The Children’s Place, Inc. — Form 10-K Summary
Period clarification: The supplied filing is the 10-K for fiscal 2018, the 52 weeks ended February 2, 2019—not a filing for 2017 Q4. Fiscal 2017, the principal comparison, comprised 53 weeks. Amounts below are U.S. dollars.
Business context
The company is a children’s apparel retailer operating stores, e-commerce, wholesale and franchise channels. At year-end it operated 972 North American stores and had 217 international points of distribution in 20 countries. It closed 42 stores and opened none during fiscal 2018.
Financial performance and liquidity
| Metric | Fiscal 2018 | Fiscal 2017 |
|---|---|---|
| Net sales | $1,938.1 million | $1,870.3 million |
| Comparable retail sales growth | 4.6% | 5.8% |
| Gross profit / gross margin | $683.6 million / 35.3% | $711.4 million / 38.0% |
| Operating income / margin | $111.3 million / 5.7% | $161.5 million / 8.6% |
| Net income | $101.0 million | $84.7 million |
| Diluted EPS | $6.01 | $4.67 |
| Operating cash flow | $139.9 million | $214.4 million |
| Capital expenditures | $71.1 million | $58.7 million |
Sales rose 3.6%, led by comparable sales and partly offset by the prior-year extra week and lower international sales. E-commerce, including shipping and handling, rose to approximately 28% of net sales from 23%. Gross margin declined about 270 basis points, primarily from more competitive pricing and a higher e-commerce mix with greater fulfillment costs. SG&A increased 4.6% to $498.3 million; operating income fell 31.1%.
Net income increased despite lower operating income, mainly because the effective tax rate fell to 7.0% from 47.5%. Fiscal 2017 tax expense included a $51.8 million Tax Act charge; excluding that charge, the prior-year effective tax rate was 15.4%. Fiscal 2018 also included $6.1 million of impairment charges, including $4.4 million for IT systems, and $1.1 million of other income from a distribution-center lease settlement.
Cash and cash equivalents were $69.1 million, down from $244.5 million; working capital was $104.0 million, down from $296.0 million. The company attributed much of the working-capital decline to share repurchases. It had $48.9 million outstanding under its $250 million revolving facility and $194.1 million available; the facility expires in September 2020. There was no long-term debt reported. Operating cash flow declined $74.5 million, primarily due to working-capital needs. Financing cash outflows included $253.5 million of share repurchases and $33.0 million of dividends.
Material changes and outlook
- U.S. segment sales increased 4.7%, while international sales declined 4.3%, affected by currency, fewer stores and flat Canadian comparable sales. U.S. operating income fell to $87.0 million from $132.2 million; international operating income fell to $24.3 million from $29.4 million.
- Management described fiscal 2018 as the first year of a three-year digital investment plan and said it accepted short-term gross-margin pressure to support long-term competitiveness and market share.
- Fiscal 2019 capital expenditures were estimated at $70–$80 million, primarily for technology transformation. The company planned to close approximately 300 stores through fiscal 2020, including 211 closures already completed since the initiative began.
- After year-end, the company agreed to pay $76 million for Gymboree and Crazy 8 intellectual property and related assets, funded with cash and revolver borrowings. Management expected Gymboree’s store liquidation to adversely affect sales and net income in the first half of fiscal 2019.
- The company authorized a fiscal 2019 quarterly dividend of $0.56 per share. A $239 million balance remained on the fiscal 2018 repurchase authorization at year-end.
- Adoption of the new lease standard in fiscal 2019 was expected to add $400–$450 million of right-of-use assets and lease liabilities, without a material effect on reported operating results or cash flows.
Risks, contingencies and unusual items
- Management highlighted intense retail competition, promotional pressure, changing customer demand, weather sensitivity, inventory forecasting, store-closure execution and technology transformation risks.
- Trade exposure is notable: approximately 19% of merchandise was sourced from China. The filing described proposed U.S. tariffs that could expand or increase, with potential material adverse effects.
- Foreign exchange movements affect Canadian sales and sourcing costs. The company used $17.9 million of currency forwards, reported as an asset of $1.9 million.
- Contractual commitments included $487.6 million of operating lease payments and $122.4 million of merchandise purchase commitments. The company also recorded a $2.2 million provision for potential foreign exchange-control penalties; management said actual penalties could exceed its estimated range.
- A proposed class-action settlement over discount-price advertising remained subject to court approval; a $5.0 million reserve had been recorded in fiscal 2017. Management said other ordinary-course proceedings were not expected to have a material adverse effect.
- Independent auditors issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective.
Most important facts for investors to verify
- Whether gross margin stabilizes after the fiscal 2018 decline and whether digital growth generates adequate returns after fulfillment costs.
- The actual financial impact and closing status of the Gymboree asset acquisition, including the effect of the competitor’s liquidation.
- Liquidity and borrowing levels after the acquisition, capital spending, dividends and continued share repurchases.
- Exposure to proposed China tariffs and other sourcing, currency and supply-chain disruptions.
- Progress and costs of planned store closures, lease obligations and the fiscal 2019 lease-accounting transition.
- Resolution of the advertising settlement and foreign exchange-control penalty matter.