Business context and reporting period
Carter’s, Inc. designs, sources and sells branded children’s apparel through wholesale, retail and licensing channels. This filing is a Form 10-Q for the quarter ended October 1, 2011, and covers fiscal 2011’s third quarter and first nine months. This differs from the request metadata’s “2010 Q3”; the filing compares results with periods ended October 2, 2010.
Bonnie Togs, a Canadian children’s apparel retailer, was acquired June 30, 2011. Its results are included from July 3, 2011. The company reported 591 stores at quarter-end, including 37 Bonnie Togs and 27 Carter’s/OshKosh Canadian stores.
Financial results and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $639.6m | $517.9m | $1,503.1m | $1,254.0m |
| Gross profit / margin | $191.9m / 30.0% | $192.8m / 37.2% | $484.4m / 32.2% | $489.9m / 39.1% |
| Operating income / margin | $56.8m / 8.9% | $79.9m / 15.4% | $132.4m / 8.8% | $184.5m / 14.7% |
| Net income | $34.4m | $49.7m | $79.2m | $111.6m |
| Diluted EPS | $0.58 | $0.83 | $1.35 | $1.86 |
Sales rose 23.5% in Q3 and 19.9% year to date, reflecting the acquisition and growth across segments. Net income fell 30.6% and 29.0%, respectively. Gross margin contracted 720 basis points in Q3 and 690 basis points year to date, primarily from higher cotton, labor and other product costs; Q3 and year-to-date results also included $5.9m of acquired-inventory fair-value step-up expense.
For the first nine months, operating cash flow was negative $85.8m, versus positive $5.2m a year earlier, reflecting working-capital changes and lower earnings. Capital expenditures were $29.2m. Cash and equivalents were $81.6m at October 1, 2011, down from $182.3m a year earlier. Receivables were $214.6m and inventories $386.0m.
Debt was $236.0m under the revolving credit facility, with $13.8m of letters of credit outstanding; the facility’s commitment is $375m and expires October 15, 2015. The company said it was in compliance with its financial covenants. It stated that cash, operating cash flow and revolver availability should meet foreseeable working-capital and capital-expenditure needs, but gave no assurance. Fiscal 2011 capital expenditures were expected to be approximately $50m.
Material changes and management commentary
- Carter’s wholesale sales grew 14.6% in Q3, driven by higher unit shipments and average prices. Carter’s retail sales grew 22.3%; comparable sales increased 5.5%, although transactions declined 2.6% as consumer traffic weakened.
- OshKosh retail sales rose 3.2%, but comparable sales declined 2.3% as transactions fell 6.9%. OshKosh wholesale sales increased 2.6%.
- International sales rose to $59.4m in Q3, largely due to Bonnie Togs and higher international wholesale sales. Segment reporting was realigned and prior periods recast.
- Management said elevated product costs and currency effects were expected to pressure profitability and cash flow through at least the first half of fiscal 2012. The company had raised some prices but did not expect to fully offset cost increases; competitive pricing could constrain further increases.
- At October 1, the discounted contingent consideration liability for Bonnie Togs was approximately $23m. Total acquisition consideration was up to CAD $95m, including CAD $60m paid at closing and up to CAD $35m contingent on earnings targets.
- On November 1, 2011, after quarter-end, the company reached an agreement in principle to settle consolidated shareholder class actions; the proposed settlement is to be paid by insurers, subject to definitive agreements and court approval.
Risks, contingencies and unusual items
- Key risks include higher input costs, foreign-exchange movements, consumer weakness, price competition, inventory forecasting, dependence on foreign suppliers and a sourcing agent responsible for approximately 90% of inventory purchases, and risks integrating Bonnie Togs.
- Variable-rate debt was $236.0m; management estimated a 1% rate change would alter annual interest cost by approximately $2.4m.
- Gross unrecognized tax benefits were approximately $9.6m; an IRS audit of fiscal 2009 was ongoing, with no material payment or effective-tax-rate impact anticipated by management.
- The company disclosed continuing government investigations related to historical customer margin support, legal proceedings and potential indemnification costs. The settlement described above remained subject to court approval.
Investor verification priorities
- Confirm the reporting-period discrepancy: the filing is for Q3 fiscal 2011, not Q3 2010.
- Assess whether pricing, sourcing and other actions can offset elevated product costs and restore gross margins.
- Track working-capital needs, inventory levels, cash generation and actual revolver availability.
- Review Bonnie Togs’ operating contribution, integration progress and the contingent-consideration revaluation.
- Verify the status and final terms of the shareholder settlement, insurance coverage and remaining legal or regulatory matters.