CARTERS INC (CRI) FY 2022 MD&A

ITEM 7. 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 condition. You should read this discussion in conjunction with our consolidated historical financial statements and notes included elsewhere in this Annual Report on Form 10-K. Our discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products, and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K. Those risk factors expressly qualify all subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf. Except for any ongoing obligations to disclose material information as required by federal securities laws, we do not have any intention or obligation to update forward-looking statements after we file this Annual Report on Form 10-K.

For a comparison of our results for fiscal year 2020 to our results for fiscal year 2019 and other financial information related to fiscal year 2019, refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2020 Annual Report on Form 10-K, filed with the SEC on February 26, 2021.

Fiscal Years

Our fiscal year ends on the Saturday in December or January nearest December 31. Every five or six years, our fiscal year includes an additional 53rd week of results. Fiscal 2021, which ended on January 1, 2022, contained 52 weeks. Fiscal 2020, which ended on January 2, 2021, contained 53 weeks. Fiscal 2019, which ended on December 28, 2019, contained 52 weeks.

The 53rd week in fiscal 2020 contributed approximately $32.1 million of incremental consolidated revenue. Certain expenses increased in relationship to the additional revenue from the 53rd week, while other expenses, such as fixed costs and expenses incurred on a calendar-month basis, did not increase. Consolidated gross margin for revenue in the 53rd week was slightly lower than consolidated gross margin for fiscal 2020 due to increased promotional activity during the 53rd week.

Our Business

We are the largest branded marketer in North America of apparel exclusively for babies and young children. We own two of the most highly recognized and most trusted brand names in the children’s apparel industry, Carter’s and OshKosh B’gosh (or “OshKosh”). Our brand portfolio also includes Skip Hop, a leading baby and young child lifestyle brand, exclusive Carter’s brands developed for specific wholesale customers, and little planet, a brand focused on organic fabrics and sustainable materials.

Established in 1865, our Carter’s brand is recognized and trusted by consumers for high-quality apparel and accessories for children in sizes newborn to 14.

Established in 1895, OshKosh is a well-known brand, trusted by consumers for high-quality apparel and accessories for children in sizes newborn to 14, with a focus on playclothes for toddlers and young children. We acquired OshKosh in 2005.

Established in 2003, the Skip Hop brand re-thinks, re-energizes, and re-imagines durable necessities to create higher value, superior quality, and top-performing products for parents, babies, and toddlers. We acquired Skip Hop in 2017.

Additionally, Child of Mine, an exclusive Carter’s brand, is sold at Walmart; Just One You, an exclusive Carter’s brand, is sold at Target, and Simple Joys, an exclusive Carter’s brand, is available on Amazon.

Launched in 2021, the little planet brand focuses on sustainable clothing through the sourcing of mostly organic cotton as certified under the Global Organic Textile Standard. This brand includes a wide assortment of baby apparel and accessories, sleepwear, and gift bundles.

Our mission is to serve the needs of all families with young children, with a vision to be the world’s favorite brands in young children’s apparel and related products. We believe our brands provide a complementary product offering and aesthetic, are each uniquely positioned in the marketplace, and offer strong value to families with young children. The baby and young children’s apparel market ages zero to 10 in the U.S. is approximately $31 billion. In this market, our Carter’s brands, including our exclusive brands, hold the #1 position with approximately 10% market share and our OshKosh brand has approximately 1% market share as of December 2021.

Our multi-channel, global business model, which includes retail stores, eCommerce, and wholesale sales channels, as well as omni-channel capabilities in the United States and Canada, enables us to reach a broad range of consumers around the world. At

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the end of fiscal 2021, our channels included 980 retail stores, approximately 18,800 wholesale locations, and eCommerce websites in North America, as well as our international wholesale accounts and licensees who operate in over 90 countries.

We have extensive experience in the young children’s apparel and accessories market and focus on delivering products that satisfy our consumers’ needs. Our long-term growth strategy focuses on:

•providing the best value and experience in apparel and related products for young children;

•extending the reach of our brands; and

•improving profitability.

Segments

Our three business segments are: U.S. Retail, U.S. Wholesale, and International. These segments are our operating and reporting segments. Our U.S. Retail segment consists of revenue primarily from sales of products in the United States through our retail stores and eCommerce websites. Similarly, our U.S. Wholesale segment consists of revenue primarily from sales in the United States of products to our wholesale partners. Finally, our International segment consists of revenue primarily from sales of products outside the United States, largely through our retail stores and eCommerce websites in Canada and Mexico, and sales to our international wholesale customers and licensees. Additional financial and geographical information about our segments is contained in Item 8 “Financial Statements and Supplementary Data” and under Note 14, Segment Information, to the consolidated financial statements.

Gross Profit and Gross Margin

Gross profit is calculated as consolidated net sales less cost of goods sold less adverse purchase commitments (inventory and raw materials), net, and gross margin is calculated as gross profit divided by consolidated net sales. Cost of goods sold includes expenses related to the merchandising, design, and procurement of product, including inbound freight costs, purchasing and receiving costs, and inspection costs. Also included in costs of goods sold are the costs of shipping eCommerce product to end consumers. Retail store occupancy costs, distribution expenses, and generally all other expenses other than interest and income taxes are included in Selling, general, and administrative (“SG&A”) expenses. Distribution expenses that are included in SG&A primarily consist of payments to third-party shippers and handling costs to process product through our distribution facilities, including eCommerce fulfillment costs, and delivery to our wholesale customers and to our retail stores. Our gross profit and gross margin may not be comparable to other entities that define their metrics differently.

Recent Developments

During fiscal 2020, the global pandemic caused by the spread of the novel strain of coronavirus (inclusive of variants, “COVID-19”) negatively affected the global economy, disrupted global supply chains, and created significant disruption of financial and retail markets, including a disruption in consumer demand for baby and children’s clothing and accessories. The COVID-19 pandemic has had, and will likely continue to have adverse effects on our business, financial condition, and results of operations. There is still potential further disruption to our business due to rolling lockdowns and other precautionary measures in the event of new strains or outbreaks. We cannot estimate with certainty the length or severity of this pandemic, or the extent to which the disruption may materially impact our consolidated financial position, consolidated results of operations, and consolidated cash flows. Refer to risks set forth in “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K. In fiscal 2021, the COVID-19 pandemic continued to impact our financial results.

For instance, the COVID-19 pandemic continues to impact supply chain operations, causing delays in the production and transportation of our product. To help mitigate production delays and meet consumer demand for our products, we have leveraged our strong relationships with our suppliers to shift production schedules when possible. To help mitigate the delay in the transportation of our product and to maintain our strong relationships with our customers, we spent considerably more than typical on inbound air freight, $33.6 million, in fiscal 2021 than in fiscal 2020. We expect these delays, and the increased costs to mitigate these delays, to continue and to adversely impact our financial results in fiscal 2022.

Additionally, in fiscal 2021 and the early part of 2022, the costs of raw materials, packaging materials, labor, energy, fuel, and other inputs necessary for the production and distribution of our products have rapidly increased. We also expect the pressures of input cost inflation to continue into 2022. We plan to offset these cost pressures through increases in the selling prices of some of our products, although these actions could have an adverse impact on demand.

Our attempts to offset these cost pressures, such as through increases in the selling prices of some of our products, may not be successful. Higher product prices may result in reductions in sales volume, as consumers may choose less expensive options, or forego some purchases altogether, during an economic downturn. To the extent that price increases are not sufficient to offset

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these increased costs adequately or in a timely manner, and/or if they result in significant decreases in sales volume, our business, financial condition, or operating results may be adversely affected.

Through disciplined inventory management processes, we were largely able to avoid the high inventory charges we took in fiscal 2020 as a result of disruptions related to the COVID-19 pandemic. In fiscal 2021, we successfully sold through our initial related pack and hold at prices generally above cost by selling through our retail channels at higher gross margins compared to “off-price” channels. As a result, our pack and hold inventory decreased almost 50.0% as of the end of fiscal 2021 compared to the end of fiscal 2020. However, to manage through supply chain delays and preserve strong margins, we decided to pack and hold certain late arriving inventory until future periods.

In fiscal 2020, we announced our plan to close approximately 25% of our stores in the United States, when leases come up for renewal or where there is a kick-out provision in the lease. We closed approximately 13%, or 110, of our stores in the United States in fiscal 2021, and we expect to close approximately 30 more stores in fiscal 2022. These retail store closures are primarily related to older, less profitable stores or stores in less trafficked shopping centers. We continue to look for new, profitable retail store locations that allow us to better serve customers, including our omni-channel customers. We do not expect to close as many stores as originally planned, and we are now planning on increasing our store count in the United States in fiscal 2022, with additional net store growth planned over the next five years to serve the needs of families with young children.

We continue to innovate and design products that consumers desire. In 2021, we launched the little planet brand, which focuses on sustainable clothing through the sourcing of mostly organic cotton as certified under the Global Organic Textile Standard. This brand includes a wide assortment of baby apparel and accessories, sleepwear, and gift bundles.

Fiscal Year 2021 Highlights

Unless otherwise stated, comparisons are to fiscal 2020.

•Consolidated net sales increased $462.1 million, or 15.3%, to $3.49 billion.

◦U.S. Retail store sales increased 29.1% primarily due to increased average selling prices per unit as a result of decreased promotions as our marketing strategy focused more on emotional marketing and increased retail store traffic in the United States as a result of progress in vaccinations and easing COVID-19 related restrictions. The passage of pandemic relief legislation in March 2021, including enhanced child tax credits, also contributed to this increase.

◦We closed approximately 110 less profitable retail stores in the United States in fiscal 2021. While these retail store closures negatively impacted total retail store sales, these closures helped improve our operating profitability. We focused on digital marketing and omni-channel capabilities in order to retain customers and to continue to serve their needs.

◦U.S. Wholesale sales increased 13.1%, primarily due to increased demand in our Carter’s brands, including our exclusive Carter’s brands. Demand from our wholesale customers has remained strong, and although we managed through supply chain and transportation delays, our sales were negatively impacted.

◦International sales increased 29.2% in fiscal 2021, primarily due to strong performance in our Canadian retail stores and eCommerce channels. Additionally, we saw significant growth in sales from our international wholesale partners as these partners recovered from business disruptions as a result of COVID-19.

◦Our omni-channel programs continued to deliver growth as a result of our investments and enhancements in these programs, which included implementing omni-channel programs in Canada during fiscal 2021.

•Gross profit increased $348.8 million, or 26.6%, to $1.66 billion. Gross margin increased 430 basis points (“bps”) to 47.7%, primarily driven by higher consolidated net sales across our business segments, coupled with increased average selling prices per unit. Increased inbound transportation and inbound freight costs, including increased transportation rates and $33.6 million in inbound air freight, primarily related to the U.S. Wholesale segment, were partially offset by a release of adverse purchase commitments related to better than expected sales of inventory and utilization of fabric that were reserved for in fiscal 2020.

•SG&A expenses as a percentage of total net sales (“SG&A rate”) decreased 240 bps to 34.2%. The decrease in the SG&A rate was primarily driven by increased consolidated net sales and better leverage of retail store expenses as more sales shifted back to the retail stores. Additional drivers include decreased eCommerce fulfillment costs, decreased organizational restructuring charges, and decreased costs associated with the COVID-19 pandemic, which were partially offset by increased performance-based compensation expense. This increase in performance-based compensation, which includes bonuses, 401(k) contributions, and other incentive compensation, is an investment in

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rewarding and retaining our high quality employees, who have remained focused on providing the best value and experience in young children’s apparel.

•Operating income increased $307.2 million to $497.1 million, and operating margin increased 800 bps to 14.3%, primarily due to the factors discussed above and the recognition of $44.2 million in goodwill and indefinite-lived tradename assets impairments charges in fiscal 2020 that did not re-occur in fiscal 2021.

•Net income increased $230.0 million to $339.7 million, primarily due to the factors discussed above, partially offset by an increase in income taxes.

•Diluted net income per common share increased from $2.50 to $7.81.

•Because of the significant adverse impact that the COVID-19 pandemic had on our operations during the first half of fiscal 2020, we believe that a better understanding of the profitability growth that has resulted from our strong product offerings, increased price realization, and productivity initiatives is obtained by comparing to our pre-pandemic results in fiscal 2019.

◦Compared to fiscal 2019, consolidated net sales decreased $32.8 million, or 0.9%, primarily due to decreased sales of our Carter’s brands as we focused on more profitable customers and decreased sales in our U.S. retail stores as a result of store closures throughout fiscal 2021. Despite the disruptions related to the COVID-19 pandemic, we improved on our average selling prices per unit, increased sales in our overall U.S. Retail segment partially due to investments in eCommerce and omni-channel capabilities, and saw meaningful growth in our exclusive Carter’s brands and in our International segment.

◦Compared to fiscal 2019, gross profit increased $153.7 million, or 10.2%, and gross margin increased 480 bps, primarily due to increased average selling prices per unit. These drivers were partially offset by the increased inbound transportation and inbound freight costs mentioned above.

◦Compared to fiscal 2019, operating income increased $125.2 million, or 33.7%, and operating margin increased 370 bps compared to fiscal 2019, primarily due to the increase in gross margin discussed above, partially offset by a 180 bps increase in SG&A rate. The increase in SG&A rate was primarily due to increased performance-based compensation expense, partially offset by better leverage of retail store expenses and the closure of less profitable stores in fiscal 2021. Fiscal 2019 was also impacted by a $30.8 million non-cash impairment charge related to the Skip Hop tradename in fiscal 2019 that did not re-occur in fiscal 2021.

•Inventories increased $48.5 million, or 8.1%, to $647.7 million primarily due to increased demand and increased in-transit inventory due to delays in the production and transportation of our products.

•Net cash provided by operating activities decreased $320.2 million, primarily due to a decrease in vendor payment terms.

•In fiscal 2021, we reinstated our common stock repurchase program and resumed paying cash dividends on our common shares. Under these return of capital initiatives, we returned $359.5 million to our shareholders, comprised of $299.3 million in share repurchases and $60.1 million in cash dividends. Compared to fiscal 2019, the return of capital to our shareholders increased 25.5%.

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RESULTS OF OPERATIONS

2021 FISCAL YEAR ENDED JANUARY 1, 2022 (52 WEEKS) COMPARED TO 2020 FISCAL YEAR ENDED JANUARY 2, 2021 (53 WEEKS)

The following table summarizes our results of operations. All percentages shown in the below table and the discussion that follows have been calculated using unrounded numbers.

(*)Effective tax rate is calculated by dividing the provision for income taxes by income before income taxes.

Note: Results may not be additive due to rounding. Percentage changes that are considered not meaningful are denoted with "nm".

Consolidated Net Sales

Consolidated net sales increased $462.1 million, or 15.3%, to $3.49 billion in fiscal 2021. This increase was primarily driven by increased average selling prices per unit as a result of decreased promotions and increased retail store traffic. The passage of pandemic relief legislation in March 2021, including enhanced child tax credits, strong consumer reaction to our product offerings, increased demand with many of our wholesale customers, increased net sales in Canada as we continue to gain market share, and increased demand with our international wholesale partners as these partners began to recover from COVID-19 business disruptions also contributed to this increase. Higher sales in these channels were partially offset by decreased net sales in our domestic eCommerce channel as customer traffic rebounded in our stores. Fiscal 2020 was adversely impacted by the temporary closure of our retail stores in March, April, and May 2020 and reduced demand in our other businesses as a result of disruptions related to COVID-19.

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The 53rd week in fiscal 2020 contributed approximately $32.1 million in additional consolidated net sales. Changes in foreign currency exchange rates used for translation in fiscal 2021, as compared to fiscal 2020, had a favorable effect on our consolidated net sales of approximately $20.0 million.

Gross Profit and Gross Margin

Our consolidated gross profit increased $348.8 million, or 26.6%, to $1.66 billion in fiscal 2021. Consolidated gross margin increased 430 bps to 47.7%.

The increase in consolidated gross profit and gross margin was primarily driven by higher consolidated net sales across our business segments, coupled with increased average selling prices per unit. Increased inbound transportation and inbound freight costs, including increased transportation rates and $33.6 million in inbound air freight, primarily related to the U.S. Wholesale segment, were partially offset by a release of adverse purchase commitments related to better than expected sales of inventory and utilization of fabric that were reserved in fiscal 2020. As a result of labor shortages, supply chain constraints, and inflation, we expect the increase in transportation rates to continue in fiscal 2022.

Royalty Income

Royalty income increased $2.4 million, or 9.2%, to $28.7 million in fiscal 2021, primarily due to increased licensee sales volume as our licensees recovered from business disruptions related to COVID-19.

Selling, General, and Administrative Expenses

Consolidated SG&A expenses increased $88.3 million, or 8.0%, to $1.19 billion in fiscal 2021 while the SG&A rate decreased approximately 240 bps to 34.2%. The decrease in the SG&A rate was primarily driven by increased consolidated net sales and better leverage of retail store expenses as sales in retail stores rebounded from COVID-19 related disruptions in fiscal 2020. Additional drivers include decreased eCommerce fulfillment costs, decreased organizational restructuring charges, and decreased costs associated with the COVID-19 pandemic, which were partially offset by increased performance-based compensation expense. Organizational restructuring charges were $2.4 million in fiscal 2021 compared to $16.6 million in fiscal 2020.

Goodwill Impairment

During the first quarter of fiscal 2020, the Company’s market capitalization declined, and actual and projected sales and profitability decreased as a result of disruptions related to COVID-19. Based on these events, we concluded that a triggering event occurred, and we performed an interim quantitative impairment test as of March 28, 2020. Based upon the results of the impairment test, we recognized a goodwill impairment charge of $17.7 million during the first quarter of fiscal 2020 which was recorded to the Other International reporting unit in the International segment. This charge did not reoccur in fiscal 2021.

Intangible Asset Impairment

During the first quarter of fiscal 2020, actual and projected sales and profitability decreased as a result of disruptions related to COVID-19. Based on these events, we concluded that a triggering event occurred, and we performed an interim quantitative impairment test as of March 28, 2020. Based upon the results of the impairment test, we recognized non-cash impairment charges of $15.5 million and $11.0 million during the first quarter of fiscal 2020 related to our OshKosh and Skip Hop tradename assets that were recorded in connection with the acquisition of OshKosh B’Gosh, Inc. in July 2005 and Skip Hop Holdings, Inc. in February 2017, respectively. This charge did not reoccur in fiscal 2021.

Operating Income

Consolidated operating income increased $307.2 million to $497.1 million in fiscal 2021 and increased as a percentage of net sales by approximately 800 bps to 14.3%, primarily due to the factors discussed above.

Interest Expense

Interest expense increased $4.2 million, or 7.5%, to $60.3 million in fiscal 2021. Weighted-average borrowings for fiscal 2021 were $1.00 billion at an effective interest rate of 6.02%, compared to weighted-average borrowings for fiscal 2020 of $1.03 billion at an effective interest rate of 5.39%. The decrease in weighted-average borrowings was attributable to the absence of borrowings under our secured revolving credit facility during all of fiscal 2021, partially offset by the issuance of $500 million in principal amount of senior notes in May 2020. The increase in the effective interest rate was primarily due to the interest rate differential between our secured revolving credit facility and our senior notes.

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Income Taxes

Our consolidated income tax provision increased $73.3 million to $98.5 million in fiscal 2021 and the effective tax rate increased approximately 380 bps to 22.5% in fiscal 2021 from 18.7% in fiscal 2020. The increased effective tax rate in fiscal 2021 primarily reflected a greater proportion of our income earned in the U.S., which has a higher tax rate than other jurisdictions income is generated.

Net Income

Our consolidated net income increased $230.0 million to $339.7 million in fiscal 2021, due to the factors previously discussed.

Results by Segment - Fiscal Year 2021 (52 Weeks) compared to Fiscal Year 2020 (53 Weeks)

The following table summarizes net sales and operating income, by segment, for the fiscal years ended January 1, 2022 and January 2, 2021:

Comparable Sales Metrics

As a result of the temporary store closures in fiscal 2020 in response to COVID-19, we have not included a discussion of fiscal 2021 retail comparable sales as we do not believe it is a meaningful metric during the period.

U.S. Retail

U.S. Retail segment net sales increased $227.6 million, or 13.6%, to $1.90 billion in fiscal 2021. The increase in net sales was primarily driven by increased retail store traffic due to more stores being open throughout fiscal 2021 compared to fiscal 2020 and increased average selling prices per unit as a result of decreased promotions. These drivers were partially offset by decreased net sales through our eCommerce channel. The 53rd week in fiscal 2020 contributed approximately $18.2 million in additional sales to the U.S. Retail segment.

As of January 1, 2022, we operated 751 retail stores in the U.S. compared to 864 in fiscal 2020. All stores were open as of January 1, 2022.

U.S. Retail segment operating income increased $221.4 million to $368.2 million, and operating margin increased 1,060 bps to 19.4%. The primary drivers of the increase in operating margin were a 600 bps increase in gross margin and a 390 bps decrease in SG&A rate. The increase in gross margin was primarily due to increased average selling prices per unit and a release of adverse purchase commitment reserves related to better than expected sales of inventory and utilization of fabric that were reserved in fiscal 2020. The decrease in the SG&A rate was primarily due to increased net sales, better leverage of retail store expenses due to increased store traffic, and decreased COVID-19 related charges, partially offset by increased performance-based compensation expense. Additional drivers include operating lease assets impairment charges in fiscal 2020 that did not reoccur in fiscal 2021 and decreased organizational restructuring expenses, partially offset by increased marketing expense. The

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increase in operating margin was also impacted by intangible assets impairment charges in fiscal 2020 that did not reoccur in fiscal 2021.

U.S. Wholesale

U.S. Wholesale segment net sales increased $130.3 million, or 13.1%, to $1.13 billion in fiscal 2021, primarily due to increased demand for our Carter’s brands, including our exclusive Carter’s brands. The 53rd week in fiscal 2020 contributed approximately $10.6 million in additional sales to the U.S. Wholesale segment.

U.S. Wholesale segment operating income increased $53.9 million, or 38.1%, to $195.4 million, and operating margin increased 310 bps to 17.3%. The primary drivers of the increase in operating margin were a 130 bps increase in gross margin, a 10 bps increase in royalty income, and a 100 bps decrease in SG&A rate. The increase in gross margin was primarily due to favorable customer mix, decreased inventory provisions, and a release of adverse purchase commitment reserves related to better than expected sales of inventory and utilization of fabric that were reserved in fiscal 2020, offset by increased inbound transportation and inbound freight costs. Additional drivers include increased average selling prices per unit and decreased product costs. The increase in royalty income was primarily due to increased licensee sales volume as our licensees recovered from business disruptions related to COVID-19. The decrease in the SG&A rate was primarily due to increased sales, decreased COVID-19 related charges, and decreased bad debt expense, partially offset by increased performance-based compensation expense and increased marketing expense. The increase in operating margin was also impacted by intangible assets impairment charges in fiscal 2020 that did not reoccur in fiscal 2021.

International

International segment net sales increased $104.2 million, or 29.2%, to $460.8 million in fiscal 2021. Changes in foreign currency exchange rates, primarily between the U.S. dollar and the Canadian dollar, had a $20.0 million favorable effect on International segment net sales. The increase in net sales was primarily driven by increased retail store traffic in Canada, growth in our Canadian eCommerce business due to increased demand and the introduction of omni-channel capabilities, and increased sales to our international partners. The 53rd week in fiscal 2020 contributed approximately $3.3 million in additional sales to the International segment.

As of January 1, 2022, we operated 186 retail stores in Canada, compared to 193 at the end of fiscal 2020. As of January 1, 2022, we operated 43 retail stores in Mexico, compared to 44 in fiscal 2020. Due to COVID-19 related disruptions, we temporarily closed a number of retail stores and reduced retail store operating hours throughout fiscal 2021.

International segment operating income was $63.8 million in fiscal 2021 compared to an operating loss of $1.2 million in fiscal 2020. Operating margin increased 1,410 bps to 13.8%. The increase in the operating margin was primarily attributable to a 440 bps increase in gross margin and a 400 bps decrease in the SG&A rate. The increase in gross margin was primarily due to increased average selling prices per unit and a release of adverse purchase commitment reserves related to better than expected sales of inventory and utilization of fabric that were reserved in fiscal 2020. The decrease in the SG&A rate was primarily due to increased net sales, better leverage of retail store expenses due to increased store traffic, and decreased COVID-19 related charges, partially offset by increased performance-based compensation expense. The operating loss in fiscal 2020 also included a $17.7 million goodwill impairment charge and intangible assets impairment charges in fiscal 2020 that did not reoccur in fiscal 2021.

Unallocated Corporate Expenses

Unallocated corporate expenses include corporate overhead expenses that are not directly attributable to one of our business segments and include unallocated accounting, finance, legal, human resources, and information technology expenses, occupancy costs for our corporate headquarters, and other benefit and compensation programs, including stock-based compensation.

Unallocated corporate expenses increased $33.1 million, or 34.1%, to $130.3 million in fiscal 2021. Unallocated corporate expenses, as a percentage of consolidated net sales, increased 50 bps to 3.7%. The increase as a percentage of consolidated net sales was primarily due to increased performance-based compensation expense, partially offset by increased net sales.

FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY

Our ongoing cash needs are primarily for working capital, capital expenditures, interest on debt, and the return of capital to our shareholders. We expect that our primary sources of liquidity will be cash and cash equivalents on hand, cash flow from operations, and available borrowing capacity under our secured revolving credit facility. We believe that our sources of liquidity will fund our projected requirements for at least the next twelve months. However, these sources of liquidity may be

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affected by the COVID-19 pandemic and other events described in our risk factors, as discussed under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.

As discussed under the heading “Recent Developments” in Part II, Item 7 of this Annual Report on Form 10-K, we expect delays in the production and transportation of our product, and the increased costs to mitigate these delays, to continue and to adversely impact our financial results in fiscal 2022. We cannot predict the timing and amount of such impact.

As of January 1, 2022, we had approximately $984.3 million of cash and cash equivalents held at major financial institutions, including approximately $112.7 million held at financial institutions located outside of the United States. We maintain cash deposits with major financial institutions that exceed the insurance coverage limits provided by the Federal Deposit Insurance Corporation in the United States, and by similar insurers for deposits located outside the United States. To mitigate this risk, we utilize a policy of allocating cash deposits among major financial institutions that have been evaluated by us and third-party rating agencies as having acceptable risk profiles.

Balance Sheet

Net accounts receivable at January 1, 2022 were $231.4 million compared to $186.5 million at January 2, 2021. The increase of $44.8 million, or 24.0%, primarily reflects increased wholesale customer demand and the timing of wholesale customer receipts, partially offset by improved days sales outstanding.

Inventories at January 1, 2022 were $647.7 million compared to $599.3 million at January 2, 2021. The increase of $48.5 million, or 8.1%, was primarily due to increased demand and increased in-transit inventory due to delays in production and transportation of our products, partially offset by decreased pack and hold inventory.

Accounts payable at January 1, 2022 were $407.0 million compared to $472.1 million at January 2, 2021. The decrease of $65.1 million, or 13.8%, is primarily due a decrease in vendor payment terms, which had been extended in fiscal 2020 in response to the COVID-19 pandemic.

Cash Flow

Net Cash Provided by Operating Activities

Net cash provided by operating activities for fiscal 2021 was $268.3 million, compared to $588.5 million in fiscal 2020. Our cash flow provided by operating activities is driven by net income and changes in our working capital. The decrease in net cash provided by operating activities was primarily due to a decrease in vendor payment terms, partially offset by increased profitability.

We facilitate a voluntary supply chain finance (“SCF”) program through participating financial institutions. This SCF program enables our suppliers to sell their receivables due from the Company to a participating financial institution at their discretion. We are not a party to the agreements between the participating financial institutions and the suppliers in connection with the SCF program. The range of payment terms we negotiate with our suppliers is consistent, irrespective of whether a supplier participates in the SCF program. No guarantees are provided by the Company or any of our subsidiaries under the SCF program. The amounts payable to participating financial institutions for suppliers who voluntarily participate in the SCF program are included in Accounts payable on our consolidated statement balance sheets. Payments made under the SCF program, like payments on other Accounts payable, are a reduction to our operating cash flow.

Net Cash Used in Investing Activities

Net cash used in investing activities was $32.4 million in fiscal 2021, compared to $31.5 million in fiscal 2020. This increase in net cash used in investing activities is primarily due to increased capital expenditures, partially offset by increased proceeds from sales of investments in marketable securities. Capital expenditures in fiscal 2021 primarily included $22.6 million for information technology initiatives, $9.1 million for omni-channel initiatives and our U.S. and international retail store openings and remodels, and $4.2 million for our distribution facilities.

We plan to invest approximately $65 million in capital expenditures in fiscal 2022, which primarily relates to U.S. and international retail store openings and remodels, strategic information technology initiatives, and investments in our distribution facilities.

Net Cash (Used in) Provided by Financing Activities

Net cash used in financing activities was $352.7 million in fiscal 2021, compared to net cash provided by financing activities of $324.8 million in fiscal 2020. This change in cash flow from financing activities was primarily due to an issuance of $500

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million in principal amount of senior notes in May 2020, which did not reoccur in fiscal 2021, and an increase in the return of capital to our shareholders through common stock share repurchases and cash dividends in fiscal 2021.

Secured Revolving Credit Facility

As of January 1, 2022, we had no outstanding borrowings under our secured revolving credit facility, exclusive of $4.1 million of outstanding letters of credit. As of January 2, 2021, we had no outstanding borrowings under our secured revolving credit facility, exclusive of $5.0 million of outstanding letters of credit. As of January 1, 2022 and January 2, 2021, there was approximately $745.9 million and $745.0 million available for future borrowing, respectively. Any outstanding borrowings under our secured revolving credit facility are classified as non-current liabilities on our consolidated balance sheets due to contractual repayment terms under the credit facility. However, these repayment terms also allow us to repay some or all of the outstanding borrowings at any time.

Terms of the Secured Revolving Credit Facility

Our secured revolving credit facility provides for an aggregate credit line of $750 million which includes a $650 million U.S. dollar facility and a $100 million multicurrency facility denominated in U.S. dollars, Canadian dollars, Euros, Pounds Sterling, or other currencies agreed to by the applicable lenders. The credit facility matures on September 21, 2023. The facility contains covenants that restrict the Company’s ability to, among other things: (i) create or incur liens, debt, guarantees or other investments, (ii) engage in mergers and consolidations, (iii) pay dividends or other distributions to, and redemptions and repurchases from, equity holders, (iv) prepay, redeem or repurchase subordinated or junior debt, (v) amend organizational documents, and (vi) engage in certain transactions with affiliates.

On May 4, 2020, through our wholly owned subsidiary, The William Carter Company (“TWCC”), we entered into Amendment No. 2 to our fourth amended and restated credit agreement (“Amendment No. 2”). Amendment No. 2 provided for, among other things, access to additional capital and increased flexibility under financial maintenance covenants, which we sought in part due to the unforeseen negative effects of the COVID-19 pandemic.

On April 21, 2021, through our wholly owned subsidiary, TWCC, we entered into Amendment No. 3 to our fourth amended and restated credit agreement (“Amendment No. 3”). Among other things, Amendment No. 3 provided that through the remainder of the Restricted Period, which ended on the date the we delivered our financial statements and associated certificates relating to the third quarter of fiscal 2021:

•we must have maintained a minimum liquidity (defined as cash-on-hand plus availability under the secured revolving credit facility) on the last day of each fiscal month of at least $950 million (the “Revised Liquidity Requirement”), which was increased by $250 million from $700 million; and

•we were permitted to make additional restricted payments, including to pay cash dividends and repurchase common stock, in an amount not to exceed $250 million, provided that (a) no default or event of default will have occurred and be continuing or would result from the payment and (b) after giving effect to the payment, we would have been in compliance with Revised Liquidity Requirement as of the last day of the most recent month.

Approximately $0.2 million, including both bank fees and other third-party expenses, has been capitalized in connection with Amendment No. 3 and is being amortized over the remaining term of the secured revolving credit facility.

As of January 1, 2022, our secured revolving credit facility returned to its pre-COVID 19 terms that were in effect prior to Amendment No. 2.

There were no weighted-average borrowings for fiscal 2021 compared to $212.2 million of weighted-average borrowings for fiscal 2020. The decrease in weighted-average borrowings for fiscal 2021 was due to the absence of borrowings under our secured revolving credit facility during fiscal 2021.

As of January 1, 2022, the interest rate margins applicable to the amended revolving credit facility were 1.125% for LIBOR rate and 0.125% for base rate loans. The effective interest rate for borrowings under the secured revolving credit facility during fiscal 2020 was 2.84%.

As of January 1, 2022, we were in compliance with our financial and other covenants under our secured revolving credit facility.

Senior Notes

As of January 1, 2022, TWCC had $500.0 million principal amount of senior notes outstanding, bearing interest at a rate of

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5.500% per annum, and maturing on May 15, 2025, and $500.0 million principal amount of senior notes outstanding, bearing interest at a rate of 5.625% per annum, and maturing on March 15, 2027. On our consolidated balance sheet, the $1.00 billion of outstanding senior notes as of January 1, 2022 is reported net of $8.6 million of unamortized issuance-related debt costs, and the $1.00 billion of outstanding senior notes as of January 2, 2021 is reported net of $10.5 million of unamortized issuance-related debt costs.

The senior notes mentioned above are unsecured and are fully and unconditionally guaranteed by Carter’s, Inc. and certain domestic subsidiaries of TWCC. The guarantor subsidiaries are 100% owned directly or indirectly by Carter’s, Inc. and all guarantees are joint, several and unconditional.

The indentures governing the senior notes provides that upon the occurrence of specific kinds of changes of control, unless a redemption notice with respect to all the outstanding senior notes has previously or concurrently been mailed or delivered, we will be required to make an offer to purchase the senior notes at 101% of their principal amount, plus accrued and unpaid interest to (but excluding) the date of purchase.

The indentures governing the senior notes include a number of covenants, that, among other things and subject to certain exceptions, restrict TWCC’s ability and the ability of certain of its subsidiaries to: (a) incur certain types of indebtedness that is secured by a lien; (b) enter into certain sale and leaseback transactions; and (c) consolidate or merge with or into, or sell substantially all of the issuer’s assets to, another person, under certain circumstances. Terms of the notes contain customary affirmative covenants and provide for events of default which, if certain of them occur, would permit the trustee or the holders of at least 25.0% in principal amount of the then total outstanding senior notes to declare all amounts owning under the notes to be due and payable. Carter’s, Inc. is not subject to these covenants.

Fiscal 2022 Debt Extinguishment

We intend to redeem our 5.500% senior notes in the first quarter of fiscal 2022, subject to market conditions, using cash on hand. Redemption of the 5.500% senior notes will require payment of an early redemption premium, which along with transaction fees and unamortized debt issuance costs is estimated to result in a loss on extinguishment of debt of approximately $21 million in the first quarter of fiscal 2022.

Share Repurchases

On February 24, 2022, our Board of Directors authorized share repurchases up to $1.00 billion, inclusive of approximately $301.9 million remaining under previous authorizations.

Open-market repurchases of our common stock during fiscal years 2021 and 2020 were as follows:

The total remaining capacity under outstanding repurchase authorizations as of January 1, 2022 was approximately $351.1 million, exclusive of the February 2022 share repurchase authorization, based on settled repurchase transactions. The share repurchase authorizations have no expiration dates.

In the third quarter of fiscal 2021, we reinstated our common stock share repurchase program. We had previously announced the suspension of our common stock share repurchase program, in connection with the COVID-19 pandemic, at the end of the first quarter in fiscal 2020. Future repurchases may occur from time to time in the open market, in privately negotiated transactions, or otherwise. The timing and amount of any repurchases will be at our discretion subject to restrictions under our revolving credit facility, market conditions, stock price, other investment priorities, and other factors.

Dividends

On February 24, 2022, the Company's Board of Directors authorized a quarterly cash dividend payment of $0.75 per common share, payable on March 18, 2022 to shareholders of record at the close of business on March 8, 2022.

Our Board of Directors declared and we paid cash dividends of $0.60 per share in the first quarter of fiscal 2020. On May 1, 2020, in connection with the COVID-19 pandemic, our Board of Directors suspended our quarterly cash dividend. As a result,

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the Board of Directors did not declare and we did not pay cash dividends in the second, third, or fourth quarters of fiscal 2020, or in the first quarter of fiscal 2021. The Board of Directors declared and we paid cash dividends of $0.40 per share in each of the second and third quarters of fiscal 2021 and $0.60 per share in the fourth quarter of fiscal 2021. Our Board of Directors will evaluate future dividend declarations based on a number of factors, including restrictions under our secured revolving credit facility, business conditions, our financial performance, and other considerations.

Provisions in our secured revolving credit facility could have the effect of restricting our ability to pay cash dividends on, or make future repurchases of, our common stock, as further described in Item 8 “Financial Statements and Supplementary Data” under Note 8, Long-Term Debt, to the consolidated financial statements.

Commitments

The following table summarizes as of January 1, 2022, the maturity or expiration dates of mandatory contractual obligations and commitments for the following fiscal years:

(1)Reflects: i) a fixed interest rate of 5.500% for the senior notes due 2025, and ii) a fixed interest rate of 5.625% for the senior notes due 2027.

(2)The minimum lease obligation includes all lease and non-lease components that were included in the measurement of the lease liability.

(3)The table above excludes our reserves for income taxes, as we are unable to reasonably predict the ultimate amount or timing of settlement.

(4)The table above excludes purchase obligations. Our estimate as of January 1, 2022 for commitments to purchase inventory in the normal course of business, which are cancellable (with or without penalty, depending on the stage of production) and span a period of one year or less, was between $550 million and $650 million.

(5)The table above excludes any potential future Company funding for obligations under our defined benefit retirement plans. Our estimates of such obligations as of January 1, 2022 have been determined in accordance with U.S. GAAP and are included in other current liabilities and other long-term liabilities on our consolidated balance sheet, as described in Item 8 “Financial Statements and Supplementary Data” under Note 11, Employee Benefit Plans, to the consolidated financial statements.

Liquidity Outlook

Based on our current outlook, we believe that cash generated from operations and available cash, together with amounts available under our secured revolving credit facility, will be adequate to meet our working capital needs and capital expenditure requirements for our longer-term strategic plans, although no assurance can be given in this regard.

Seasonality

We experience seasonal fluctuations in our sales and profitability due to the timing of certain holidays and key retail shopping periods, which generally has resulted in lower sales and gross profit in the first half of our fiscal year versus the second half of the fiscal year. Accordingly, our results of operations during the first half of the year may not be indicative of the results we expect for the full year.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in our accompanying consolidated financial statements. The following discussion addresses our critical accounting policies and estimates, which are those policies that require management’s most

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difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Revenue Recognition and Accounts Receivable Allowance

Our revenues, which are reported as Net sales, consist of sales to customers, net of returns, discounts, chargebacks, and cooperative advertising. We recognize revenue when (or as) the performance obligation is satisfied. Generally, the performance obligation is satisfied when we transfer control of the goods to the customer.

Our retail store revenues, also reported as Net sales, are recognized at the point of sale. Retail sales through our on-line channels are recognized at time of delivery to the customer. We recognize retail sales returns at the time of transaction by recording adjustments to both revenue and cost of goods sold. Additionally, we maintain an asset, representing the goods we expect to receive from the customer, and a liability for estimated sales returns. There are no accounts receivable associated with our retail customers.

Our accounts receivable reserves for wholesale customers include an allowance for expected credit losses and an allowance for chargebacks. The allowance for expected credit losses includes estimated losses resulting from the inability of our customers to make payments. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, an additional allowance could be required. Past due balances over 90 days are reviewed individually for collectibility. Our credit and collections department reviews all other balances regularly. Account balances are charged off against the allowance when it is probable that the receivable will not be recovered. Provisions for the allowance for expected credit losses are reflected in Selling, general and administrative expenses on our consolidated statement of operations and provisions for chargebacks are reflected as a reduction in Net sales on our consolidated statement of operations.

Cooperative advertising arrangements reimburse customers for marketing activities for certain of our products. We record these reimbursements under cooperative advertising arrangements with certain of our major wholesale customers at fair value. Fair value is determined based upon, among other factors, comparable market analysis for similar advertisements. We have included the fair value of these arrangements of approximately $0.2 million for fiscal 2021, $0.5 million for fiscal 2020, and $3.1 million for fiscal 2019 as a component of SG&A expenses on our consolidated statements of operations, rather than as a reduction of net sales. Amounts determined to be in excess of the fair value of these arrangements are recorded as a reduction of net sales.

Except in very limited circumstances, we do not allow our wholesale customers to return goods to us.

Inventory

Our inventories, which consist primarily of finished goods, are stated approximately at the lower of cost (first-in, first-out basis for wholesale inventory and average cost for retail inventories) or net realizable value. Obsolete, damaged, and excess inventory is carried at net realizable value by establishing reserves after assessing historical recovery rates, current market conditions, and future marketing and sales plans. Rebates, discounts and other cash consideration received from a vendor related to inventory purchases are reflected as reductions in the cost of the related inventory item, and are therefore reflected in cost of goods sold when the related inventory item is sold. The Company also has minimum inventory purchase commitments, including fabric commitments, with our suppliers which secure a portion of our raw material needs for future seasons. In the event anticipated market sales prices are lower than these committed costs or customer orders are canceled, the Company records a reserve for these adverse inventory and fabric purchase commitments. Increases to this reserve are reflected in Costs of goods sold on our consolidated statement of operations. Due to the materiality of these charges in fiscal 2020, these charges have been presented separately on our consolidated statement of operations.

Goodwill and Tradename

The carrying values of goodwill and indefinite-lived tradename assets are subject to annual impairment reviews as of the last day of each fiscal year. Between annual assessments, impairment reviews may also be triggered by any significant events or changes in circumstances affecting our business. Factors affecting such impairment reviews include the continued market acceptance of our current products and the development of new products. We use qualitative and quantitative methods to assess for impairment, including the use of discounted cash flows (“income approach”) and relevant data from guideline public companies (“market approach”).

We perform impairment tests of goodwill at the reporting unit level. A qualitative assessment determines if it is “more likely than not” that the fair value of the reporting unit is less than its carrying value. Qualitative factors may include, but are not limited to: macroeconomic conditions; industry and market considerations; cost factors that may have a negative effect on earnings; overall financial performance; and other relevant entity-specific events. If the results of a qualitative test determine

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that it is “more likely than not” that the fair value of a reporting unit is less than its carrying value, then a goodwill impairment test using quantitative assessments must be performed. If it is determined that it is not “more likely than not” that the fair value of the reporting unit is less than its carrying value, then no further testing is required.

Under a quantitative assessment for goodwill, we compare the fair value of a reporting unit to its carrying value, including goodwill. We use the income approach and the market approach to determine the fair value of a reporting unit. The assumptions used in these approaches include revenue growth and profitability, terminal values, discount rates, and an implied control premium. These assumptions are consistent with those we believe hypothetical marketplace participants would use. An impairment is recorded for any excess carrying value above the fair value of the reporting unit, not to exceed the carrying value of goodwill.

A tradename is considered impaired if the estimated fair value of the tradename is less than the carrying amount. Impairment reviews for an indefinite-lived tradename can be conducted using qualitative analysis, and if necessary, by a quantitative impairment test. If a tradename is considered impaired, we recognize a loss equal to the difference between the carrying amount and the estimated fair value of the tradename. The process of estimating the fair value of a tradename incorporates the relief-from-royalty method, which requires us to make assumptions and to apply judgment, including forecasting revenue growth rates and selecting the appropriate terminal value, discount rate, and royalty rate.

A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models, but may also negatively impact other assumptions used in our analysis, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, we are required to ensure that assumptions used to determine fair value in our analysis are consistent with the assumptions a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analysis may increase or decrease based on market conditions and trends, regardless of whether our actual cost of capital has changed. Therefore, we may recognize an impairment of an intangible asset or assets even though realized actual cash flows are approximately equal to or greater than our previously forecast amounts.

Based upon our most recent annual assessment, performed as of January 1, 2022, using a qualitative assessment, there were no impairments in the values of goodwill or indefinite-lived or definite-lived intangible assets.

In the first quarter of fiscal 2020, the Company concluded that impairment indicators existed due to the decrease in the Company’s market capitalization, lower than expected actual sales, and lower projected sales and profitability, primarily due to the impacts from the outbreak of COVID-19. As a result, during the first quarter of fiscal 2020, the Company conducted interim quantitative impairment assessments of 1) the goodwill ascribed to the Other International reporting unit recorded in connection with the allocation of goodwill to the newly created International segment as a result of the acquisition of Bonnie Togs in 2011 and 2) on the value of the Company’s indefinite-lived OshKosh and Skip Hop tradename assets that was recorded in connection with the acquisition of OshKosh B’Gosh Inc. in July 2005 and Skip Hop Holdings, Inc. in February 2017, respectively.

The goodwill impairment assessment for the Other International reporting unit was performed in accordance with ASC 350, “Intangibles--Goodwill and Other” (“ASC 350”) and compares the carrying value of the Other International reporting unit to its fair value. Consistent with prior practice, the fair value of the Other International reporting unit was determined using discounted cash flows (“income approach”) and relevant data from guideline public companies (“market approach”). As a result of this assessment, a goodwill impairment charge of $17.7 million was recorded to our Other International reporting unit in the International segment during the first quarter of fiscal 2020. The goodwill impairment charge recorded on our Other International reporting unit included charges of $9.4 million, $5.2 million, and $3.1 million to Skip Hop, Carter’s, and Carter’s Mexico goodwill, respectively. The carrying value of the Company’s goodwill for the Other International reporting unit as of January 1, 2022 was $11.7 million.

The OshKosh and Skip Hop indefinite-lived tradename asset assessments were performed in accordance with ASC 350 and were determined using a discounted cash flow analysis which examined the hypothetical cost savings that accrue as a result of not having to license the tradename from another owner. Based on these assessments, charges of $15.5 million and $11.0 million were recorded during the first quarter of fiscal 2020 on our indefinite-lived OshKosh and Skip Hop tradename assets, respectively. The charge recorded on our indefinite-lived OshKosh tradename asset included charges of $13.6 million, $1.6 million, and $0.3 million in the U.S. Retail, U.S. Wholesale, and International segments, respectively, to reflect the impairment of the value ascribed to the indefinite-lived OshKosh tradename asset. The charge recorded on our indefinite-lived Skip Hop tradename asset included charges of $6.8 million, $3.7 million, and $0.5 million in the U.S. Wholesale, International, and U.S. Retail segments, respectively, to reflect the impairment of the value ascribed to the indefinite-lived Skip Hop tradename asset. The carrying values of the Company’s indefinite-lived OshKosh and Skip Hop tradename assets as of January 1, 2022 were $70.0 million and $15.0 million, respectively.

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Accrued Expenses

Accrued expenses for workers’ compensation, incentive compensation, health insurance, 401(k), and other outstanding obligations are assessed based on actual commitments, statistical trends, and/or estimates based on projections and current expectations, and these estimates are updated periodically as additional information becomes available.

Loss Contingencies

We record accruals for various contingencies including legal exposures as they arise in the normal course of business. We determine whether to disclose and accrue for loss contingencies based on an assessment of whether the risk of loss is remote, reasonably possible, or probable. Our assessment is developed in consultation with our internal and external counsel and other advisers and is based on an analysis of possible outcomes under various strategies. Loss contingency assumptions involve judgments that are inherently subjective and can involve matters that are in litigation, which, by their nature are unpredictable. We believe that our assessment of the probability of loss contingencies is reasonable.

Accounting For Income Taxes

As part of the process of preparing the accompanying consolidated financial statements, we are required to estimate our actual current tax exposure (state, federal, and foreign). We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting dates. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. If it is more likely than not that a tax position would not be sustained, then no tax benefit would be recognized. Where applicable, associated interest related to unrecognized tax benefits is recognized as a component of interest expense and associated penalties related to unrecognized tax benefits are recognized as a component of income tax expense.

We also assess permanent and temporary differences resulting from differing basis and treatment of items for tax and accounting purposes, such as the carrying value of intangibles, deductibility of expenses, depreciation of property, plant, and equipment, stock-based compensation expense, and valuation of inventories. Temporary differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. Actual results could differ from this assessment if sufficient taxable income is not generated in future periods. To the extent we determine the need to establish a valuation allowance or increase such allowance in a period, we must include an expense within the tax provision in the accompanying consolidated statements of operations.

Based on our results for fiscal 2021, a hypothetical 100 bps increase in our effective tax rate would have resulted in an increase in our income tax expense of $4.4 million.

Foreign Currency

The functional currency of substantially all of our foreign operations is the local currency.

Assets and liabilities are translated into U.S. dollars using the current exchange rates in effect at the balance sheet date, while revenues and expenses are translated at the average exchange rates for the period. The resulting translation adjustments are recorded as a component of Accumulated other comprehensive income (loss) within stockholders’ equity.

Transaction gains and losses, such as those resulting from the settlement of nonfunctional currency receivables and payables, including intercompany balances, are included in Other expense (income), net in our consolidated statements of operations. Additionally, payable and receivable balances denominated in nonfunctional currencies are marked-to-market at the end of each reporting period, and the gain or loss is recognized in Other expense (income), net in our consolidated statements of operations.

As part of our overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, primarily between the U.S. dollar and the currencies of Canada and Mexico, we may use foreign currency forward contracts to hedge purchases that are made in U.S. dollars, primarily for inventory purchases in our Canadian and Mexican businesses. As part of a hedging strategy, we may use foreign currency forward exchange contracts that typically have maturities of less than 12 months and provide continuing coverage throughout the hedging period. Historically, these contracts have not been designated for hedge accounting treatment, and therefore changes in the fair value of these contracts were recorded in our consolidated statement of operations. Such foreign currency gains and losses include the mark-to-market fair value adjustments at the end of each reporting period related to any open contracts, as well as any realized gains and losses on contracts settled during the reporting period. Fair values for open contracts are calculated by using readily observable market inputs (market-

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quoted currency exchange rates), classified as Level 2 within the fair value hierarchy. At January 1, 2022, there were no unsettled foreign currency forward contracts.

Employee Benefit Plans

We sponsor a frozen defined benefit pension plan and other unfunded post-retirement plans. The defined benefit pension and post-retirement plans require an actuarial valuation to determine plan obligations, and related periodic costs. Plan valuations require economic assumptions, including expected rates of return on plan assets, discount rates to value plan obligations and employee demographic assumptions including mortality rates. The actuarial assumptions used may differ materially from actual results due to changing market and economic conditions. Actual results that differ from the actuarial assumptions are reflected as deferred gains and losses in Accumulated other comprehensive income (loss) within stockholder’s equity. Deferred gains and losses that exceed 10% of the greater of the plan’s projected benefit obligations or market value of assets are amortized to earnings over the average remaining life of inactive plan participants.

Any future obligation under our pension plan not funded from returns on plan assets are expected to be funded from cash flows from operations.

The most significant assumption used to determine the Company’s projected benefit obligation under its defined benefit plans is the discount rate. For further details on rates and assumptions, see Item 8 “Financial Statements and Supplementary Data” under Note 11, Employee Benefit Plans, to the consolidated financial statements.

Stock-Based Compensation Arrangements

We recognize the cost resulting from all stock-based payment transactions in the financial statements at grant date fair value. The fair value of stock awards is determined based on the quoted closing price of our common stock on the date of grant. The fair value of stock options is determined based on the Black-Scholes option pricing model, which requires the use of subjective assumptions. These assumptions include the following:

•Volatility – This is a measure of the amount by which a stock price has fluctuated or is expected to fluctuate. We use actual monthly historical changes in the market value of our stock covering the expected life of stock options being valued. An increase in the expected volatility will increase the fair value of the stock option and related compensation expense.

•Risk-free interest rate – This is the U.S. Treasury rate as of the grant date having a term equal to the expected term of the stock option. An increase in the risk-free interest rate will increase the fair value of the stock option and related compensation expense.

•Expected term – This is the period of time over which the stock options granted are expected to remain outstanding and is based on historical experience and estimated future exercise behavior. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. An increase in the expected term will increase the fair value of the stock option and related compensation expense.

•Dividend yield – We estimate a dividend yield based on the current dividend amount as a percentage of our current stock price. An increase in the dividend yield will decrease the fair value of the stock option and related stock-based compensation expense.

•Forfeitures – We estimate forfeitures of stock-based awards based on historical experience and expected future activity.

Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized in the accompanying consolidated statements of operations.

We account for performance-based awards over the vesting term of the awards that are expected to vest based on whether it is probable that the performance criteria will be achieved. We reassess the probability of vesting at each reporting period for awards with performance criteria and adjust stock-based compensation expense based on the probability assessments.

During the requisite service period, we recognize a deferred income tax benefit for the expense recognized for U.S. GAAP. At time of subsequent vesting, exercise, forfeiture, or expiration of an award, the difference between our actual income tax deduction, if any, and the previously accrued income tax benefit is recognized in our income tax expense/benefit during the current period.

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