Business context and reporting period
Carter’s, Inc. designs, sources, and markets children’s apparel through wholesale, mass-channel, retail, e-commerce, and licensing businesses. This 10-Q covers the quarter ended July 2, 2011 and the first half of fiscal 2011; the comparable 2010 period ended July 3, 2010. The request metadata says “2010 Q2,” which conflicts with the filing’s stated 2011 reporting period.
On June 30, 2011, Carter’s acquired Canadian retailer Bonnie Togs. The acquisition added 59 stores and had an immaterial effect on the reported quarter’s and half-year’s operating results because it closed near period-end.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $394.5 million | $327.0 million | $863.5 million | $736.1 million |
| Gross profit / margin | $134.7 million / 34.2% | $130.3 million / 39.8% | $292.5 million / 33.9% | $297.1 million / 40.4% |
| Operating income / margin | $22.0 million / 5.6% | $33.4 million / 10.2% | $75.7 million / 8.8% | $104.6 million / 14.2% |
| Net income / diluted EPS | $12.7 million / $0.22 | $19.1 million / $0.32 | $44.8 million / $0.76 | $61.9 million / $1.03 |
- Sales grew 20.6% in Q2 and 17.3% in the first half, with growth across distribution channels. Carter’s retail comparable sales rose 8.1% in Q2 and 4.5% in the first half; OshKosh comparable sales rose 2.2% in Q2 but fell 4.1% in the first half.
- Gross margin fell 560 basis points in Q2 and 650 basis points in the first half, mainly reflecting approximately $30 million and $60 million, respectively, of higher product costs, including cotton and labor inflation. Selective price increases only partly offset costs.
- SG&A increased in dollars but declined as a share of sales: 30.4% versus 31.9% in Q2 and 26.9% versus 28.5% in the first half. Higher e-commerce operating and marketing costs partly offset expense leverage.
- Cash and equivalents were $86.7 million at July 2, 2011, versus $245.0 million a year earlier. First-half operating cash flow was negative $86.3 million, versus positive $15.3 million, primarily due to working-capital changes and lower earnings; inventory increased to $458.1 million from $260.7 million a year earlier.
- First-half capital expenditures were $16.1 million; management expected approximately $55 million for fiscal 2011, primarily for store openings and information technology.
- Long-term debt was $236.0 million, all under a revolving facility expiring October 2015; outstanding letters of credit were $18.5 million. The facility is $375 million, and the company said it was in covenant compliance. Variable-rate debt exposure was $236 million; a 1 percentage-point rate change would change annual interest cost by approximately $2.4 million.
- Current assets were $709.9 million and current liabilities $156.7 million. Stockholders’ equity was $732.9 million. No dividend or repurchase activity was reported for the periods.
Material changes, outlook, and risks
- Bonnie Togs was acquired for CAD $60 million cash at closing, subject to adjustment, with up to CAD $35 million of additional contingent consideration tied to earnings targets through June 2015. Carter’s recorded a discounted contingent-consideration liability of approximately $24 million and will remeasure it as expectations change. Preliminary purchase accounting included $54.5 million of goodwill.
- Management expected higher product costs to continue pressuring profitability and cash flow through at least the first half of fiscal 2012. It planned selective price increases but said it did not expect to offset all cost increases in the near term; customer acceptance and competitive pricing remain uncertainties.
- Management expected cash, operating cash generation, and revolver availability to fund working capital and planned capital spending for the foreseeable future, while noting there could be no assurance. The company’s sales and profitability are seasonal, with about 57% of sales historically generated in the second half; first-half results may not indicate full-year performance. No full-year earnings guidance is provided in the text.
- Store plans included 55 Carter’s openings for fiscal 2011, with no further Carter’s closures anticipated in the second half; for OshKosh, three openings and 13 closures were planned. The company also planned six co-branded Canadian stores in the second half.
- Key risks include raw-material, labor, freight, and currency costs; consumer demand and promotional pressure; foreign sourcing and supplier concentration; inventory forecasting; variable interest rates; and integrating and operating the Canadian acquisition.
- Shareholder securities litigation remained active: after dismissal without prejudice in March 2011, plaintiffs filed a second amended complaint on July 20, 2011; the company said it intended to defend the case. A derivative action and government investigations were also disclosed. The company reported approximately $9.5 million of gross unrecognized tax benefits.
Important facts for investors to verify
- Confirm the reporting period: the filing is for Q2 2011, despite the request metadata’s “2010 Q2.”
- Track whether pricing, sourcing, and cost actions stabilize gross margin as elevated product costs persist.
- Assess inventory growth, operating cash conversion, and liquidity after the acquisition and planned capital expenditures.
- Monitor Bonnie Togs integration, store expansion, purchase-accounting adjustments, and the probability-sensitive contingent-consideration liability.
- Review revolver availability and covenant headroom, and the effects of variable rates and legal or tax matters.