	1.86		$	1.41

For the three and nine-month periods ended October 2, 2010, anti-dilutive shares of 673,804 and 601,404, respectively, were excluded from the computations of diluted earnings per share. For the three and nine-month periods ended October 3, 2009, anti-dilutive shares of 474,800 and 1,292,900, respectively, and performance-based stock options of 200,000, were excluded from the computations of diluted earnings per share.

NOTE 14 – RECENT ACCOUNTING PRONOUNCEMENTS:

In January 2010, the Financial Accounting Standards Board issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance became effective for the Company with the reporting period beginning January 3, 2010, except for the disclosure on the roll forward activities for Level 3 fair value measurements, which will become effective for the Company with the reporting period beginning January 1, 2011. Other than requiring additional disclosures, adoption of this new guidance will not have a material impact on the Company’s unaudited condensed consolidated financial statements.

In February 2010, new accounting guidance was issued related to subsequent events. This guidance amended guidance previously issued in May 2009 regarding subsequent events and states that an entity that is a SEC filer is no longer required to disclose the date through which subsequent events have been evaluated. The adoption of this guidance did not have a material impact on the Company’s unaudited condensed consolidated financial statements.

CARTER’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 15 – SUBSEQUENT EVENTS:

On October 15, 2010, the Company entered into a new five year $375 million ($130 million sub-limit for letters of credit and a swing line sub-limit of $40 million) revolving credit facility with Bank of America, N.A., as sole lead arranger and administrative agent, JP Morgan Chase, and certain other financial institutions. The new revolving credit facility was immediately drawn upon to pay off the Company’s existing Term Loan of $232.2 million and pay transaction fees and expenses of $3.8 million, leaving approximately $130 million available under the revolver for future borrowings (net of letters of credit of approximately $8.6 million). In connection with the repayment of the Term Loan, in the fourth quarter of fiscal 2010, the Company expects to write off approximately $1.2 million in unamortized debt issuance costs.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:

The following is a discussion of our results of operations and current financial position. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes included elsewhere in this quarterly report.

RESULTS OF OPERATIONS

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

	Three-month periods ended						Nine-month periods ended
	October 2, 2010			October 3, 2009			October 2, 2010			October 3, 2009

Wholesale sales:
Carter’s		36.0	%		34.4	%		35.4	%		34.0	%
OshKosh