Business context and reporting period
Carter’s, Inc. designs, sources and markets children’s apparel and related products under Carter’s, OshKosh and Skip Hop, among other brands. It operated 1,049 stores in the U.S., Canada and Mexico at June 30, 2018. The supplied filing is a Form 10-Q for the fiscal quarter ended June 30, 2018—not 2017 Q2 as stated in the request metadata. Comparisons below are with the quarter and first two fiscal quarters ended July 1, 2017.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $696.2 million | $691.8 million | $1,452.0 million | $1,424.6 million |
| Gross margin | 44.5% | 43.8% | 44.2% | 43.4% |
| Operating income | $57.0 million | $64.3 million | $117.3 million | $142.8 million |
| Operating margin | 8.2% | 9.3% | 8.1% | 10.0% |
| Net income | $37.3 million | $37.8 million | $79.7 million | $84.4 million |
| Diluted EPS | $0.79 | $0.77 | $1.68 | $1.72 |
Q2 sales grew 0.6%; first-half sales grew 1.9%. Higher gross margin reflected favorable product costs and a greater contribution from higher-margin retail channels, partly offset by lower wholesale margins. SG&A rose 5.3% in Q2 and 9.2% in the first half, outpacing sales growth and weighing on operating income. Lower effective tax rates—22.8% in Q2 and 21.2% for the first half, versus 34.5% and 34.8%—helped support earnings per share. Management estimated a full-year 2018 effective tax rate of approximately 22%.
Sales by segment
- U.S. Retail sales increased 2.7% in Q2 and 4.0% year to date, supported by eCommerce and new stores; comparable retail sales, including eCommerce, increased 0.9% and 1.9%, respectively. Comparable store sales declined, primarily with lower traffic.
- U.S. Wholesale sales declined 3.8% in Q2 and 3.9% year to date. Management cited weaker demand related to customer bankruptcies; first-half results included approximately $12.8 million of customer-bankruptcy charges.
- International sales increased 2.6% in Q2 and 10.6% year to date. Acquired businesses and Canada retail contributed to growth, while international wholesale sales declined. Currency translation added approximately $2.6 million to Q2 and $5.4 million to first-half consolidated sales.
Cash flow, balance sheet and capital allocation
- First-half operating cash flow was $103.1 million, down from $107.3 million. Inventory increased by $117.5 million as a use of cash; the filing attributes the year-over-year operating cash-flow decline primarily to lower net income and working-capital timing.
- First-half capital expenditures were $31.8 million. Management planned approximately $85 million for full-year 2018, mainly for store openings and remodels, IT, and distribution facilities.
- Cash was $183.2 million at June 30, 2018. Long-term debt, net, was $682.8 million: $400 million principal on 5.25% senior notes due August 2021 and $286 million drawn on the revolving facility. The revolver had approximately $459.5 million available, excluding $4.5 million of letters of credit; its weighted-average borrowing rate was 3.38%. The company reported compliance with credit-facility covenants.
- Finished-goods inventory was $663.3 million, up 8.7% from July 1, 2017; accounts receivable was $152.5 million, down 7.7% year over year. The filing cautions that balances are affected by seasonality.
- First-half financing used $65.7 million of cash. The company repurchased 820,627 shares for $89.1 million and paid $42.3 million in dividends; quarterly dividends were $0.45 per share. Approximately $496.5 million remained under repurchase authorizations, which have no expiration date.
Outlook, risks and unusual items
- No specific revenue or earnings guidance is provided in the filing. Management expects liquidity from cash on hand, operating cash flow and revolver availability to meet foreseeable needs, and projected approximately 85 million dollars of 2018 capital expenditures.
- Management notes that sales and profitability are seasonal, generally lower in the first half than the second half; interim results may not indicate full-year results. Store-count projections for year-end 2018 were 848 U.S., 187 Canada and 44 Mexico stores.
- Variable-rate borrowings expose the company to interest-rate risk: a 1% rate change on the $286 million revolver balance would change annual pretax interest expense by approximately $2.9 million. Foreign-exchange movements also affect reported results and cash flows.
- The company adopted ASC 606 retrospectively in fiscal 2018. It primarily accelerated recognition of gift-card breakage and reclassified estimated returns; reported prior periods were adjusted, with limited effects on earnings per share.
- The company said it was not party to legal proceedings expected to have a material adverse effect, and reported no material changes to the risk factors in its 2017 Form 10-K. Management concluded disclosure controls were effective and reported no material change in internal control during the quarter.
Important facts for investors to verify
- Size, timing and recoverability of the approximately $12.8 million customer-bankruptcy charge and related wholesale receivables.
- Whether ongoing eCommerce, marketing, distribution and acquired-business costs can be absorbed without further pressure on operating margins.
- Inventory levels, seasonal sell-through and cash conversion, given the year-over-year inventory increase and first-half operating cash flow.
- Debt, variable-rate exposure, covenant headroom and capacity to sustain dividends and share repurchases; debt agreements may restrict distributions.
- Execution of the 2018 store and capital-spending plans, and actual full-year results against management’s approximate 22% tax-rate estimate.