CARTERS INC (CRI) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
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 contains certain forward-looking statements within the meaning of the federal securities laws relating to our future performance. 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 2022 to our results for fiscal year 2021 and other financial information related to fiscal year 2021, refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2022 Annual Report on Form 10-K, filed with the SEC on February 24, 2023.
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 2023 ended on December 30, 2023, fiscal 2022 ended on December 31, 2022, and fiscal 2021 ended on January 1, 2022. All three fiscal years contained 52 calendar weeks.
Our Business
We are the largest branded marketer of young children’s apparel in North America. We own two of the most highly recognized and trusted brand names in the children’s apparel market, Carter’s and OshKosh B’gosh (or “OshKosh”). We also own Skip Hop, a leading young children’s lifestyle brand, Little Planet, a brand focused on organic fabrics and sustainable materials and exclusive Carter’s brands developed for Amazon, Target, and Walmart.
Our multichannel global business model, which includes retail stores, eCommerce, and wholesale distribution 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 the end of fiscal 2023, our channels included 1,034 company-owned retail stores, eCommerce websites, approximately 19,350 wholesale locations in North America, as well as our international wholesale accounts and licensees who operate in over 1,100 locations outside of North America in over 90 countries.
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. 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 business segments is contained in Item 8 “Financial Statements and Supplementary Data” and under Note 18, 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. 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, purchasing, receiving, 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.
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Known or Anticipated Trends
Macroeconomic Factors and Consumer Demand
Macroeconomic factors, including inflationary pressures on families with young children, increased interest rates, the lapping of government stimulus, increased consumer debt levels, decreased savings rates, resumption of student loan repayments, geopolitical unrest, and increased risks of a recession continued to create a complex and challenging environment for our business in fiscal 2023. We believe these macroeconomic factors have resulted in lower consumer sentiment and negatively impacted demand for our products. While the impact of these macroeconomic factors is difficult to quantify, we expect continued pressure on consumer demand in fiscal 2024.
Inflationary Pressures
In fiscal 2022, the cost of transportation, particularly ocean freight rates, raw materials, packaging materials, labor, energy, fuel, and other inputs necessary for the production and distribution of our products rapidly increased. As a result, we offset some of these cost pressures through increases in the selling prices of some of our products, product cost optimization, increasing and diversifying our portfolio of suppliers, renegotiating our longer-term shipping container contracts, and reductions in discretionary spending.
While some of these inflationary pressures, including freight input costs and product input costs, improved in fiscal 2023 and we expect further improvement in fiscal 2024, we may continue to experience inflationary pressures on our product input costs and distribution costs. Additionally, our pricing actions could have an adverse impact on demand and may not be sufficient to cover all increased costs that we may experience.
Inventory Levels
As consumer and wholesale customer demand in the marketplace began to slow in fiscal 2022 in response to the onset of significant inflation, the Company implemented a strategy whereby inventory originally intended for sale in fiscal 2022 was packed and held (“pack and hold” inventory) for sale profitably in a future period. In fiscal 2023, the Company had profitably sold through the majority of this inventory. Additionally, in response to increased inventory levels at the end of fiscal 2022, the Company utilized its own retail channel, as well as off-price channels, to sell through excess inventory.
Compared to the end of fiscal 2022, our inventories decreased $207.4 million, or 27.9%, to $537.1 million, due to this decreased “pack and hold” inventory, decreased days of supply, and decreased product costs. “Pack and hold” inventory decreased $88.0 million, or 88.7% to $11.2 million. In part due to our inventory management strategies taken in fiscal 2023, inventory provisions as a percentage of sales decreased and benefited our gross margin by approximately 50 basis points (“bps”).
We are currently experiencing stable inventory levels, inventory transit times, and flow of seasonal product in line with our historical experience. As a result, we expect inventory levels in the first quarter of fiscal 2024 to be lower than those in the first quarter of fiscal 2023, and we expect inventory levels in the remainder of fiscal 2024 to be relatively consistent with those in the same periods in fiscal 2023.
Recent Developments
Red Sea Conflict
We have recently experienced delays with respect to our inventory shipments via ocean vessels due to attacks by a militant group at the entrance to the Red Sea region. These attacks have required our carriers to route shipments around the Cape of Good Hope at the southern tip of Africa, which has added an additional seven to ten days of transit time. Typically, approximately 65% of our products are shipped through the Red Sea to arrive at their destination on the East Coast of the U.S. and we expect delays of approximately seven to ten days if the hostilities in the region continue. We expect that the adverse impact of the hostilities in the region, including additional transportation fees to re-reroute these shipments, could be approximately $6.0 to $7.0 million through the end of June 2024. If these hostilities continue or escalate, our business and results of operations could be materially adversely affected.
Organizational Restructuring
In fiscal 2023, we initiated several organizational restructuring initiatives which included a reorganization of staffing models across multiple functions to drive labor savings and increase efficiencies. In conjunction with these plans, we incurred costs of approximately $6.2 million in fiscal 2023. These costs were primarily related to severance and other termination benefits. As of
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December 30, 2023, there is approximately $1.9 million related to these plans included in Other current liabilities on our consolidated balance sheets.
Corporate Office Lease Amendment
During the first quarter of fiscal 2023, we executed an amendment to the lease of our corporate headquarters in Atlanta, Georgia which resulted in returning three floors to the landlord and extending the lease to 2035. As a result of the reduction in leased office space, we recorded a net gain of $1.8 million related to the partial termination of the lease in the first quarter of fiscal 2023.
Business Strategies and Outlook
We believe that our growth in the years ahead will be driven by new retail store openings and omni-channel sales in North America and our exclusive Carter’s brands in the wholesale channel.
During fiscal 2023, we opened 48 stores and closed 13 low-margin stores in our U.S. Retail segment. We are projecting approximately 40 new store openings and 30 store closures in fiscal 2024, with a greater number of net store openings in future years.
In our U.S. Wholesale segment, we expect our exclusive Carter’s brands to be the largest contributor to our sales growth, with additional growth planned across customers that sell our core Carter’s brand.
In international markets, we expect our growth will be driven through new store openings and omni-channel capabilities in Mexico and Canada, expansion through our wholesale partner in Brazil, and growth with other wholesale customers.
We expect that our profitability in the years ahead will be driven by improved inventory management and pricing capabilities, favorable trends in product costs and ocean freight rates, productivity benefits that enable investments in growth, and continued return of capital through share repurchases
Fiscal Year 2023 Financial Highlights
Unless otherwise stated, comparisons are to fiscal 2022.
•Consolidated net sales decreased $267.1 million, or 8.3%, to $2.95 billion, due to macroeconomic factors, including inflationary pressures on families with young children, increased interest rates, increased consumer debt levels, decreased savings rates, and risk of recession, driving lower consumer demand.
•Gross margin increased 160 bps to 47.4%, due to decreased inventory provisions, decreased ocean freight rates, and improved price realization.
•SG&A expenses decreased $16.1 million, or 1.4%, to $1.09 billion, due to decreased eCommerce expenses on decreased sales, decreased transportation costs, and decreased marketing expenses. SG&A as a percentage of consolidated net sales (“SG&A rate”) increased 250 bps to 37.1%, due to fixed cost deleverage on decreased sales, increased performance-based compensation expense, and increased consulting costs. Our consulting costs were incurred as an investment in our ongoing initiatives to grow our market share, deepen our relationships with our current customers, improve productivity, and increase shareholder value. While we will continue to focus on effectively managing our variable costs, we will also look to invest in growing our business, including adding new omni-channel capabilities, opening new retail stores, and investing in more effective brand marketing.
•Consolidated operating income decreased $55.8 million, or 14.7%, to $323.4 million, and adjusted operating income, a non-GAAP financial measure, decreased 60.4 million, or 15.5%, to 327.8 million. The decrease in consolidated operating income is due to the factors discussed above, partially offset by the nonrecurrence of a $9.0 million non-cash pre-tax impairment charge related to the Skip Hop tradename in fiscal 2022.
•Other (income) expense, net was $8.0 million in fiscal 2023, primarily due to a $6.9 million payment received in January 2024 as a result of a court-approved settlement in December 2023 related to payment card interchange fees.
•Diluted net income per common share decreased $0.10, or 1.6%, to $6.24, and adjusted diluted net income per common share decreased $0.71, or 10.3%, to $6.19.
•Inventories decreased $207.4 million, or 27.9%, to $537.1 million, due to decreased “pack and hold” inventory, decreased days of supply, and decreased product costs.
•As a result of our strong financial position and available liquidity, we returned $212.0 million to our shareholders, comprised of $100.0 million in share repurchases and $112.0 million in cash dividends.
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RESULTS OF OPERATIONS
2023 FISCAL YEAR ENDED DECEMBER 30, 2023 COMPARED TO 2022 FISCAL YEAR ENDED DECEMBER 31, 2022
The following table summarizes our results of operations:
| Fiscal year ended | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands, except per share data) | December 30, 2023 | December 31, 2022 | $ Change | % / bps Change | ||||||||||
| Consolidated net sales | $ | 2,945,594 | $ | 3,212,733 | $ | (267,139) | (8.3) | % | ||||||
| Cost of goods sold | 1,549,659 | 1,740,375 | (190,716) | (11.0) | % | |||||||||
| Gross profit | 1,395,935 | 1,472,358 | (76,423) | (5.2) | % | |||||||||
| Gross profit as % of consolidated net sales | 47.4 | % | 45.8 | % | 160 bps | |||||||||
| Royalty income, net | 21,410 | 25,820 | (4,410) | (17.1) | % | |||||||||
| Royalty income as % of consolidated net sales | 0.7 | % | 0.8 | % | (10) bps | |||||||||
| Selling, general, and administrative expenses | 1,093,940 | 1,110,007 | (16,067) | (1.4) | % | |||||||||
| SG&A expenses as % of consolidated net sales | 37.1 | % | 34.6 | % | 250 bps | |||||||||
| Intangible asset impairment | — | 9,000 | (9,000) | nm | ||||||||||
| Operating income | 323,405 | 379,171 | (55,766) | (14.7) | % | |||||||||
| Operating income as % of consolidated net sales | 11.0 | % | 11.8 | % | (80) bps | |||||||||
| Interest expense | 33,973 | 42,781 | (8,808) | (20.6) | % | |||||||||
| Interest income | (4,776) | (1,261) | (3,515) | 278.7 | % | |||||||||
| Other (income) expense, net | (8,034) | 975 | (9,009) | nm | ||||||||||
| Loss on extinguishment of debt | — | 19,940 | (19,940) | nm | ||||||||||
| Income before income taxes | 302,242 | 316,736 | (14,494) | (4.6) | % | |||||||||
| Income tax provision | 69,742 | 66,698 | 3,044 | 4.6 | % | |||||||||
| Effective tax rate(*) | 23.1 | % | 21.1 | % | 200 bps | |||||||||
| Net income | $ | 232,500 | $ | 250,038 | $ | (17,537) | (7.0) | % | ||||||
| Basic net income per common share | $ | 6.24 | $ | 6.34 | $ | (0.10) | (1.6) | % | ||||||
| Diluted net income per common share | $ | 6.24 | $ | 6.34 | $ | (0.10) | (1.6) | % | ||||||
| Dividend declared and paid per common share | $ | 3.00 | $ | 3.00 | $ | — | — | % |
(*)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 decreased $267.1 million, or 8.3%, to $2.95 billion. This decrease was driven by macroeconomic factors, including inflationary pressures on families with young children, increased interest rates, increased consumer debt levels, decreased savings rates, and risk of recession, driving lower consumer demand. This decreased demand resulted in lower traffic in our eCommerce channels and in our retail stores in the United States and Canada. These decreases were partially offset by increased average selling prices per unit due to improved price realization and growth from our Mexican retail stores. Units sold decreased in the low-teens, while average selling prices per unit increased low-single digits. Changes in foreign currency exchange rates used for translation in fiscal 2023 had an immaterial impact on our consolidated net sales.
Gross Profit and Gross Margin
Our consolidated gross profit decreased $76.4 million, or 5.2%, to $1.40 billion and consolidated gross margin increased 160 bps to 47.4%. The decrease in consolidated gross profit was impacted by decreased net sales. The increase in consolidated gross margin was driven by decreased inventory provisions and increased average selling prices per unit. In part due to our inventory management strategies taken in fiscal 2023, inventory provisions as a percentage of sales decreased and favorably impacted gross margin by approximately 50 bps. These factors were partially offset by an increase in the mix of U.S. Wholesale net sales, including sales of our exclusive Carter’s brands, which have a lower contribution to gross margin than our U.S. Retail segment. Average cost per unit sold remained relatively consistent as increased product input costs were offset by decreased
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ocean freight rates. We expect product input costs to decrease in fiscal 2024, and we expect inbound transportation rates, including ocean freight rates, to decrease in the first half of fiscal 2024.
Royalty Income
We have licensing agreements with domestic and international licensees that grant licensees the right to access certain trademarks in return for royalty payments or licensing fees. Royalty income decreased $4.4 million, or 17.1%, to $21.4 million, driven by decreased customer demand.
Selling, General, and Administrative Expenses
Consolidated SG&A expenses decreased $16.1 million, or 1.4%, to $1.09 billion in fiscal 2023 while SG&A rate increased approximately 250 bps to 37.1%. The increase in SG&A rate was driven by fixed cost deleverage on decreased sales, increased performance-based compensation expense, increased consulting and professional fees, retail store openings, and organizational restructuring charges. Our consulting costs were incurred as an investment in our ongoing initiatives to grow our market share, deepen our relationships with our current customers, improve productivity, and increase shareholder value. These factors were partially offset by decreased transportation costs and expenses related to the relocation of inventory from an exited third-party warehouse in fiscal 2022 that did not reoccur in fiscal 2023. Performance-based compensation expense as a percentage of net sales increased 50 bps, due to a lower-than-expected financial performance in fiscal 2022.
Intangible Asset Impairment
In fiscal 2022, we recognized a non-cash pre-tax impairment charge of $9.0 million related to our Skip Hop indefinite-lived tradename asset. There were no impairments recorded to goodwill or indefinite-lived intangible assets in fiscal 2023.
Operating Income
Consolidated operating income decreased $55.8 million, or 14.7%, to $323.4 million, and consolidated operating margin decreased as a percentage of net sales by approximately 80 bps to 11.0%, due to the factors discussed above.
Interest Expense
Interest expense decreased $8.8 million, or 20.6%, to $34.0 million due to a decrease in weighted-average borrowings. Weighted-average borrowings were $545.5 million at an effective interest rate of 6.22%, compared to weighted-average borrowings for fiscal 2022 of $738.7 million at an effective interest rate of 5.84%.
The decrease in weighted-average borrowings was attributable to the early extinguishment of our $500 million in aggregate principal amount of 5.500% senior notes due May 2025 in the second quarter of fiscal 2022 and decreased borrowings under our secured revolving credit facility for fiscal 2023. The increase in the effective interest rate was due to increased interest rates on our secured revolving credit facility, reflecting the broader rise in market interest rates.
Loss on Extinguishment of Debt
During fiscal 2022, loss on extinguishment of debt was $19.9 million due to the early extinguishment of our $500 million in aggregate principal amount of 5.500% senior notes due May 2025.
Other (Income) Expense, Net
Other (income) expense, net was $8.0 million in fiscal 2023, primarily due to a net $6.9 million payment received in January 2024 as a result of a court-approved settlement in December 2023 related to payment card interchange fees.
Income Taxes
Our consolidated income tax provision increased $3.0 million, or 4.6%, to $69.7 million, and the effective tax rate increased approximately 200 bps to 23.1%. The increased effective tax rate relates to a higher proportion of income generated in the United States, which is a higher tax jurisdiction relative to the locations of our international operations.
Net Income
Our consolidated net income decreased $17.5 million, or 7.0%, to $232.5 million, due to the factors previously discussed.
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Results by Segment - Fiscal Year 2023 compared to Fiscal Year 2022
The following table summarizes net sales and operating income, by segment, for the fiscal years ended December 30, 2023 and December 31, 2022:
| Fiscal year ended | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | December 30, 2023 | % of consolidated net sales | December 31, 2022 | % of consolidated net sales | $ Change | % Change | ||||||||||||||
| Net sales: | ||||||||||||||||||||
| U.S. Retail | $ | 1,501,780 | 51.0 | % | $ | 1,680,159 | 52.3 | % | $ | (178,379) | (10.6) | % | ||||||||
| U.S. Wholesale | 1,014,584 | 34.4 | % | 1,080,471 | 33.6 | % | (65,887) | (6.1) | % | |||||||||||
| International | 429,230 | 14.6 | % | 452,103 | 14.1 | % | (22,873) | (5.1) | % | |||||||||||
| Consolidated net sales | $ | 2,945,594 | 100.0 | % | $ | 3,212,733 | 100.0 | % | $ | (267,139) | (8.3) | % | ||||||||
| Operating income: | % of segment net sales | % of segment net sales | ||||||||||||||||||
| U.S. Retail | $ | 190,620 | 12.7 | % | $ | 252,497 | 15.0 | % | $ | (61,877) | (24.5) | % | ||||||||
| U.S. Wholesale | 198,849 | 19.6 | % | 161,659 | 15.0 | % | 37,190 | 23.0 | % | |||||||||||
| International | 44,940 | 10.5 | % | 56,617 | 12.5 | % | (11,677) | (20.6) | % | |||||||||||
| Unallocated corporate expenses | (111,004) | n/a | (91,602) | n/a | (19,402) | 21.2 | % | |||||||||||||
| Consolidated operating income | $ | 323,405 | 11.0 | % | $ | 379,171 | 11.8 | % | $ | (55,766) | (14.7) | % |
Comparable Sales Metrics
We present comparable sales metrics because we consider them an important supplemental measure of our U.S. Retail and International performance, and the Company uses such information to assess the performance of the U.S. Retail and International segments. Additionally, we believe they are frequently used by securities analysts, investors, and other interested parties in the evaluation of our business.
Our comparable sales metrics include sales for all stores and eCommerce sites that were open and operated by us during the comparable fiscal period, including stand-alone format stores that converted to multi-branded format stores and certain remodeled or relocated stores. A store or site becomes comparable following 13 consecutive full fiscal months of operations. If a store relocates within the same center with no business interruption or material change in square footage, the sales of such store will continue to be included in the comparable store metrics. If a store relocates to another center more than five miles away, or there is a material change in square footage, such store is treated as a new store. Stores that are closed during the relevant fiscal period are included in the comparable store sales metrics up to the last full fiscal month of operations.
The method of calculating sales metrics varies across the retail industry. As a result, our comparable sales metrics may not be comparable to those of other retailers.
U.S. Retail
U.S. Retail segment net sales decreased $178.4 million, or 10.6%, to $1.50 billion. The decrease in net sales was driven by macroeconomic factors, including inflationary pressures on families with young children, increased interest rates, increased consumer debt levels, decreased savings rates, and risk of recession, driving lower consumer demand. This decreased demand resulted in lower traffic in our eCommerce channels and in our retail stores. This decrease was partially offset by increased average selling prices per unit due to improved price realization. Units sold decreased in the mid-teens, while average selling prices per unit increased mid-single digits.
Comparable net sales, including retail store and eCommerce, decreased 12.2% driven by the factors mentioned above. As of December 30, 2023, we operated 792 retail stores in the U.S. compared to 757 in fiscal 2022.
U.S. Retail segment operating income decreased $61.9 million, or 24.5%, to $190.6 million, due to a decrease in gross profit of $91.0 million, partially offset by a decrease in SG&A expenses of $31.0 million. Operating margin decreased 230 bps to 12.7%. The primary drivers of the decrease in operating margin were a 320 bps increase in SG&A rate, partially offset by a 90 bps increase in gross margin. The increase in gross margin was due to increased average selling prices per unit and decreased
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inventory provisions, partially offset by increased average cost per unit and an increased mix of clearance sales. Average cost per unit increased low-single digits, reflecting increases to product input costs, partially offset by decreased ocean freight rates. The increase in the SG&A rate was driven by fixed cost deleverage on decreased net sales, increased performance-based compensation expense, and retail store openings, partially offset by decreased marketing expense.
U.S. Wholesale
U.S. Wholesale segment net sales decreased $65.9 million, or 6.1%, to $1.01 billion, driven by macroeconomic factors and reflects lower seasonal bookings and lower consumer replenishment demand as our wholesale customers executed inventory reductions during fiscal 2023. Unit sold decreased high-single digits, while average selling prices per unit increased low-single digits.
U.S. Wholesale segment operating income increased $37.2 million, or 23.0%, to $198.8 million, due to an increase of gross profit of $17.2 million and a decrease in SG&A expenses of $15.7 million. Operating margin increased 460 bps to 19.6%. Operating income in fiscal 2022 included an intangible asset impairment charge of $5.6 million related to the Skip Hop tradename. The primary drivers of the increase in operating margin were a 330 bps increase in gross margin, an 80 bps decrease in SG&A rate, and the nonrecurrence of the intangible asset impairment charge in fiscal 2022. The increase in gross margin was due to increased average selling prices per unit, decreased inventory provisions and fabric purchase commitment charges, and decreased air freight costs. Due in part to our inventory management strategies taken in fiscal 2023, inventory provisions as a percentage of sales decreased and benefited our gross margin by approximately 110 bps. These factors were partially offset by an increased mix of sales of our exclusive Carter’s brands and off-priced sales. Average cost per unit sold remained relatively consistent as increased product input costs were offset by decreased ocean freight rates. The decrease in the SG&A rate was driven by decreased transportation costs and expenses related to the relocation of inventory from an exited third-party warehouse in fiscal 2022 that did not reoccur in fiscal 2023, partially offset by fixed cost deleverage on decreased sales and increased performance-based compensation expense.
International
International segment net sales decreased $22.9 million, or 5.1%, to $429.2 million in fiscal 2023. Changes in foreign currency exchange rates, primarily between the U.S. dollar and the Canadian dollar, used for translation in fiscal 2023 had an immaterial impact on International segment net sales. The decrease in net sales was driven by decreased net sales in Canada, decreased demand from our international wholesale partners, and a strengthening of the U.S. Dollar against other foreign currencies. These decreases were partially offset by growth in sales in our Mexico retail stores and wholesale channels and increased average selling prices per unit. Units sold decreased high-single digits, while average selling prices per unit increased mid-single digits.
Canadian comparable net sales, including retail stores and eCommerce, decreased 7.3% driven by decreased traffic in our eCommerce channel and in our retail stores. As of December 30, 2023, we operated 188 retail stores in Canada, compared to 187 at the end of fiscal 2022. As of December 30, 2023, we operated 54 retail stores in Mexico, compared to 49 in fiscal 2022.
International segment operating income decreased $11.7 million, or 20.6%, to $44.9 million, due to a decrease in gross profit of $2.6 million and an increase in SG&A expenses of $11.3 million. Operating margin decreased 200 bps to 10.5%. Operating income in fiscal 2022 included an intangible asset impairment charge of $3.0 million related to the Skip Hop tradename. The primary drivers of the decrease in operating margin were a 440 bps increase in SG&A rate, partially offset by a 180 bps increase in gross margin and the nonrecurrence of the intangible asset impairment charge in fiscal 2022. The increase in gross margin was due to increased average selling prices per unit and decreased inventory provisions. Average cost per unit sold remained relatively consistent as increases to product input costs were offset by decreased ocean freight rates. The increase in the SG&A rate was due to fixed cost deleverage on decreased sales, increased investments in our Mexican retail stores and technology, and increased performance-based compensation expense.
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 performance-based compensation.
Unallocated corporate expenses increased $19.4 million, or 21.2%, to $111.0 million in fiscal 2023, and unallocated corporate expenses, as a percentage of consolidated net sales, increased 90 bps to 3.8%. The increase as a percentage of consolidated net
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sales was driven fixed cost deleverage on decreased sales, increased consulting and professional fees, organizational restructuring charges, and increased performance-based compensation expense.
RECONCILIATION OF NON-GAAP FINANCIAL MEASURES TO GAAP MEASURES
We have provided non-GAAP adjusted operating income, income taxes, net income, and diluted net income per common share measures, which exclude certain items presented below. We believe that this information provides a meaningful comparison of our results and affords investors a view of what management considers to be our core performance, and we also, from time to time, use some of these non-GAAP measures, such as adjusted operating income, as performance metrics in awards under our annual and long-term incentive compensation plans. These measures are not in accordance with, or an alternative to, generally accepted accounting principles in the U.S. (GAAP). The most comparable GAAP measures are operating income, income tax provision, net income, and diluted net income per common share, respectively. Adjusted operating income, income taxes, net income, and diluted net income per common share should not be considered in isolation or as a substitute for analysis of our results as reported in accordance with GAAP. Other companies may calculate adjusted operating income, income taxes, net income, and diluted net income per common share differently than we do, limiting the usefulness of the measure for comparisons with other companies.
| Fiscal Year Ended | |||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 30, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||||
| (In millions, except earnings per share) | Operating Income | % Net Sales | Income Taxes | Net Income | Diluted Net Income per Common Share | Operating Income | % Net Sales | Income Taxes | Net Income | Diluted Net Income per Common Share | |||||||||||||||||||||||||||
| As reported (GAAP) | $ | 323.4 | 11.0 | % | $ | 69.7 | $ | 232.5 | $ | 6.24 | $ | 379.2 | 11.8 | % | $ | 66.7 | $ | 250.0 | $ | 6.34 | |||||||||||||||||
| Organizational restructuring(1) | 4.4 | 1.0 | 3.4 | 0.09 | — | — | — | — | |||||||||||||||||||||||||||||
| Legal settlement(2) | — | (1.7) | (5.3) | (0.14) | — | — | — | — | |||||||||||||||||||||||||||||
| Loss on extinguishment of debt(3) | — | — | — | — | — | 4.8 | 15.2 | 0.38 | |||||||||||||||||||||||||||||
| Intangible asset impairment(4) | — | — | — | — | 9.0 | 2.1 | 6.9 | 0.17 | |||||||||||||||||||||||||||||
| As adjusted | $ | 327.8 | 11.1 | % | $ | 69.1 | $ | 230.6 | $ | 6.19 | $ | 388.2 | 12.1 | % | $ | 73.6 | $ | 272.0 | $ | 6.90 |
(1)Related to charges for organizational restructuring and related corporate office lease amendment actions in fiscal 2023.
(2)In fiscal 2023, a pre-tax adjustment of approximately $6.9 million ($5.3 million net of tax, or $0.14 per diluted share) was made related to a gain on a court-approved settlement in December 2023.
(3)In fiscal 2022, a pre-tax adjustment of approximately $19.9 million ($15.2 million net of tax, or $0.38 per diluted share) was made related to a loss on extinguishment of debt in fiscal 2022.
(4)Related to the write-down of the Skip Hop tradename asset in fiscal 2022.
Note: Results may not be additive due to rounding.
LIQUIDITY AND CAPITAL RESOURCES
Our ongoing cash needs are primarily for working capital (consisting primarily of inventory), capital expenditures, employee compensation, interest on debt, the return of capital to our shareholders, and other general corporate purposes. 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 are sufficient to meet our cash requirements for at least the next twelve months. However, these sources of liquidity may be affected by events described in the “Forward-Looking Statements” section, in our risk factors, as discussed under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K, and in other reports filed with the Securities and Exchange Commission from time to time.
As discussed under the heading “Known or Anticipated Trends” in Part II, Item 7 of this Annual Report on Form 10-K, we expect continued pressure on consumer sentiment in fiscal 2024, which may adversely impact our financial results in fiscal 2024. We cannot predict the timing and amount of such impact.
As of December 30, 2023, we had approximately $351.2 million of cash and cash equivalents held at major financial institutions, including approximately $79.0 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
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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 December 30, 2023 were $183.8 million compared to $198.6 million at December 31, 2022. The decrease of $14.8 million, or 7.5%, was driven by decreased net sales and the timing of wholesale customer shipments and associated payments.
Inventories at December 30, 2023 were $537.1 million compared to $744.6 million at December 31, 2022. The decrease of $207.4 million, or 27.9%, was due to decreased “pack and hold” inventory, decreased days of supply, and decreased product costs. We are currently experiencing stable inventory levels, inventory transit times, and flow of seasonal product in line with our historical experience. As a result, we expect inventory levels in the first quarter of fiscal 2024 to be lower than those in the first quarter of fiscal 2023, and we expect inventory levels in the remainder of fiscal 2024 to be relatively consistent with those in the same periods in fiscal 2023.
Accounts payable at December 30, 2023 were $242.1 million compared to $264.1 million at December 31, 2022. The decrease of $21.9 million, or 8.3%, is driven by the timing of payments to our vendors and a decrease in open capital expenditures projects at the end of the year.
Cash Flow
Net Cash Provided by Operating Activities
Net cash provided by operating activities increased $440.8 million, or 498.9%, to $529.1 million. Our cash flow provided by operating activities is driven by net income and changes in our net working capital. The increase in operating cash flows in fiscal 2023 was primarily due to favorable changes in working capital, including a 27.9% reduction in inventories, and lower payments of performance-based compensation, partially offset by decreased net income.
Net Cash Used in Investing Activities
Net cash used in investing activities increased $19.5 million, or 48.3%, to $59.9 million. This increase in net cash used in investing activities is primarily due to increased capital expenditures. Capital expenditures in fiscal 2023 primarily included $42.2 million for our U.S. and international retail store openings and remodels, $9.0 million for information technology, and $7.2 million for our distribution facilities.
We plan to invest approximately $80 million in capital expenditures in fiscal 2024, which primarily relates to U.S. and international retail store openings and remodels, investments in our distribution facilities, and strategic information technology initiatives.
Net Cash Used in Financing Activities
Net cash used in financing activities decreased $486.6 million, or 59.4%, to $332.6 million. This change in cash flow used in financing activities was primarily due to the early extinguishment of our $500 million in aggregate principal amount of 5.500% senior notes due May 2025 in the second quarter of fiscal 2022 and decreased commons stock share repurchases, partially offset by payments on our secured revolving credit facility.
Share Repurchases
On February 24, 2022, our Board of Directors authorized share repurchases up to $1.00 billion, inclusive of $301.9 million remaining under previous authorizations. The total remaining capacity under outstanding repurchase authorizations as of December 30, 2023 was approximately $649.5 million, based on settled repurchase transactions. The share repurchase authorizations have no expiration dates.
In fiscal 2023, we repurchased and retired 1,446,269 shares in open market transactions for approximately $100.0 million, at an average price of $69.17 per share. In fiscal 2022, we repurchased and retired 3,747,187 shares in open market transactions for approximately $299.7 million, at an average price of $79.97 per share.
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 the discretion of the Company subject to restrictions under the Company’s secured revolving credit facility and considerations given to market conditions, stock price, other investment priorities, excise taxes, and other factors.
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Dividends
On February 26, 2024, the Company's Board of Directors declared a quarterly cash dividend payment of $0.80 per common share, payable on March 29, 2024 to shareholders of record at the close of business on March 11, 2024.
In each quarter of fiscal 2023, the Board of Directors declared, and the Company paid, a cash dividend per common share of $0.75 (for an aggregate cash dividend per common share of $3.00 for fiscal 2023). In fiscal 2022 the Board of Directors declared, and the Company paid, a cash dividend per common share of $0.75 (for an aggregate cash dividend per common share of $3.00 for fiscal 2022). 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 10, Long-Term Debt, to the consolidated financial statements.
Financing Activities
Secured Revolving Credit Facility
As of December 30, 2023, we had no outstanding borrowings under our secured revolving credit facility, exclusive of $4.4 million of outstanding letters of credit. As of December 31, 2022, we had $120.0 million outstanding borrowings under our secured revolving credit facility, exclusive of $3.5 million of outstanding letters of credit. As of December 30, 2023 and December 31, 2022, there was approximately $845.6 million and $726.5 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 $850 million which includes a $750 million U.S. dollar facility and a $100 million multicurrency facility. The credit facility matures in April 2027. 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 April 11, 2022, the Company, through TWCC entered into Amendment No. 4 to its fourth amended and restated credit agreement (“Amendment No. 4”) that, among other things, increased the borrowing capacity of the secured revolving credit facility to $850.0 million (combined U.S. dollar and multicurrency facility borrowings), extended the maturity of the secured revolving credit facility from September 2023 to April 2027, and reduced the number of financial maintenance covenants from two to one.
In particular, Amendment No. 4 provides for the following:
•increases the borrowing capacity of the secured revolving credit facility from $750 million to $850 million - the U.S. Dollar facility commitment increases to $750 million from $650 million and the multicurrency facility commitment remains at $100 million;
•extends the maturity of the secured revolving credit facility from September 2023 to April 2027;
•adds a springing maturity date component, which states that if the Company has not redeemed or refinanced at least $250 million of the senior notes due 2027 prior to the 91st day before the maturity of the senior notes due March 15, 2027, then the maturity date of the secured revolving credit facility will be the 91st day before the original maturity of the senior notes due 2027;
•reduces the number of financial maintenance covenants from two to one - the Lease Adjusted Leverage Ratio has been simplified to a Consolidated Total Leverage Ratio and the Consolidated Fixed Charge Coverage Ratio has been eliminated. The Consolidated Total Leverage Ratio maximum permitted shall be 3.50:1.00 and temporarily increases to 4.00:1:00 in the event of a Material Acquisition;
•Term Benchmark Loans bear interest at a rate determined by reference to the Adjusted Term SOFR (Secured Overnight Financing Rate), CDOR (Canadian Dollar Offered Rate), or the Adjusted EURIBOR (Euro Interbank
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Offered Rate). Each Term Benchmark Loan is subject to interest charges equal to the per annum respective benchmark rate plus an initial applicable rate of 1.375% which may be adjusted from 1.125% to 1.625% based upon a leverage-based pricing schedule; and
•Other Base, Prime, and Overnight Rate Loans are subject to interest charges equal to the per annum, respective, benchmark rate plus an initial applicable rate of 0.375% which may be adjusted from 0.125% to 0.625% based upon a leverage-based pricing schedule. An Applicable Commitment Fee initially equal to 0.20% per annum and ranging from 0.15% per annum to 0.25% per annum, based upon a leverage-based pricing grid, is payable quarterly in arrears with respect to the average daily unused portion of the revolving loan commitments. Capitalized items are Defined Terms pursuant to Amendment No. 4, dated as of April 11, 2022.
Approximately $2.4 million, including both bank fees and other third-party expenses, was capitalized in fiscal 2022 in connection with Amendment No. 4 and is being amortized over the remaining term of the secured revolving credit facility.
As of December 30, 2023, the interest rate margins applicable to the amended revolving credit facility were 1.375% for adjusted term SOFR rate loans and 0.375% for base rate loans.
Weighted-average borrowings were $45.6 million and $106.6 million for fiscal 2023 and fiscal 2022, respectively. The effective interest rate for borrowings under the secured revolving credit facility during fiscal 2023 was 6.07%. As of December 30, 2023, any U.S. dollar borrowings outstanding under the secured revolving credit facility would have accrued interest at an adjusted term SOFR rate plus the applicable margin, which would have resulted in a borrowing rate of 6.82%. There were no Canadian dollar or other foreign currency borrowings outstanding on December 30, 2023.
As of December 30, 2023, the Company was in compliance with the financial and other covenants under the secured revolving credit facility.
Senior Notes
As of December 30, 2023, TWCC had $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 $500.0 million of outstanding senior notes as of December 30, 2023 is reported net of $2.6 million of unamortized issuance-related debt costs, and the $500.0 million of outstanding senior notes as of December 31, 2022 is reported net of $3.4 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.
Contractual Obligations and Commitments
We enter into contractual obligations and commitments in the ordinary course of business that may require future cash payments. Such obligations include: 1) debt repayments and letters of credit (as described in Item 8 “Financial Statements and Supplementary Data” under Note 10, Long-Term Debt, to the consolidated financial statements), 2) operating lease liabilities (as described in Item 8 “Financial Statements and Supplementary Data” under Note 5, Leases, to the consolidated financial statements) and 3) liabilities related to employee benefit plans (as described in Item 8 “Financial Statements and Supplementary Data” under Note 17, Employee Benefit Plans, to the consolidated financial statements).
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In addition, we have commitments to purchase inventory in the normal course of business, which are cancelable (with or without penalty, depending on the stage of production) and span a period of one year or less. Our estimate as of December 30, 2023 for commitments to purchase inventory was between $400 million and $500 million.
We are unable to reasonably predict future reserves for income taxes, as these are contingent on the ultimate amount or timing of settlement.
Liquidity Outlook
Based on our current outlook, we believe that cash and cash equivalents on hand, cash flow generated from operations, and available borrowing capacity 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 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 online channels are recognized at time of delivery to the customer. Revenue from omni-channel sales, including buy-online and pick-up in-store, buy-online, ship-to-store, and buy-online, deliver-from-store, are recognized when the product has been picked up by the customer at the store or when the product is physically delivered 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. Our credit and collections department reviews all past due balances regularly. Account balances are charged off against the allowance when it is probable that the receivable will not be recovered. The allowance for chargebacks is based on historical experience and includes estimated losses resulting from pricing adjustments, short shipments, handling charges, returns, and freight. 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. For arrangements in which the Company receives a distinct good or service, we record these reimbursements under cooperative
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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 when fair value is determinable. We have included the fair value of these arrangements of approximately $0.6 million for fiscal 2022 and $0.2 million for fiscal 2021 as a component of SG&A expenses on the Company’s consolidated statements of operations, rather than as a reduction of Net sales. There were no amounts for cooperative advertising arrangements recorded as a component of SG&A expenses for fiscal 2023. Amounts determined to be in excess of the fair value of these arrangements are recorded as a reduction of net sales. For arrangements in which the Company does not receive a distinct good or service, we record these reimbursements as a reduction of net sales. The majority of the Company’s digital cooperative advertising arrangements are recorded as a reduction of net sales as there was no distinct good or service received by the Company.
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. Adjustments to bring inventory to net realizable value as a result of obsolete, damaged, and excess inventory decreased $10.3 million, or 53.3%, to $9.0 million as of December 30, 2023. This decrease is primarily due to the decrease in inventory balances, including decreased “pack and hold” inventory. 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 an estimated liability 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. We have recast the consolidated statement of operations for the fiscal year ended December 31, 2022 and January 1, 2022 to conform to our current presentation of combining Adverse purchase commitments within Cost of goods sold.
Impairment of Goodwill and Other Indefinite-Lived Intangible Assets
The carrying values of the goodwill and indefinite-lived tradename assets are subject to annual impairment reviews which are performed as of the last day of each fiscal year. Additionally, a review for potential impairment is performed whenever significant events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The impairment models included in our analysis utilize significant estimates and assumptions to determine asset fair values. A deterioration of macroeconomic factors may negatively impact these estimates and assumptions and result in future impairment charges.
Goodwill
The Company performs impairment tests of its goodwill at the reporting unit level. Qualitative and quantitative methods are used to assess for impairment, including the use of discounted cash flows (“income approach”) and relevant data from guideline public companies (“market approach”).
Under a qualitative assessment, we estimate 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 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 a 50% weighting of the income approach and a 50% weighting of the market approach to determine the fair value of a reporting unit. The assumptions used in these approaches include revenue growth and profitability, terminal growth rates, discount rates, market multiples, and an implied control premium. Discount rates are dependent upon interest rates and the cost of capital at a point in time. These assumptions are consistent with those we believe hypothetical marketplace
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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.
In fiscal 2022, the Company performed a quantitative impairment test on the goodwill ascribed to each of the Company’s reporting units and on the value of its indefinite-lived intangible tradename assets as of December 31, 2022 due to increased discount rates, decreased actual and projected sales and profitability, and the announcement of the substantial doubt of a Skip Hop wholesale customer’s ability to continue to operate as a going concern. Based upon this assessment, there were no impairments on the value of goodwill.
Based upon our most recent annual assessment, performed as of December 30, 2023, using a qualitative assessment, there were no impairments to the value of goodwill.
Indefinite-Lived Intangible Assets
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 valuation method, which requires us to make assumptions and to apply judgment, including forecasting revenue growth and profitability and selecting the appropriate terminal growth rate, discount rate, and royalty rate.
As discussed above, the Company performed quantitative impairment assessments on the value of the Company’s indefinite-lived intangible tradename assets as of December 31, 2022. Based on these assessments, a non-cash pre-tax impairment charge of $9.0 million was recorded during the fourth quarter of fiscal 2022 on our indefinite-lived Skip Hop tradename asset to write-down the carrying value to $6.0 million. The charge recorded on our indefinite-lived Skip Hop tradename asset included charges of $5.6 million, $3.0 million, and $0.4 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. Sensitivity tests on the Skip Hop indefinite-lived tradename asset showed that a 100 basis point increase in the discount rate or a 10% decrease in forecasted revenues would result in further impairment charges of approximately $1.0 million, and a 25 basis point decrease in the royalty rate would result in further impairment charges of approximately $3.0 million.
The assessment in fiscal 2022 also indicated that the OshKosh indefinite-lived tradename asset’s fair value exceeded its carrying value by approximately 27%. Sensitivity tests on the OshKosh indefinite-lived tradename asset showed that a 100 basis point increase in the discount rate, a 10% decrease in forecasted revenues, or a 25 basis point decrease in the royalty rate would not change the conclusion and would not result in an impairment charge.
Due to favorable changes in certain of our key assumptions, we elected to utilize a qualitative assessment to perform our most recent annual assessment, as of December 30, 2023. Based on these assessments, there were no impairments in the value of our indefinite-lived tradenames. Although the Company determined that no impairment exists for the OshKosh or Skip Hop indefinite-lived tradename assets, these assets could be at risk for impairment should macroeconomic factors, including declining consumer sentiment, adversely affect the Company’s financial results.
Impairment of Other Long-Lived Assets
We review other long-lived assets, including right of use (“ROU”) lease assets, property, plant, and equipment, definite-lived tradename assets, and customer relationship assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of such an asset may not be recoverable. To determine whether there has been a permanent impairment on such assets, a recoverability test is performed by comparing anticipated undiscounted future cash flows from the use and eventual disposition of the asset or asset group to the carrying value of the asset. If the undiscounted cash flows are less than the related carrying value of the other long-lived asset, they are written down to their fair value. The process of estimating the fair value requires us to make assumptions and to apply judgement including forecasting revenue growth and profitability, utilizing external market participant assumptions, including estimated market rents, and selecting the appropriate discount rate. Long-lived assets that meet the definition of held for sale will be valued at the lower of carrying amount or fair value, less costs to sell.
We review all stores leases that have been opened for greater than 14 months for impairment on at least an annual basis, or sooner if circumstances so dictate. In determining undiscounted future cash flows for the recoverability test of store leases, we take various factors into account, including the continued market acceptance of our current products, the development of new products, changes in merchandising strategy, retail store cost controls, store traffic, competition, and the effects of
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macroeconomic factors such as consumer spending. In determining the fair value of store leases, we utilize external market participant assumptions, including market rents per square foot and market rent growth rates.
A deterioration of macroeconomic factors may not only negatively impact the estimated future 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 discount rates. Changes in these estimates and assumptions may have a significant impact on our assessment of fair value and result in future impairment charges.
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 and whether the loss can be reasonably estimated. 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 2023, a hypothetical 1% increase in our effective tax rate would have resulted in an increase in our income tax expense of $3.0 million.
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. Plan valuations based on the actuarial assumptions used may differ materially from actual results due to changing market and economic conditions. Actual results that differ from the plan valuations are reflected as deferred gains and losses in Accumulated other comprehensive income (loss) within shareholder’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 is expected to be funded from cash flows from operations.
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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 17, Employee Benefit Plans, to the consolidated financial statements.
Stock-Based Compensation Arrangements
We recognize the cost resulting from all stock-based compensation arrangements 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. There have been no issuances of stock options since 2018, and there are no unrecognized compensation costs remaining on outstanding stock options.
Subjective assumptions include a forfeiture rate assumption for all restricted stock awards and an estimate for the probability that the performance criteria will be achieved for performance awards. We estimate forfeitures of restricted stock awards based on historical experience and expected future activity. 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.
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.
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.