form10q.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 SEPTEMBER 27, 2008 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of  “accelerated filer, large 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 (X)  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 30, 2008
Common stock, par value $0.01 per share
  
56,315,141

 
 
 

CARTER’S, INC.
INDEX

     
Page
 
       
 
 
  
   
   
   
   
   
 
 
 
       
 
       
 
 
 
 
 
 
 







 
2
 

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARTER’S, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except for share data)
(unaudited)
   
September 27,
2008
    
December 29,
2007
  
             
ASSETS
            
Current assets:
            
Cash and cash equivalents
   $ 59,660     $ 49,012  
Accounts receivable, net
     160,094       119,707  
Finished goods inventories, net
     214,359       225,494  
Prepaid expenses and other current assets
     12,667       9,093  
Assets held for sale
     3,500       6,109  
Deferred income taxes
      24,921       24,234  
                 
Total current assets
     475,201       433,649  
Property, plant, and equipment, net
     76,377       75,053  
Tradenames
     305,733       308,233  
Cost in excess of fair value of net assets acquired
     136,570       136,570  
Deferred debt issuance costs, net
     3,892       4,743  
Licensing agreements, net
     6,174       8,915  
Other assets
     8,310       7,505  
                 
       Total assets
   $ 1,012,257     $ 974,668  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
Current liabilities:
                
Current maturities of long-term debt
   $ 4,379     $ 3,503  
Accounts payable
     58,624       56,589  
Other current liabilities
     58,174       46,666  
                 
Total current liabilities
     121,177       106,758  
Long-term debt
     335,399       338,026  
Deferred income taxes
     112,873       113,706  
Other long-term liabilities
     32,134       34,049  
                 
Total liabilities
     601,583       592,539  
                 
Commitments and contingencies
                
Stockholders’ equity:
                
Preferred stock; par value $.01 per share; 100,000 shares authorized; none issued or outstanding at September 27, 2008 and
         December 29, 2007
     --       --  
Common stock, voting; par value $.01 per share; 150,000,000 shares authorized; 56,533,319 and 57,663,315 shares issued and
           outstanding at September 27, 2008 and December 29, 2007, respectively
     565       576  
Additional paid-in capital
     213,546       232,356  
Accumulated other comprehensive income
     2,324       2,671  
Retained earnings
     194,239       146,526  
                 
Total stockholders’ equity
     410,674       382,129  
                 
       Total liabilities and stockholders’ equity
   $ 1,012,257     $ 974,668  

See accompanying notes to the unaudited condensed consolidated financial statements

 
3
 


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
  
   
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Net sales                                                                         
   $ 436,419     $ 410,949     $ 1,068,066     $ 1,018,852  
Cost of goods sold                                                                         
     281,752       265,093       708,903       671,198  
                                 
Gross profit                                                                         
     154,667       145,856       359,163       347,654  
Selling, general, and administrative expenses
     104,536       94,241       289,019       267,122  
Intangible asset impairment (Note 4)                                                                         
     --       --       --       154,886  
Executive retirement charges (Note14)                                                                         
     --       --       5,325       --  
Facility write-down and closure costs (Note 11)
     2,609       256       2,609       5,233  
Royalty income                                                                         
     (9,576 )     (8,649 )     (24,693 )     (22,894 )
                                 
Operating income (loss)                                                                         
     57,098       60,008       86,903       (56,693 )
Interest expense, net                                                                         
     4,048       6,021       13,357       17,453  
                                 
Income (loss) before income taxes
     53,050       53,987       73,546       (74,146 )
Provision for income taxes                                                                         
     19,675       19,369       25,833       25,074  
                                 
Net income (loss)
   $ 33,375     $ 34,618     $ 47,713     $ (99,220 )
                                 
Basic net income (loss) per common share
   $ 0.60     $ 0.60     $ 0.85     $ (1.71 )
Diluted net income (loss) per common share
   $ 0.58     $ 0.58     $ 0.82     $ (1.71 )
Basic weighted-average number of shares outstanding
     56,015,725       57,745,717       56,462,515       58,010,633  
Diluted weighted-average number of shares outstanding
     57,963,941       59,975,130       58,490,406       58,010,633  

See accompanying notes to the unaudited condensed consolidated financial statements



 
4
 

CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
   
For the
nine-month periods ended
  
   
September 27,
2008
    
September 29,
2007
  
Cash flows from operating activities:
            
Net income (loss)                                                                                        
   $ 47,713     $ (99,220 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
                
Depreciation and amortization                                                                                       
     20,576       22,526  
Amortization of debt issuance costs                                                                                       
     851       872  
    Non-cash intangible asset impairment charges                                                                                         
     --       154,886  
Non-cash stock-based compensation expense                                                                                       
     6,756       4,653  
Income tax benefit from exercised stock options                                                                                       
     (3,457 )     (7,797 )
Loss on disposal of property, plant, and equipment                                                                                       
     383       620  
Deferred income taxes                                                                                       
     (1,399 )     (8,890 )
Non-cash facility write-down and closure costs (Note 11)
     2,609       2,450  
Effect of changes in operating assets and liabilities:
                
     Accounts receivable                                                                                    
     (40,387 )     (49,454 )
     Inventories                                                                                    
     11,135       (52,941 )
     Prepaid expenses and other assets                                                                                    
     (4,722 )     (5,302 )
     Accounts payable and other liabilities                                                                                    
     17,295       (1,020 )
                 
     Net cash provided by (used in) operating activities
     57,353       (38,617 )
                 
Cash flows from investing activities:
                
Capital expenditures                                                                                        
     (19,197 )     (13,228 )
Proceeds from sale of property, plant, and equipment                                                                                        
     --       53  
                 
     Net cash used in investing activities                                                                                
     (19,197 )     (13,175 )
                 
Cash flows from financing activities:
                
Payments on term loan                                                                                        
     (1,751 )     (2,627 )
Share repurchase (Note 8)                                                                                        
     (29,774 )     (47,406 )
Borrowings from revolving loan facility                                                                                        
     --       117,600  
Payments on revolving loan facility                                                                                        
     --       (96,000 )
Income tax benefit from exercised stock options                                                                                        
     3,457       7,797  
Proceeds from exercise of stock options                                                                                        
     560       2,576  
Other                                                                                        
     --       10,561  
                 
     Net cash used in financing activities                                                                                
     (27,508 )     (7,499 )
                 
Net increase (decrease) in cash and cash equivalents                                                                                         
     10,648       (59,291 )
Cash and cash equivalents, beginning of period                                                                                         
     49,012       68,545  
                 
Cash and cash equivalents, end of period                                                                                         
   $ 59,660     $ 9,254  

See accompanying notes to the unaudited condensed consolidated financial statements

 
5
 

CARTER’S, INC.
 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(dollars in thousands, except for share data)
(unaudited)

   
Common
stock
    
Additional
paid-in
capital
    
Accumulated
other comprehensive
income (loss)
    
Retained
earnings
    
Total
stockholders’
equity
  
                               
Balance at December 29, 2007                                                       
   $ 576     $ 232,356     $ 2,671     $ 146,526     $ 382,129  
Income tax benefit from exercised stock options
     --       3,457       --       --       3,457  
Exercise of stock options (579,445 shares)
     6       554       --       --       560  
Stock-based compensation expense
     --       6,306       --       --       6,306  
Issuance of common stock (43,386 shares)
     1       629       --       --       630  
Share repurchase (1,898,183 shares) (Note 8)
     (18 )     (29,756 )     --       --       (29,774 )
Comprehensive income (loss):
                                        
Net income                                                       
     --       --       --       47,713       47,713  
Unrealized loss on interest rate swap, net of tax benefit of $199
     --       --       (375 )     --       (375 )
Unrealized gain on interest rate collar, net of tax of $28
     --       --       28       --       28  
Total comprehensive (loss) income
     --       --       (347 )     47,713       47,366  
Balance at September 27, 2008                                                        
   $ 565     $ 213,546     $ 2,324     $ 194,239     $ 410,674  

See accompanying notes to the unaudited condensed consolidated financial statements

 
6
 

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 Year, OshKosh, and related brands.  Our products are sourced through contractual arrangements with manufacturers worldwide for wholesale distribution to major domestic retailers, including the mass channel, and to our Carter’s and 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 comprise the consolidated financial statements of Carter’s, Inc. and its 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 statement of our financial position as of September 27, 2008, the results of our operations for the three and nine-month periods ended September 27, 2008 and September 29, 2007, cash flows for the nine-month periods ended September 27, 2008 and September 29, 2007, and changes in stockholders’ equity for the nine-month period ended September 27, 2008.  Operating results for the three and nine-month periods ended September 27, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending January 3, 2009.  Our accompanying condensed consolidated balance sheet as of December 29, 2007 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 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 December 29, 2007.

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 2008 reflect our financial position as of September 27, 2008.  The third quarter and first nine months of fiscal 2007 ended on September 29, 2007.

Certain prior year amounts have been reclassified for comparative purposes.


 
7
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

NOTE 3 – COMPREHENSIVE INCOME (LOSS):

Comprehensive income (loss) is summarized as follows:

(dollars in thousands)
  
For the
three-month periods ended
    
For the
nine-month periods ended
  
   
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Net income (loss)                                                              
   $ 33,375     $ 34,618     $ 47,713     $ (99,220 )
Unrealized gain (loss) on interest rate swap, net of taxes of $110, $(584), $(199), and $(606)
     188       (1,018 )     (375 )     (1,058 )
Unrealized gain (loss) on interest rate collar, net of taxes of $203, $(117), $28, and $(84)
     345       (204 )     28       (146 )
Settlement of pension asset, net of tax benefit of $75
     --       --       --       (132 )
Total comprehensive income (loss)
   $ 33,908     $ 33,396     $ 47,366     $ (100,556 )


NOTE 4 – COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS:

Cost in excess of fair value of net assets acquired represents the excess of the cost of the acquisition of Carter’s, Inc. by Berkshire Partners LLC which was consummated on August 15, 2001 (the “2001 acquisition”) over the fair value of the net assets acquired.  Our cost in excess of fair value of net assets acquired is not deductible for tax purposes.

In connection with the 2001 acquisition, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” (“SFAS 141”), and applied the required provisions of SFAS No. 142, “Goodwill and other Intangible Assets” (“SFAS 142”).  Accordingly, our Carter’s tradename and cost in excess of fair value of net assets acquired have been concluded to have indefinite lives and are not being amortized.

In connection with the acquisition of OshKosh B’Gosh, Inc. on July 14, 2005 (the “Acquisition”), the Company recorded cost in excess of fair value of net assets acquired, tradename, licensing, and leasehold interest assets in accordance with SFAS 141.  During the second quarter of fiscal 2007, as a result of negative trends in sales and profitability of the Company’s OshKosh B’Gosh wholesale and retail segments and re-forecasted projections for such segments for the balance of fiscal 2007, the Company conducted an interim impairment assessment on the value of the intangible assets that the Company recorded in connection with the Acquisition.  This assessment was performed in accordance with SFAS 142.  Based on this assessment, impairment charges of approximately $36.0 million and $106.9 million were recorded to reflect the impairment of the cost in excess of fair value of net assets acquired for the OshKosh wholesale and retail segments, respectively.  In addition, an impairment charge of $12.0 million was recorded to reflect the impairment of the value ascribed to the OshKosh tradename asset.  For cost in excess of fair value of net assets acquired, the fair value was determined using the expected present value of future cash flows.  For the OshKosh tradename, the fair value was determined using a discounted cash flow analysis which examined the hypothetical cost savings that accrue as a result of our ownership of the tradename.

During the first nine months of fiscal 2008, approximately $1.5 million of tax contingencies recorded in connection with the Acquisition were reversed due to settlement with taxing authorities and closure of applicable statute of limitations.  This reversal resulted in a corresponding reduction to the OshKosh tradename asset of $2.5 million and a reduction in the related deferred tax liability of $1.0 million in accordance with Emerging Issues Task Force (“EITF”) Issue No. 93-7, “Uncertainties Related to Income Taxes in a Purchase Business Combination” (“EITF 93-7”).


 
8
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

NOTE 4 – COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS:  (Continued)

 
The Company’s intangible assets were as follows:

     
September 27, 2008
    
December 29, 2007
  
(dollars in thousands)
Weighted-average useful life
  
Gross amount
    
Accumulated amortization
    
Net amount
    
Gross amount
    
Accumulated amortization
    
Net amount
  
                                       
Carter’s cost in excess of fair value of net assets acquired
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     $ 88,000     $ --     $ 88,000  
OshKosh licensing agreements
4.7 years
   $ 19,100     $ 12,926     $ 6,174     $ 19,100     $ 10,185     $ 8,915  
Leasehold interests
4.1 years
   $ 1,833     $ 1,492     $ 341     $ 1,833     $ 1,149     $ 684  


Amortization expense for intangible assets was approximately $1.0 million and $3.1 million for the three and nine-month periods ended September 27, 2008 and $1.0 million and $3.4 million for the three and nine-month periods ended September 29, 2007.  Annual amortization expense for the OshKosh licensing agreements and leasehold interests is expected to be as follows:

(dollars in thousands)
      
Fiscal Year
  
Estimated
amortization
expense
  
       
2008 (period from September 28 through January 3, 2009)
   $ 1,021  
2009                                                                                 
     3,717  
2010                                                                                 
     1,777  
         
              Total                                                                                 
   $ 6,515  

NOTE 5 – INCOME TAXES:

The Company and its subsidiaries file income tax returns in the United States and in various states and local jurisdictions.  The Internal Revenue Service has recently completed an income tax examination for fiscal 2004 and 2005, and has recently begun its audit of fiscal 2006.  In most cases, the Company is no longer subject to state and local tax authority examinations for years prior to fiscal 2004.

During the first nine months of fiscal 2008, we recognized approximately $1.6 million in tax benefits due to the completion of the Internal Revenue Service audit for fiscal 2004 and 2005.  In addition, we recognized approximately $0.9 million of pre-Acquisition uncertainties previously reserved for upon completion of these audits.  These pre-Acquisition uncertainties have been reflected as a reduction in the OshKosh tradename asset in accordance with EITF 93-7.  We also recognized approximately $0.3 million in tax benefits due to various statute closures, primarily state and local jurisdictions during the third quarter of fiscal 2008 and approximately $0.6 million of pre-Acquisition uncertainties previously reserved for upon the closure of applicable statute of limitations.  These pre-Acquisition uncertainties have been reflected as a reduction in the OshKosh tradename asset in accordance with EITF 93-7.

 
9
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

NOTE 5 – INCOME TAXES: (Continued)

As of September 27, 2008, the Company had gross unrecognized tax benefits of approximately $7.0 million.  The Company’s reserve for unrecognized tax benefits as of September 27, 2008 includes approximately $5.4 million of reserves which, if ultimately recognized, will impact the Company’s effective tax rate in the period settled.  The reserve for unrecognized tax benefits also includes $1.2 million of reserves which, if ultimately recognized, would be reflected as an adjustment to the Carter’s cost in excess of fair value of net assets acquired or the OshKosh tradename asset and $0.4 million for 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 are approximately $0.6 million of reserves for which the statute of limitations is expected to expire in the third quarter of fiscal 2009.  Such exposures relate primarily to state and local income tax matters.  If these tax benefits are ultimately recognized, such recognition may impact our annual effective tax rate for fiscal 2009 and the 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 $0.5 million of interest accrued as of September 27, 2008.

NOTE 6 – FAIR VALUE MEASUREMENTS:

Effective December 30, 2007 (the first day of our 2008 fiscal year), the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), 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 under SFAS 157 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 at September 27, 2008, as required by SFAS 157:

(dollars in millions)
  
Level 1
    
Level 2
    
Level 3
  
                   
Assets
                  
Investments
   $ --     $ --     $ --  
                         
Liabilities
                        
Interest rate swap
   $ --     $ 0.9     $ --  
Interest rate collar
   $ --     $ 0.5     $ --  

Our senior credit facility requires us to hedge at least 25% of our variable rate debt under the term loan.  On September 22, 2005, we entered into an interest rate swap agreement to receive floating interest and pay fixed interest.  This interest rate swap agreement is designated as a cash flow hedge of the variable interest payments on a portion of our variable rate term loan debt.  The interest rate swap agreement matures on July 30, 2010.  As of September 27, 2008, approximately $59.4 million of our outstanding term loan debt was hedged under this agreement.

 
10
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

NOTE 6 – FAIR VALUE MEASUREMENTS: (Continued)

On May 25, 2006, we entered into an interest rate collar agreement with a floor of 4.3% and a ceiling of 5.5%.  The interest rate collar agreement covers $100 million of our variable rate term loan debt and is designated as a cash flow hedge of the variable interest payments on such debt.  The interest rate collar agreement matures on January 31, 2009.

Both our interest rate swap and collar 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.

NOTE 7 – 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 other liabilities are net of these expected employee contributions.  Additionally, we have an obligation under a defined benefit plan covering certain former officers and their spouses.  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 net periodic post-retirement benefit cost charged to operations are as follows:

   
For the
three-month periods ended
    
For the
nine-month periods ended
  
(dollars in thousands)
  
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Service cost – benefits attributed to service during the period
   $ 26     $ 26     $ 79     $ 78  
Interest cost on accumulated post-retirement benefit obligation
     132       131       395       391  
    Total net periodic post-retirement benefit cost
   $ 158     $ 157     $ 474     $ 469  

The components of net periodic pension benefit cost charged to operations are as follows:

   
For the
three-month periods ended
    
For the
nine-month periods ended
  
(dollars in thousands)
  
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Interest cost on accumulated pension benefit obligation
   $ 13     $ 13     $ 39     $ 43  
Actuarial gain
     --       (53 )     --       (53 )
Total net periodic pension benefit cost
   $ 13     $ (40 )   $ 39     $ (10 )



 
11
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 7 – EMPLOYEE BENEFIT PLANS:  (Continued)

The Company acquired two defined benefit pension plans in connection with the Acquisition.  The benefits for certain current and former employees of OshKosh under these pension plans were frozen as of December 31, 2005.  During the second quarter of fiscal 2007, the Company liquidated one of these plans, the OshKosh B’Gosh Collective Bargaining Pension Plan (the “Plan”), distributed each participant’s balance, and the remaining net assets of $2.2 million were contributed to the Company’s defined contribution plan to offset future employer contributions.  In connection with the liquidation of the Plan, the Company recorded a pre-tax gain of approximately $0.3 million related to the Plan settlement during the second quarter of fiscal 2007.

The Company’s net periodic pension benefit included in the statements of operations is comprised of:

   
For the
three-month periods ended
    
For the
nine-month periods ended
  
(dollars in thousands)
  
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Interest cost on accumulated pension benefit obligation
   $ 562     $ 551     $ 1,686     $ 1,654  
Expected return on assets
     (943 )     (897 )     (2,830 )     (3,213 )
Amortization of actuarial gain
     (19 )     (34 )     (57 )     (104 )
Gain on settlement
     --       --       --       (276 )
    Total net periodic pension benefit
   $ (400 )   $ (380 )   $ (1,201 )   $ (1,939 )

NOTE 8 – COMMON STOCK:

On February 16, 2007, the Company’s Board of Directors approved a stock repurchase program, pursuant to which the Company is authorized to purchase up to $100 million of its outstanding common shares.  Such repurchases may occur from time to time in the open market, in negotiated transactions, or otherwise.  This program has no time limit.  The timing and amount of any repurchases will be determined by the Company’s management, based on its evaluation of market conditions, share price, and other factors.

During the third quarter and first nine months of fiscal 2008, the Company repurchased and retired approximately $10 million and $30 million, or 578,098 and 1,898,183 shares, of its common stock at an average price of $16.81 and $15.69 per share, respectively.  During the third quarter and first nine months of fiscal 2007, the Company repurchased and retired approximately $7 million and $47 million, or 338,100 and 1,985,519 shares, of its common stock at an average price of $21.87 and $23.88 per share, respectively.  Since inception of the program and through the first nine months of fiscal 2008, the Company repurchased and retired approximately $87 million, or 4,371,402 shares, of its common stock at an average price of $19.96 per share.  Accordingly, we have reduced common stock by the par value of such shares and have deducted the remaining excess repurchase price over par value from additional paid-in capital.

During the first nine months of fiscal 2008, the Company issued 43,386 shares of common stock at a fair market value of $14.52 to its non-management board members.  Accordingly, we recognized $630,000 in stock-based compensation expense.  We received no proceeds from the issuance of these shares.

During the third quarter and first nine months of fiscal 2007, the Company issued 2,062 shares and 23,482 shares of common stock at a fair market value of $21.82 and $25.21 to its non-management board members and recognized $45,000 and $585,000 in stock-based compensation expense, respectively.  We received no proceeds from the issuance of these shares.


 
12
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 9 – STOCK-BASED COMPENSATION:

We account for stock-based compensation expense in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment.”  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 September 27, 2008.

   
Assumptions
  
       
Volatility
     34.16 %
Risk-free interest rate
     3.49 %
Expected term (years)
     5.62  
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 September 27, 2008:
   
Time-based
stock options
    
Performance-based
stock
options
    
Retained
stock options
    
Restricted
stock
  
                         
Outstanding, December 29, 2007
     4,315,689       620,000       661,870       372,283  
                                 
Granted
     532,250       --       --       152,606  
Exercised
     (31,089 )     --       (548,356 )     --  
Vested restricted stock
     --       --       --       (39,850 )
Forfeited
     (17,150 )     (400,000 )     --       (7,250 )
Expired
     (8,450 )     --       --       --  
                                 
Outstanding, September 27, 2008
     4,791,250       220,000       113,514       477,789  
                                 
Exercisable, September 27, 2008
     3,623,170       --       113,514       --  

As a result of the retirement of an executive officer during the second quarter of fiscal 2008, the Company recognized approximately $2.2 million of stock-based compensation expense as a result of the accelerated vesting of 400,000 performance-based stock options (see Note 14, “Executive Retirement Charges”).

During the three-month period ended September 27, 2008, we granted 495,000 time-based stock options with a weighted-average Black-Scholes fair value of $5.81 and a weighted-average exercise price of $15.23.  In connection with these grants, we recognized approximately $165,000 in stock-based compensation expense.

During the nine-month period ended September 27, 2008, we granted 532,250 time-based stock options with a weighted-average Black-Scholes fair value of $5.89 and a weighted-average exercise price of $15.35.  In connection with these grants, we recognized approximately $194,000 in stock-based compensation expense.

During the three-month period ended September 27, 2008, we granted 127,500 shares of restricted stock to employees with a weighted-average fair value on the date of grant of $16.59.  In connection with these grants, we recognized approximately $88,000 in stock-based compensation expense.


 
13
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 9 – STOCK-BASED COMPENSATION:  (Continued)

During the nine-month period ended September 27, 2008, we granted 152,606 shares of restricted stock to employees and a director with a weighted-average fair value on the date of grant of $16.59.  In connection with these grants, we recognized approximately $143,000 in stock-based compensation expense.

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

(dollars in thousands)
  
Time-based
stock
options
    
Restricted
stock
    
Total
  
                   
2008 (period from September 28 through January 3, 2009)
   $ 917     $ 751     $ 1,668  
2009
     2,665       2,464       5,129  
2010
     1,897       1,829       3,726  
2011
     1,276       1,298       2,574  
2012
     270       313       583  
       Total
   $ 7,025     $ 6,655     $ 13,680  

NOTE 10 – SEGMENT INFORMATION:

We report segment information in accordance with the provisions of SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information,” 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.


 
14
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 10 – SEGMENT INFORMATION:  (Continued)

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)    
  
September 27,
2008
    
% of
Total
    
September 29,
2007
    
% of
Total
    
September
27,
2008
    
% of
Total
    
September 29,
2007
    
% of
Total
  
                                                 
Net sales:
                                                
Wholesale-Carter’s
   $ 151,848       34.8 %   $ 149,918       36.4 %   $ 364,002       34.1 %   $ 355,865       34.9 %
Wholesale-OshKosh
     22,801       5.2 %     28,197       6.9 %     55,010       5.1 %     63,417       6.2 %
Retail-Carter’s
     112,508       25.8 %     102,429       24.9 %     291,566       27.3 %     253,530       24.9 %
Retail-OshKosh
     72,568       16.6 %     62,800       15.3 %     166,816       15.6 %     157,533       15.5 %
Mass Channel-Carter’s
     76,694       17.6 %     67,605       16.5 %     190,672       17.9 %     188,507       18.5 %
         Total net sales
   $ 436,419       100.0 %   $ 410,949       100.0 %   $ 1,068,066       100.0 %   $ 1,018,852       100.0 %
                                                                 
Operating income (loss):
          
% of
segment
net sales
            
% of
segment
net sales
            
% of
segment
net sales
            
% of
segment
net sales
  
Wholesale-Carter’s
   $ 29,520       19.4 %   $ 33,484       22.3 %   $ 63,086       17.3 %   $ 70,972       19.9 %
                                                                 
Wholesale-OshKosh
     1,546       6.8 %     2,624       9.3 %     (5,290 )     (9.6 )%     (1,010 )     (1.6 )%
                                                                 
OshKosh cost in excess of fair value of net assets acquired-impairment
     --       --       --       --       --       --       (35,995 )     (56.8 )%
                                                                 
Net Wholesale-OshKosh
     1,546       6.8 %     2,624       9.3 %     (5,290 )     (9.6 )%     (37,005 )     (58.4 )%
                                                                 
Retail-Carter’s
     20,367       18.1 %     19,599       19.1 %     42,167       14.5 %     33,235       13.1 %
                                                                 
Retail-OshKosh
     9,810       13.5 %     2,541       4.0 %     431       0.3 %     (478 )     (0.3 )%
                                                                 
OshKosh cost in excess of fair value of net assets acquired-impairment
     --       --       --       --       --       --       (106,891 )     (67.9 )%
                                                                 
Net Retail-OshKosh
     9,810       13.5 %     2,541       4.0 %     431       0.3 %     (107,369 )     (68.2 )%
                                                                 
Mass Channel-Carter’s
     10,055       13.1 %     12,898       19.1 %     24,576       12.9 %     30,043       15.9 %
                                                                 
Mass Channel-OshKosh (a)
     764       --       615       --       1,923       --       1,503       --  
                                                                 
Segment operating income (loss)
     72,062       16.5 %     71,761       17.5 %     126,893       11.9 %     (8,621 )     (0.8 )%
                                                                 
Other reconciling items
     (14,964 ) (b)     (3.4 )%     (11,753 )     (2.9 )%     (39,990 ) (b),(c)     (3.7 )%     (36,072 ) (d)     (3.5 )%
                                                                 
OshKosh tradename impairment
     --       --       --       --       --       --       (12,000 )     (1.2 )%
                                                                 
Net other reconciling items
     (14,964 )     (3.4 )%     (11,753 )     (2.9 )%     (39,990 )     (3.7 )%     (48,072 )     (4.7 )%
                                                                 
Total operating income (loss)
   $ 57,098       13.1 %   $ 60,008       14.6 %   $ 86,903       8.1 %   $ (56,693 )     (5.6 )%

(a
(a)
OshKosh mass channel consists of a licensing agreement with Target.  Operating income consists of royalty income, net of related expenses.
(b)
Includes $2.6 million related to the write-down of the carrying value of the OshKosh distribution center (see Note 11).
(c)
Includes $5.3 million in executive retirement charges in connection with Mr. Rowan’s retirement (see Note 14).
(d)
Includes $7.4 million in closure costs related to the closure of our OshKosh distribution center, including $2.1 million in accelerated depreciation (see Note 11).


 
 

 
15
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 11 – FACILITY CLOSURE AND RESTRUCTURING COSTS:

OshKosh Distribution Facility

The Company continually evaluates opportunities to reduce its supply chain complexity and lower costs.  In the first quarter of fiscal 2007, the Company determined that OshKosh brand products could be effectively distributed through its other distribution facilities and third-party logistics providers.  On February 15, 2007, the Company’s Board of Directors approved management’s plan to close the Company’s White House, Tennessee distribution facility, which was utilized to distribute the Company’s OshKosh brand products.

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” under a held and used model, it was determined that the distribution facility assets were impaired as of the end of January 2007, as it became “more likely than not” that the expected life of the OshKosh distribution facility would be significantly shortened.  Accordingly, we wrote down the assets to their estimated recoverable fair value as of the end of January 2007.  The adjusted asset values were subject to accelerated depreciation over their remaining estimated useful life.  Distribution operations at the OshKosh facility ceased as of April 5, 2007, at which point the land, building, and equipment assets of $6.1 million were reclassified as held for sale.  Over the past year, the Company has been actively trying to sell this facility for its appraised value.  However, due to recent declines in the commercial real estate market, the Company lowered the anticipated selling price of the facility during the third quarter of fiscal 2008 and has written down the carrying value of the facility by $2.6 million to reflect the new anticipated selling price.

During the first nine months of fiscal 2007, we recorded closure costs of $7.4 million, consisting of asset impairment charges of $2.4 million related to a write-down of the related land, building, and equipment, $2.0 million of severance charges, $2.1 million of accelerated depreciation (included in selling, general, and administrative expenses), and $0.9 million of other closure costs.

Acquisition Restructuring

In connection with the Acquisition, management developed a plan to restructure and integrate the operations of OshKosh.  In accordance with EITF No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” liabilities were established for OshKosh severance, lease termination costs associated with the closure of 30 OshKosh retail stores, contract termination costs, and other exit and facility closure costs.

The following table summarizes restructuring reserves related to the Acquisition which were included in other current liabilities on the accompanying unaudited condensed consolidated balance sheet:

(dollars in thousands)
  
Severance
and other
exit
costs
    
Lease
termination
costs
    
Total
  
                   
Balance at December 29, 2007
   $ 489     $ 674     $ 1,163  
Payments                                           
     (458 )     --       (458 )
Balance at March 29, 2008
     31       674       705  
Payments                                           
     (53 )     --       (53 )
Adjustments                                           
     42       (42 )     --  
Balance at June 28, 2008
     20       632       652  
Payments                                           
     (31 )     (632 )     (663 )
Adjustments                                           
     11       --       11  
Balance at September 27, 2008
   $ --     $ --     $ --  


 
16
 

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 12 – EARNINGS PER SHARE:

Basic net income (loss) per share is calculated by dividing net income (loss) for the period by the weighted-average common shares outstanding for the period.  Diluted net income (loss) 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.  The following table summarizes the shares from these potentially dilutive securities, calculated using the treasury stock method:


   
For the
three-month periods ended
    
For the
nine-month periods ended
  
(dollars in thousands, except per share data)
  
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Net income (loss)                                                     
   $ 33,375     $ 34,618     $ 47,713     $ (99,220 )
                                 
Weighted-average number of common and common equivalent shares outstanding:
                                
Basic number of common shares outstanding
     56,015,725       57,745,717       56,462,515       58,010,633  
Dilutive effect of unvested restricted stock
     84,593       60,190       84,119       --  
Dilutive effect of stock options
     1,863,623       2,169,223       1,943,772       --  
                                 
Diluted number of common and common equivalent shares outstanding
     57,963,941       59,975,130       58,490,406       58,010,633  
                                 
Basic net income (loss) per common share
   $ 0.60     $ 0.60     $ 0.85     $ (1.71 )
Diluted net income (loss) per common share
   $ 0.58     $ 0.58     $ 0.82     $ (1.71 )

For the three and nine-month periods ended September 27, 2008, anti-dilutive shares of 1,400,300 and 1,545,725, respectively, and performance-based stock options of 220,000, were excluded from the computations of diluted earnings per share.  For the three-month period ended September 29, 2007, anti-dilutive shares of 658,100 and performance-based stock options of 620,000 were excluded from the computations of diluted earnings per share.  For the nine-month period ended September 29, 2007, diluted net loss per common share is the same as basic net loss per common share, as the Company had a net loss.

17

CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

NOTE 13 – RECENT ACCOUNTING PRONOUNCEMENTS:

In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. FAS 157-2 (“FSP 157-2”), which delays the effective date of SFAS 157, "Fair Value Measurements," for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  Nonfinancial assets and nonfinancial liabilities would include all assets and liabilities other than those meeting the definition of a financial asset or financial liability as defined in paragraph 6 of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.”  This FSP defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of FSP 157-2.  We have evaluated the impact that FSP 157-2 will have on our consolidated financial statements and have determined that it will not have a material impact on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141, “Business Combinations.”  SFAS 141(R) retains the underlying concepts of SFAS 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but SFAS 141(R) changed the method of applying the acquisition method in a number of significant aspects.  Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.  SFAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008.  SFAS 141(R) amends SFAS No. 109, “Accounting for Income Taxes,” such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) would also apply the provisions of SFAS 141(R).  Early adoption is not permitted.  We have evaluated the impact that SFAS 141(R) will have on our consolidated financial statements and have determined that it will not have a material impact on our consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133,” which requires enhanced disclosures on the effect of derivatives on a Company’s financial statements.  These disclosures will be required for the Company beginning with the first quarter fiscal 2009 consolidated financial statements.

In April 2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”).  The FSP amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS 142, and adds certain disclosures for an entity’s accounting policy of the treatment of the costs, period of extension, and total costs incurred.  The FSP must be applied prospectively to intangible assets acquired after January 1, 2009.  We are currently evaluating the impact that FSP 142-3 will have on our consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”).  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles.  SFAS 162 is effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.”  This statement will not have an impact on the Company’s consolidated financial statements.
 
NOTE 14 – EXECUTIVE RETIREMENT CHARGES:

On June 11, 2008, the Company announced the retirement of an executive officer.  In connection with this retirement, the Company recorded charges during the second quarter of fiscal 2008 of $5.3 million, $3.1 million of which related to the present value of severance and benefit obligations, and $2.2 million of which related to the accelerated vesting of certain stock options.
 
18

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.  You should read this discussion in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes included elsewhere in this quarterly report.

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 2008 reflect our financial position as of September 27, 2008.  The third quarter and first nine months of fiscal 2007 ended on September 29, 2007.

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
  
   
September 27,
2008
    
September 29,
2007
    
September 27,
2008
    
September 29,
2007
  
                         
Wholesale - Carter’s
     34.8 %     36.4 %     34.1 %     34.9 %
Wholesale - OshKosh
     5.2       6.9       5.1       6.2  
Retail - Carter’s
     25.8       24.9       27.3       24.9  
Retail - OshKosh
     16.6       15.3       15.6       15.5  
Mass Channel - Carter's
     17.6       16.5       17.9       18.5  
                                 
Consolidated net sales
     100.0       100.0       100.0       100.0  
Cost of goods sold
     64.6       64.5       66.4       65.9  
                                 
Gross profit
     35.4       35.5       33.6       34.1  
Selling, general, and administrative expenses
     24.0       22.9       27.1       26.2  
Intangible asset impairment
     --       --       --       15.2  
Executive retirement charges
     --       --       0.5       --  
Facility write-down and closure costs
     0.5       0.1       0.2       0.5  
Royalty income
     (2.2 )     (2.1 )     (2.3 )     (2.2 )
                                 
Operating income (loss)
     13.1       14.6       8.1       (5.6 )
Interest expense, net
     0.9       1.5       1.2       1.7  
                                 
Income (loss) before income taxes
     12.2       13.1       6.9       (7.3 )
Provision for income taxes
     4.6       4.7       2.4       2.4  
                                 
Net income (loss)
     7.6 %     8.4 %     4.5 %     (9.7 )%
                                 
Number of retail stores at end of period:
                          
Carter’s
     234       222       234       222  
OshKosh
     163        162       163        162  
Total
     397        384       397        384  


 
19
 

ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Three and nine-month periods ended September 27, 2008 compared to the three and nine-month periods ended September 29, 2007

CONSOLIDATED NET SALES

In the third quarter of fiscal 2008, consolidated net sales increased $25.5 million, or 6.2%, to $436.4 million.  In the first nine months of fiscal 2008, consolidated net sales increased $49.2 million, or 4.8%, to $1.1 billion.  These increases reflect growth in all of our Carter’s brand segments and our OshKosh brand retail segment, partially offset by a decline in net sales in our OshKosh brand wholesale segment.

   
For the three-month periods ended
    
For the nine-month periods ended
  
(dollars in thousands)
  
September 27,
2008
    
% of
Total
    
September 29,
2007
    
% of
Total
    
September 27,
2008
    
% of
Total
    
September 29,
2007
    
% of
Total
  
                                                 
Net sales:
                                                
   Wholesale-Carter’s
   $ 151,848