10-Q 1 q2201810-q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018 OR
 
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____
TO ______
Commission file number:
001-31829
CARTER’S, INC.
(Exact name of Registrant as specified in its charter)
Delaware
 
13-3912933
(state or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 

Phipps Tower
3438 Peachtree Road NE, Suite 1800
Atlanta, Georgia 30326
(Address of principal executive offices, including zip code)
(678) 791-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes (X) No ( )
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer," "accelerated filer," "smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer (X) Accelerated Filer ( )
Non-Accelerated Filer ( ) (Do not check if a smaller reporting company) Smaller Reporting Company ( )
Emerging Growth Company ( )

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ( )
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes (X) No (X)
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock
 
Outstanding Shares at July 20, 2018
Common stock, par value $0.01 per share
 
46,470,329









CARTER’S, INC.
INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets as of June 30, 2018, December 30, 2017 and July 1, 2017
 
 
Unaudited Condensed Consolidated Statements of Operations for the fiscal quarter and two fiscal quarters ended June 30, 2018 and July 1, 2017
 
 
Unaudited Condensed Consolidated Statements of Comprehensive Income for the fiscal quarter and two fiscal quarters ended June 30, 2018 and July 1, 2017
 
 
Unaudited Condensed Consolidated Statement of Changes in Stockholders' Equity for the two fiscal quarters ended June 30, 2018
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the two fiscal quarters ended June 30, 2018 and July 1, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1
 
 
 
Item 3
Defaults upon Senior Securities
 
 
 
 
 
 
 
 
 
 
 
 




PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

CARTER’S, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
(unaudited)
 
June 30, 2018
 
December 30, 2017
 
July 1, 2017
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
183,202

 
$
178,494

 
$
173,564

Accounts receivable, net
152,517

 
240,561

 
165,183

Finished goods inventories
663,263

 
548,722

 
610,423

Prepaid expenses and other current assets
51,955

 
52,935

 
46,402

Total current assets
1,050,937

 
1,020,712

 
995,572

Property, plant, and equipment, net of accumulated depreciation of $430,834, $404,173, and $384,881, respectively
364,223

 
377,924

 
382,472

Tradenames, net
365,817

 
365,551

 
365,639

Goodwill
228,555

 
230,424

 
231,709

Customer relationships, net
46,222

 
47,996

 
35,096

Other assets
27,775

 
28,435

 
23,246

Total assets
$
2,083,529

 
$
2,071,042

 
$
2,033,734

 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accounts payable
$
216,931

 
$
182,114

 
$
217,340

Other current liabilities
95,685

 
149,134

 
96,460

Total current liabilities
312,616

 
331,248

 
313,800

 
 
 
 
 
 
Long-term debt, net
682,778

 
617,306

 
661,846

Deferred income taxes
85,755

 
84,944

 
133,273

Other long-term liabilities
192,051

 
180,128

 
174,867

Total liabilities
$
1,273,200

 
$
1,213,626

 
$
1,283,786

 
 
 
 
 
 
Commitments and contingencies - Note 14

 

 

 
 
 
 
 
 
Stockholders' equity:
 
 
 
 
 
Preferred stock; par value $.01 per share; 100,000 shares authorized; none issued or outstanding at June 30, 2018, December 30, 2017, and July 1, 2017

 

 

Common stock, voting; par value $.01 per share; 150,000,000 shares authorized; 46,565,443, 47,178,346 and 47,971,577 shares issued and outstanding at June 30, 2018, December 30, 2017 and July 1, 2017, respectively
466

 
472

 
480

Accumulated other comprehensive loss
(35,532
)
 
(29,093
)
 
(30,653
)
Retained earnings
845,395

 
886,037

 
780,121

Total stockholders' equity
810,329

 
857,416

 
749,948

Total liabilities and stockholders' equity
$
2,083,529

 
$
2,071,042

 
$
2,033,734



See accompanying notes to the unaudited condensed consolidated financial statements.

1




CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(unaudited)
 
Fiscal quarter ended
 
Two fiscal quarters ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
Net sales
$
696,197

 
$
691,751

 
$
1,451,983

 
$
1,424,578

Cost of goods sold
386,239

 
388,504

 
809,548

 
805,639

Gross profit
309,958

 
303,247

 
642,435

 
618,939

Royalty income, net
10,355

 
11,210

 
18,349

 
21,768

Selling, general, and administrative expenses
263,343

 
250,146

 
543,505

 
497,940

Operating income
56,970

 
64,311

 
117,279

 
142,767

Interest expense
7,937

 
7,194

 
15,922

 
14,298

Interest income
(225
)
 
(79
)
 
(391
)
 
(219
)
Other expense (income), net
975

 
(544
)
 
593

 
(765
)
Income before income taxes
48,283

 
57,740

 
101,155

 
129,453

Provision for income taxes
11,015

 
19,947

 
21,418

 
45,065

Net income
$
37,268

 
$
37,793

 
$
79,737

 
$
84,388

 
 
 
 
 
 
 
 
Basic net income per common share
$
0.80

 
$
0.78

 
$
1.70

 
$
1.74

Diluted net income per common share
$
0.79

 
$
0.77

 
$
1.68

 
$
1.72

Dividend declared and paid per common share
$
0.45

 
$
0.37

 
$
0.90

 
$
0.74


See accompanying notes to the unaudited condensed consolidated financial statements.



2



CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)
(unaudited)

 
Fiscal quarter ended
 
Two fiscal quarters ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
Net income
$
37,268

 
$
37,793

 
$
79,737

 
$
84,388

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(4,677
)
 
3,140

 
(6,439
)
 
4,087

Comprehensive income
$
32,591

 
$
40,933

 
$
73,298

 
$
88,475



See accompanying notes to the unaudited condensed consolidated financial statements.

3


CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(amounts in thousands, except share amounts)
(unaudited)
 
Common stock - shares
 
Common
stock - $
 
Additional
paid-in
capital
 
Accumulated other comprehensive
loss
 
Retained
earnings
 
Total
stockholders’
equity
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 30, 2017
47,178,346

 
$
472

 
$

 
$
(29,093
)
 
$
886,037

 
$
857,416

Exercise of stock options
142,087

 
2

 
7,374

 

 

 
7,376

Withholdings from vesting of restricted stock
(55,933
)
 
(1
)
 
(6,666
)
 

 

 
(6,667
)
Restricted stock activity
121,570

 
1

 
(1
)
 

 

 

Stock-based compensation expense

 

 
10,266

 

 

 
10,266

Repurchase of common stock
(820,627
)
 
(8
)
 
(10,973
)
 

 
(78,112
)
 
(89,093
)
Cash dividends declared and paid

 

 

 

 
(42,267
)
 
(42,267
)
Comprehensive income

 

 

 
(6,439
)
 
79,737

 
73,298

Balance at June 30, 2018
46,565,443

 
$
466

 
$

 
$
(35,532
)
 
$
845,395

 
$
810,329


See accompanying notes to the unaudited condensed consolidated financial statements.

4



CARTER’S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
 
Two fiscal quarters ended
 
June 30, 2018
 
July 1, 2017
Cash flows from operating activities:
 
 
 
Net income
$
79,737

 
$
84,388

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation of property, plant, and equipment
41,989

 
39,705

Amortization of intangible assets
1,845

 
892

Amortization of debt issuance costs
865

 
749

Stock-based compensation expense
10,266

 
9,646

Unrealized foreign currency exchange loss (gain), net
202

 
(555
)
Provisions for doubtful accounts receivable from customers
11,511

 
605

Loss on disposal of property, plant, and equipment, net of recoveries
478

 
221

Deferred income taxes
1,400

 
3,109

Effect of changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
76,364

 
56,610

Finished goods inventories
(117,469
)
 
(91,446
)
Prepaid expenses and other assets
129

 
(13,151
)
Accounts payable and other liabilities
(4,254
)
 
16,560

Net cash provided by operating activities
103,063

 
107,333

 
 
 
 
Cash flows from investing activities:
 
 
 
Capital expenditures
(31,750
)
 
(34,276
)
Acquisitions of businesses, net of cash acquired
96

 
(143,704
)
Disposals and recoveries from property, plant, and equipment
373

 

Net cash used in investing activities
(31,281
)
 
(177,980
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Borrowings under secured revolving credit facility
150,000

 
100,000

Payments on secured revolving credit facility
(85,000
)
 
(18,965
)
Repurchases of common stock
(89,093
)
 
(98,236
)
Dividends paid
(42,267
)
 
(35,831
)
Withholdings from vestings of restricted stock
(6,667
)
 
(5,590
)
Proceeds from exercises of stock options
7,376

 
3,122

Net cash used in financing activities
(65,651
)
 
(55,500
)
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(1,423
)
 
353

Net increase (decrease) in cash and cash equivalents
4,708

 
(125,794
)
Cash and cash equivalents, beginning of period
178,494

 
299,358

Cash and cash equivalents, end of period
$
183,202

 
$
173,564


See accompanying notes to the unaudited condensed consolidated financial statements.

5


CARTER’S, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 – THE COMPANY
    
Carter's, Inc. and its wholly owned subsidiaries (collectively, the "Company," "its," "us" and "our") design, source, and market branded childrenswear and related products under the Carter's, Child of Mine, Just One YouPrecious FirstsSimple JoysOshKosh B'gosh ("OshKosh"), Skip Hop and other brands. The Company's products are sourced through contractual arrangements with manufacturers worldwide for: 1) wholesale distribution to leading department stores, national chains, and specialty retailers domestically and internationally and 2) distribution to the Company's own retail stores and eCommerce sites that market its brand name merchandise and other licensed products manufactured by other companies. As of June 30, 2018, the Company operated 1,049 retail stores in the United States, Canada, and Mexico.



NOTE 2 – BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial information and the rules and regulations of the Securities and Exchange Commission (the "SEC"). All intercompany transactions and balances have been eliminated in consolidation. 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all normal and recurring adjustments necessary to state fairly the consolidated financial condition, results of operations, comprehensive income, statement of stockholders' equity, and cash flows of the Company for the interim periods presented. Except as otherwise disclosed, all such adjustments consist only of those of a normal recurring nature. Operating results for the fiscal quarter and two fiscal quarters ended June 30, 2018 are not necessarily indicative of the results that may be expected for the current fiscal year ending December 29, 2018.

The preparation of these unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from those estimates.

The accompanying condensed consolidated balance sheet as of December 30, 2017 was derived from the Company's audited consolidated financial statements included in its most recently filed Annual Report on Form 10-K. Certain information and footnote disclosure normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC and the instructions to Form 10-Q. As disclosed in Note 2, Basis of Presentation, and Note 3, Revenue Recognition, at the beginning of fiscal 2018 the Company adopted the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification (“ASC”) No. 606, Revenue from Contracts with Customers, and related amendments (“ASC 606”) using the full retrospective adoption method. The full retrospective method required the Company to apply the standard to the financial statements for the period of adoption as well as to each prior reporting period presented.


Accounting Policies

The accounting policies the Company follows are set forth in its most recently filed Annual Report on Form 10-K. There have been no material changes to these accounting policies, except as noted below for new accounting pronouncements adopted at the beginning of fiscal 2018.


Revenue from Contracts with Customers (ASC No. 606)
At the beginning of fiscal 2018, the Company adopted the provisions of ASC No. 606, Revenue from Contracts with Customers, and all related amendments (“ASC 606”) using the full retrospective adoption method. Refer to Note 3, Revenue Recognition, for additional information.

6


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The Company uses the five-step model to recognize revenue:
1)
Identify the contract with the customer
2)
Identity the performance obligation(s)
3)
Determine the transaction price
4)
Allocate the transaction price to each performance obligation if multiple obligations exist
5)
Recognize the revenue as the performance obligations are satisfied

Performance Obligations
The Company identifies each distinct performance obligation to transfer goods (or bundle of goods). The Company recognizes revenue when (or as) it satisfies a performance obligation by transferring control of the goods to the customer. Other than inbound and outbound freight and shipping arrangements, the Company does not use third parties to satisfy its performance obligations in revenue arrangements with customers.
When Performance Obligations Are Satisfied
Wholesale Revenues - The Company typically transfers control upon shipment. However, in certain arrangements where the Company retains the risk of loss during shipment, satisfaction of the performance obligation occurs when the goods reach the customer.
Retail Revenues - For transactions in stores, the Company satisfies its performance obligation at point of sale when the customer takes possession of the goods and tenders payment. The redemption of loyalty points under the Company's rewards program and redemptions of gift cards may be part of a transaction. For purchases made through the Company’s eCommerce channel, revenue is recognized when the goods are physically delivered to the customer.
The Company satisfies its performance obligations with licensees over time as customers have the right to use the intellectual property over the contract period.
Significant Payment Terms
Retail customers tender a form of payment, such as cash or a credit/debit card, at point of sale. For wholesale customers and licensees, payment is due based on established terms.
Returns and Refunds
The Company establishes return provisions for retail customers. It is the Company's policy not to accept returns from wholesale customers.
Significant Judgments
Sale of Goods - The Company relies on shipping terms to determine when performance obligations are satisfied. When goods are shipped to wholesale customers “FOB Shipping Point,” control of the goods is transferred to the customer at the time of shipment if there are no remaining performance obligations. The Company recognizes the revenue once control passes to the customer. For retail transactions, no significant judgments are involved since revenue is recognized at the point of sale when tender is exchanged and the customer receives the goods.
Royalty Revenues - The Company transfers the right-to-use benefit to the licensee for the contract term and therefore the Company satisfies its performance obligation over time. Revenue recognized for each reporting period is based on the greater of: 1) the royalties owed on actual net sales by the licensee and 2) a minimum royalty guarantee, if applicable.
Transaction Price - The transaction price is the amount of consideration the Company expects to receive under the arrangement. The Company is required to estimate variable consideration (if any) and to factor that estimation into the determination of the transaction price. The Company may offer sales incentives to wholesale and retail customers, including discounts. For retail transactions, the Company has significant experience with return patterns and relies on this experience to estimate expected returns when determining the transaction price.

7


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Standalone Selling Prices - For arrangements that contain multiple performance obligations, the Company allocates the transaction price to each performance obligation on a relative standalone selling price basis.
Costs Incurred to Obtain a Contract - Incremental costs to obtain contracts are not material to the Company.
Policy Elections
In addition to those previously disclosed, the Company has made the following accounting policy elections and practical expedients:
Portfolio Approach - The Company uses the portfolio approach when multiple contracts or performance obligations are involved in the determination of revenue recognition.
Taxes - The Company excludes from the transaction price any taxes collected from customers that are remitted to taxing authorities.
Shipping and Handling Charges - Charges that are incurred before and after the customer obtains control of goods are deemed to be fulfillment costs.
Time Value of Money - The Company's payment terms are less than one year from the transfer of goods. Therefore, the Company does not adjust promised amounts of consideration for the effects of the time value of money.
Disclosure of Remaining Performance Obligations - The Company does not disclose the aggregate amount of the transaction price allocated to remaining performance obligations for contracts that are one year or less in term.

Classification of Costs Related to Defined Benefit Pension and Other Post-retirement Benefit Plans (ASU 2017-07)

At the beginning of fiscal 2018, the Company adopted ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost ("ASU 2017-07").  ASU 2017-07 changes how employers that sponsor defined benefit pension and/or other post-retirement benefit plans present the net periodic benefit costs in the statement of operations. Under this new guidance, an employer's statement of operations presents service cost arising in the current period in the same statement line item as other employee compensation. However, all other components of current period costs related to defined benefit plans, such as prior service costs and actuarial gains and losses, are presented on the statement of operations on a line item outside (or below) operating income. ASU 2017-07 affects only the classification of certain costs on the statement of operations, not the determination of costs. Net periodic pension costs related to the Company's frozen defined benefit pension plan and post-retirement medical benefit plan were not material for the second quarter of fiscal 2018, two fiscal quarters of 2018, or prior periods. Prior period results have not been reclassified on the Company's statement of operations due to materiality.


Modifications to Share-based Compensation Awards (ASU 2017-09)

At the beginning of fiscal 2018, the Company adopted ASU No. 2017-09, Compensation-Stock Compensation Topic 718-Scope of Modification Accounting ("ASU 2017-09"). ASU 2017-09 clarifies when changes to the terms and conditions of share-based payment awards must be accounted for as modifications. Entities apply the modification accounting guidance if the value, vesting conditions, or classification of an award changes. The Company has not modified any share-based payment awards. Should the Company modify share-based payment awards in the future, it will apply the provisions of ASU 2017-09.


Definition of a Business (ASU 2017-01)

At the beginning of fiscal 2018, the Company adopted ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business ("ASU 2017-01"). ASU 2017-01 assists entities in determining if acquired assets constitute the acquisition of a business or the acquisition of assets for accounting and reporting purposes. This distinction is important because goodwill can only be recognized in an acquisition of a business. Prior to ASU 2017-01, if revenues were generated immediately before and after a transaction, the acquisition was typically considered a business. Under ASU 2017-01, entities are required to further assess the substance of the processes they acquire. Should the Company commence or complete an acquisition in future periods, it will apply the provisions of ASU 2017-01.

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Statement of Cash Flows (ASU 2016-15)
 
At the beginning of fiscal 2018, the Company adopted ASU No. 2016-15, Statement of Cash Flows (Topic 230) ("ASU 2016-15"). ASU 2016-15 represents a consensus of the FASB’s Emerging Issues Task Force on eight separate issues that, if present, can impact classifications on the statement of cash flows. The guidance requires application using a retrospective transition method. The adoption of ASU 2016-15 only impacted the classification of certain insurance proceeds on the Company's consolidated statement of cash flows for the first two quarters of fiscal 2018.  


NOTE 3 - REVENUE RECOGNITION
The Company’s revenues are earned from contracts or arrangements with retail and wholesale customers and licensees. Contracts include written agreements, as well as arrangements that are implied by customary practices or law.
At the beginning of fiscal 2018, the Company adopted the provisions of ASC No. 606, Revenue from Contracts with Customers, and related amendments ("ASC 606") using the full retrospective adoption method. Under the full retrospective method, the Company adjusted all periods in fiscal 2017 and fiscal 2016 to reflect the provisions of ASC 606, and retained earnings at January 2, 2016 (beginning of fiscal 2016) were adjusted for the cumulative effect for prior periods. Refer to the section "Revenue from Contracts with Customers (ASC No. 606)" in Note 2, Basis of Presentation, for changes to the Company's accounting policies due to the adoption of ASC 606.
ASC 606 affected the Company's retail channels as follows:
Accelerated the recognition of breakage revenue from unredeemed gift cards, which affected net sales, gross profit, income before income taxes, and net income on the Company's statement of operations. Basic and diluted net income per share were affected by $0.01 or less for each reporting period. Related gift card liabilities and income tax liabilities were also affected.
A portion of the estimated value of goods expected to be returned by customers were reclassified between net sales and cost of goods sold, with no net effect on gross profit, income before income taxes, or net income on the Company's statement of operations. Related reclassifications were also made between other current assets and other current liabilities on the Company's balance sheet.

The effects of retrospective adoption on the Company's consolidated Statement of Operations were as follows:
 
 
Second Quarter
 
Two Fiscal Quarters
 
Year
 
Year
(dollars in thousands, except per share data)
 
Fiscal 2017
 
Fiscal 2017
 
Fiscal 2017
 
Fiscal 2016
 
 
 
 
 
 
 
 
 
Net sales
 
$
(366
)
 
$
(294
)
 
$
92

 
$
(637
)
Cost of goods sold
 
$
(156
)
 
$
26

 
$
52

 
$
(7
)
Income before income taxes
 
$
(210
)
 
$
(319
)
 
$
40

 
$
(630
)
Net income
 
$
(132
)
 
$
(201
)
 
$
84

 
(397
)
 
 
 
 
 
 
 
 

Basic net income per common share
 
$
(0.01
)
 
$
(0.01
)
 
$

 
$
(0.01
)
Diluted net income per common share
 
$
(0.01
)
 
$
(0.01
)
 
$

 
$

The cumulative effect to the Company’s retained earnings at January 2, 2016 was an after-tax increase of approximately $0.6 million.



9


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The effects of adoption of ASC 606 on the Company’s consolidated balance sheet at December 30, 2017 were as follows:
(dollars in thousands)
As Previously
Reported
 
ASC 606 Adjustments
 
 
As Amended for
ASC 606
ASSETS
 
 
 
 
 
 
Prepaid expenses and other current assets
$
49,892

 
$
3,043

(1)
 
$
52,935

Total current assets
$
1,017,669

 
$
3,043

 
 
$
1,020,712

Total assets
$
2,067,999

 
$
3,043

 
 
$
2,071,042

 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 
 
Other current liabilities
$
146,510

 
$
2,624

(2)
 
$
149,134

Total current liabilities
$
328,624

 
$
2,624

 
 
$
331,248

Deferred income taxes
$
84,848

 
$
96

 
 
$
84,944

Total liabilities
$
1,210,906

 
$
2,720

 
 
$
1,213,626

 
 
 
 
 
 
 
Retained earnings
885,714

 
323

(3)
 
886,037

Total stockholder's equity
$
857,093

 
$
323

 
 
$
857,416

 
 
 
 
 
 
 
Total liabilities and stockholders' equity
$
2,067,999

 
$
3,043

 
 
$
2,071,042

(1) Reclassification of estimated inventory expected to be returned by customers through future sales refund transactions. This amount was reclassified from the returns reserve (current liability) to a current asset. Prior to the Company's adoption of ASC 606, the Company's returns reserve (current liability) was reported net of the estimated inventory expected to be returned by customers through sales refund transactions.
(2) Amount includes a reclassification of approximately $3.0 million for estimated inventory expected to be returned by customers, partially offset by a reclassification of approximately $0.4 million for gift card liabilities.
(3) Cumulative impact of approximately $0.6 million for after-tax adjustments to retained earnings at the beginning of fiscal 2016, offset by ASC 606 effects on fiscal 2017 and fiscal 2016 results of operations.         

The retrospective adoption of ASC 606 at the beginning of fiscal 2018 also had the following effects on the Company’s unaudited condensed consolidated balance sheet at July 1, 2017:
(dollars in thousands)
As Previously
Reported
 
ASC 606 Adjustments
 
 
As Amended for
ASC 606
ASSETS
 
 
 
 
 
 
Prepaid expenses and other current assets
$
44,527

 
$
1,875

(1)
 
$
46,402

Total current assets
$
993,697

 
$
1,875

 
 
$
995,572

Total assets
$
2,031,859

 
$
1,875

 
 
$
2,033,734

 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 
 
Other current liabilities
$
94,644

 
$
1,816

(2)
 
$
96,460

Total current liabilities
$
311,984

 
$
1,816

 
 
$
313,800

Deferred income taxes
$
133,251

 
$
22

 
 
133,273

Total liabilities
$
1,281,948

 
$
1,838

 
 
$
1,283,786

 
 
 
 
 
 
 
Retained earnings
$
780,084

 
$
37

(3)
 
$
780,121

Total stockholder's equity
$
749,911

 
$
37

 
 
$
749,948

 
 
 
 
 
 
 
Total liabilities and stockholders' equity
$
2,031,859

 
$
1,875

 
 
$
2,033,734

(1) Reclassification of estimated inventory expected to be returned by customers through future sales refund transactions. This amount was reclassified from the returns reserve (current liability) to a current asset. Prior to the Company's adoption of ASC 606, the Company's returns reserve (current liability) was reported net of the estimated inventory expected to be returned by customers through sales refund transactions.

10


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(2) Amount includes a reclassification of approximately $1.9 million for estimated inventory expected to be returned by customers, partially offset by an adjustment of approximately $0.1 million for gift card liabilities.
(3) Cumulative impact of approximately $0.6 million for after-tax adjustments to retained earnings at the beginning of fiscal 2016, offset by ASC 606 impact on fiscal 2017 and fiscal 2016 results of operations.

Disaggregation of Revenue
The Company sells its products directly to consumers ("direct-to-consumer") and to other retail companies and partners that subsequently sell the products directly to their own retail customers. The Company also earns royalties from its licensees. Disaggregated revenues from these sources for the second quarter and two quarters ended fiscal 2018 and 2017 were as follows:

 
 
Fiscal quarter ended June 30, 2018
(dollars in thousands)
 
U.S. Retail
 
U.S. Wholesale
 
International
 
Total
 
 
 
 
 
 
 
 
 
Wholesale channel
 
$

 
$
209,476

 
$
25,169

 
$
234,645

Direct-to-consumer
 
402,021

 

 
59,531

 
461,552

 
 
$
402,021

 
$
209,476

 
$
84,700

 
$
696,197

 
 
 
 
 
 
 
 
 
Royalty income
 
$
4,426

 
$
4,957

 
$
972

 
$
10,355

 
 
Two fiscal quarters ended June 30, 2018
(dollars in thousands)
 
U.S. Retail
 
U.S. Wholesale
 
International
 
Total
 
 
 
 
 
 
 
 
 
Wholesale channel
 
$

 
$
490,309

 
$
62,882

 
$
553,191

Direct-to-consumer
 
785,762

 

 
113,030

 
898,792

 
 
$
785,762

 
$
490,309

 
$
175,912

 
$
1,451,983

 
 
 
 
 
 
 
 
 
Royalty income
 
$
6,011

 
$
10,802

 
$
1,536

 
$
18,349

 
 
Fiscal quarter ended July 1, 2017
(dollars in thousands)
 
U.S. Retail
 
U.S. Wholesale
 
International
 
Total
 
 
 
 
 
 
 
 
 
Wholesale channel
 
$

 
$
217,710

 
$
27,622

 
$
245,332

Direct-to-consumer
 
391,457

 

 
54,962

 
446,419

 
 
$
391,457

 
$
217,710

 
$
82,584

 
$
691,751

 
 
 
 
 
 
 
 
 
Royalty income
 
$
4,896

 
$
5,140

 
$
1,174

 
$
11,210


 
 
Two fiscal quarters ended July 1, 2017
(dollars in thousands)
 
U.S. Retail
 
U.S. Wholesale
 
International
 
Total
 
 
 
 
 
 
 
 
 
Wholesale channel
 
$

 
$
510,265

 
$
57,304

 
$
567,569

Direct-to-consumer
 
755,299

 

 
101,710

 
857,009

 
 
$
755,299

 
$
510,265

 
$
159,014

 
$
1,424,578

 
 
 
 
 
 
 
 
 
Royalty income
 
$
8,164

 
$
11,505

 
$
2,099

 
$
21,768


11


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Accounts Receivable from Customers and Licensees
The components of accounts receivable, net, as of June 30, 2018, December 30, 2017, and July 1, 2017 were as follows:
(dollars in thousands)
 
June 30, 2018
 
December 30, 2017
 
July 1, 2017
Trade receivables from wholesale customers, net
 
$
138,952

 
$
229,968

 
$
153,581

Royalties receivable
 
8,824

 
9,818

 
10,107

Tenant allowances and other receivables
 
12,168

 
14,511

 
11,265

Total gross receivables
 
$
159,944

 
$
254,297

 
$
174,953

Less:
 
 
 
 
 
 
Wholesale accounts receivable reserves
 
(7,427
)
 
(13,736
)
 
(9,770
)
Accounts receivable, net
 
$
152,517

 
$
240,561

 
$
165,183

Contract Assets and Liabilities
The Company's contract assets are not material.
Contract Liabilities
The Company recognizes a contract liability when it has received consideration from the customer and has a future obligation to transfer goods to the customer. Total contract liabilities consisted of the following amounts:        
(dollars in thousands)
June 30, 2018
 
December 30, 2017
 
July 1, 2017
 
 
 
 
 
 
Contract liabilities-current:


 


 
 
Unredeemed gift cards
$
11,072

 
$
11,945

 
$
9,991

Unredeemed customer loyalty rewards
6,164

 
7,355

 
9,835

Total contract liabilities-current *
$
17,236

 
$
19,300

 
$
19,826

* Included with Other current liabilities on the Company's consolidated balance sheet.

 
Composition of Contract Liabilities
Unredeemed gift cards - the Company is obligated to transfer goods in the future to customers who have purchased gift cards. Periodic changes in the gift card contract liability result from the redemption of gift cards by customers and the recognition of estimated breakage revenue for those gift card balances that are not expected to be redeemed. The majority of our gift cards do not have an expiration date; however, all outstanding gift card balances are classified by the Company as current liabilities since gift cards are redeemable on demand by the valid holder. The majority of the Company's gift cards are redeemed within one year of issuance.
Unredeemed loyalty rewards - points and reward certificates earned by customers under the Company’s loyalty programs represent obligations of the Company to transfer goods to the customer upon redemption. Periodic changes in the loyalty program contract liability result from coupon redemptions and expirations. The earning and redemption cycles for our loyalty program are under one year in duration.
NOTE 4 – BUSINESS ACQUISITIONS IN FISCAL 2017

Based on their purchase prices and pre-acquisition operating results and assets, neither of the businesses acquired by the Company in fiscal 2017 met the materiality requirements for preparation and presentation of pro forma financial information, either individually or in the aggregate.

Skip Hop Acquisition


12


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Carter's, Inc.'s wholly-owned subsidiary, The William Carter Company ("TWCC"), acquired 100% of the voting equity interests of Skip Hop Holdings, Inc. and subsidiaries (collectively "Skip Hop") after the close of business on February 22, 2017. The Skip Hop purchase was deemed to be the acquisition of a business under the provisions of ASC No. 805, Business Combinations ("ASC 805"). The Company's consolidated financial statements reflect the consolidation of the financial position, results of operations and cash flows of Skip Hop beginning February 23, 2017.

In the Company's unaudited condensed consolidated balance sheet at July 1, 2017, the preliminary purchase price of approximately $147.3 million, net of $0.8 million cash acquired, was comprised of the following acquired assets and assumed liabilities: $54.2 million of goodwill including an assembled workforce; $92.7 million of intangible assets comprised of a tradename and acquired customer relationships; $54.9 million of tangible assets acquired; and $20.2 million of liabilities in addition to $35.9 million of deferred income tax liabilities.

The measurement period (as defined in ASC 805) for Skip Hop was complete at the end of fiscal 2017 and all measurement period adjustments were reflected in the Company's consolidated balance sheet as of December 30, 2017. As a result of the measurement period adjustments recorded between the acquisition date and the end of fiscal 2017, the net assets acquired consisted of the following: $46.0 million of goodwill including an assembled workforce; $104.1 million of intangible assets comprised of a tradename and acquired customer relationships; $53.9 million of tangible assets acquired; and $20.8 million of liabilities in addition to $36.3 million of deferred income tax liabilities. The adjusted purchase price of approximately $142.5 million, net of $0.8 million of cash acquired.

During the first two quarters of fiscal 2017, the Company incurred approximately $1.8 million in acquisition-related costs for the Skip Hop transaction.

Acquisition of Mexican Licensee

On August 1, 2017, the Company, through certain of its wholly-owned subsidiaries, acquired the outstanding equity of the Company's licensee in Mexico and a related entity (collectively "Carter's Mexico"). Both entities are incorporated under Mexican law. Prior to the acquisition, Carter's Mexico was primarily a licensee and wholesale customer of the Company. The Carter's Mexico purchase was deemed to be the acquisition of a business under the provisions of ASC 805. The Company's consolidated financial statements reflect the consolidation of the financial position, results of operations and cash flows of Carter's Mexico beginning August 1, 2017. Carter's Mexico became part of the Company's International reportable segment.

As of December 30, 2017, preliminary values assigned to assets acquired included inventories of approximately $8.3 million, a customer relationships intangible asset of approximately $3.5 million, and goodwill of approximately $6.2 million. Measurement period adjustments made in the first quarter of fiscal 2018 were not material.

The measurement period (as defined in ASC 805) for the acquisition of the licensee in Mexico was completed during the second quarter of fiscal 2018 and all measurement period adjustments were reflected in the Company's consolidated balance sheet as of June 30, 2018. As a result of the measurement period adjustments recorded between the acquisition date and the end of the second quarter of fiscal 2018, the values assigned to assets acquired included inventories of approximately $8.0 million, a customer relationships intangible asset of approximately $3.5 million, and goodwill of approximately $6.3 million.

NOTE 5 – ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of accumulated other comprehensive loss consisted of the following:
(dollars in thousands)
June 30, 2018
 
December 30, 2017
 
July 1, 2017
Cumulative foreign currency translation adjustments
$
(27,724
)
 
$
(21,285
)
 
$
(23,537
)
Pension and post-retirement obligations (1)
(7,808
)
 
(7,808
)
 
(7,116
)
Total accumulated other comprehensive loss
$
(35,532
)
 
$
(29,093
)
 
$
(30,653
)
    
(1) Net of income taxes of $4.4 million, $4.4 million, and $4.2 million, respectively. The deferred income taxes associated with these obligations are subject to adjustments upon the Company's adoption of ASC 2018-02. See Note 16, Pending Adoption of Recent Accounting Pronouncements.



13


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

During the first and second quarters of both fiscal 2018 and fiscal 2017, no amounts were reclassified from accumulated other comprehensive loss to the statement of operations.



NOTE 6 – GOODWILL AND INTANGIBLE ASSETS

The Company's goodwill and intangible assets were as follows:
 
 
 
June 30, 2018
 
December 30, 2017
(dollars in thousands)
Weighted-average useful life
 
Gross amount
 
Accumulated amortization
 
Net amount
 
Gross amount
 
Accumulated amortization
 
Net amount
 
 
 
 
 
 
 
 
 
 
 
 
 
Carter's goodwill
Indefinite
 
$
136,570

 
 
 
$
136,570

 
$
136,570

 
 
 
$
136,570

Canada goodwill
Indefinite
 
40,367

 
 
 
40,367

 
42,223

 
 
 
42,223

 Skip Hop goodwill
Indefinite
 
45,984

 
 
 
45,984

 
45,997

 
 
 
45,997

 Carter's Mexico goodwill
Indefinite
 
5,634

 
 
 
5,634

 
5,634

 
 
 
5,634

Total goodwill
 
 
$
228,555

 

 
$
228,555

 
$
230,424

 

 
$
230,424

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Carter's tradename    
Indefinite
 
$
220,233

 
 
 
$
220,233

 
$
220,233

 
 
 
$
220,233

OshKosh tradename    
Indefinite
 
85,500

 
 
 
85,500

 
85,500

 
 
 
85,500

 Skip Hop tradename
Indefinite
 
56,800

 
 
 
56,800

 
56,800

 
 
 
56,800

 Finite-life tradenames
5-20 years
 
3,911

 
$
627

 
3,284

 
3,550

 
$
532

 
3,018

Total tradenames, net
 
 
$
366,444


$
627

 
$
365,817

 
$
366,083

 
$
532

 
$
365,551

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Skip Hop customer relationships
15 years
 
$
47,300

 
$
3,892

 
$
43,408

 
$
47,300

 
$
2,304

 
$
44,996

Carter's Mexico customer relationships
10 years
 
3,031

 
217

 
2,814

 
3,135

 
135

 
3,000

Total customer relationships, net
 
 
$
50,331

 
$
4,109

 
$
46,222

 
$
50,435

 
$
2,439

 
$
47,996

 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
 
July 1, 2017
(dollars in thousands)
Weighted-average useful life
 
Gross amount
 
Accumulated amortization
 
Net amount
 
 
 
 
 
 
 
 
Carter's goodwill
Indefinite
 
$
136,570

 
 
 
$
136,570

Canada goodwill
Indefinite
 
40,897

 
 
 
40,897

Skip Hop goodwill
Indefinite
 
54,242

 
 
 
54,242

Total goodwill
 
 
$
231,709

 

 
$
231,709

 
 
 
 
 
 
 
 
Carter's tradename    
Indefinite
 
$
220,233

 
 
 
$
220,233

OshKosh tradename    
Indefinite
 
85,500

 
 
 
85,500

Skip Hop tradename
indefinite
 
56,800

 
 
 
56,800

Finite-life tradenames
5-20 years
 
42,021

 
$
38,915

 
3,106

Total tradenames, net
 
 
$
404,554

 
$
38,915

 
$
365,639

 
 
 
 
 
 
 
 
Skip Hop customer relationships, net
15 years
 
$
35,900

 
$
804

 
$
35,096

 
 
 
 
 
 
 
 

Amortization expense for intangible assets subject to amortization was approximately $0.8 million and $0.6 million for the second fiscal quarter ended June 30, 2018 and second fiscal quarter ended July 1, 2017, respectively. For the first two quarters of fiscal 2018 and fiscal 2017, amortization expense was approximately $1.8 million and $0.9 million, respectively. Future amortization expense is estimated to be approximately $3.7 million for each of the next five fiscal years.


14


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


NOTE 7 – COMMON STOCK

OPEN MARKET SHARE REPURCHASES

The total aggregate remaining capacity under outstanding repurchase authorizations as of June 30, 2018 was approximately $496.5 million, based on settled repurchase transactions. The authorizations have no expiration date.

The Company repurchased and retired shares in open market transactions in the following amounts for the fiscal periods indicated:
 
Fiscal quarter ended
 
Two fiscal quarters ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
Number of shares repurchased
599,314

 
587,465

 
820,627

 
1,131,409

Aggregate cost of shares repurchased (dollars in thousands)
$
63,899

 
$
51,605

 
$
89,093

 
$
98,236

Average price per share
$
106.62

 
$
87.84

 
$
108.57

 
$
86.82



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 determined by the Company's management, based on its evaluation of market conditions, share price, other investment priorities, and other factors.

DIVIDENDS

In the second fiscal quarter and two fiscal quarters ended June 30, 2018, the Company declared and paid cash dividends per share of $0.45 and $0.90, respectively. In the second fiscal quarter and two fiscal quarters ended July 1, 2017, the Company declared and paid cash dividends per share of $0.37 and $0.74, respectively. Future declarations of dividends and the establishment of future record and payment dates are at the discretion of the Company's Board of Directors and based on a number of factors, including the Company's future financial performance and other investment priorities.

Provisions in the indenture governing the senior notes of TWCC and in TWCC's secured revolving credit facility could have the effect of restricting the Company's ability to pay future cash dividends on, or make future repurchases of, its common stock. Provisions related to the indenture governing the senior notes are described in the Company's Annual Report on Form 10-K for the 2017 fiscal year ended December 30, 2017.


NOTE 8 – LONG-TERM DEBT


Long-term debt consisted of the following:
(dollars in thousands)
June 30, 2018
 
December 30, 2017
 
July 1, 2017
Senior notes at amounts repayable
$
400,000

 
$
400,000

 
$
400,000

Less unamortized issuance-related costs for senior notes
(3,222
)
 
(3,694
)
 
(4,154
)
      Senior notes, net
396,778

 
396,306

 
395,846

Secured revolving credit facility
286,000

 
221,000

 
266,000

Total long-term debt, net
$
682,778

 
$
617,306

 
$
661,846


Secured Revolving Credit Facility

On August 25, 2017, TWCC and a syndicate of lenders entered into a fourth amended and restated secured revolving credit agreement.

15


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The secured revolving credit facility provides: (i) a term for the facility lasting through August 22, 2022 and (ii) an aggregate credit line of $750 million which includes a $650 million U.S. dollar facility and a $100 million multicurrency facility denominated in U.S. dollars, Canadian dollars, Euros, Pounds Sterling, or other currencies agreed to by the applicable lenders. The $650 million U.S. dollar facility is inclusive of a $100 million sub-limit for letters of credit and a swing line sub-limit of $70 million. The $100 million multicurrency facility is inclusive of a $40 million sub-limit for letters of credit and a swing line sub-limit of $15 million.

In addition, the secured revolving credit facility includes the opportunity for incremental borrowing facilities up to $425 million, which is comprised of an incremental $350 million U.S. dollar revolving credit facility and an incremental $75 million multicurrency revolving credit facility. The incremental U.S. dollar revolving credit facility can increase to an unlimited borrowing amount so long as the consolidated first lien leverage ratio (as defined in the secured revolving credit facility) does not exceed 2.25:1.00.

Under the secured revolving credit facility, TWCC and its domestic subsidiaries have granted to the collateral agent, for the benefit of the lenders, valid and perfected first priority security interests in substantially all of their present and future assets, excluding certain customary exceptions, and guarantee the obligations of the borrowers. In addition, The Genuine Canadian Corp., as Canadian borrower, and Carter’s Holdings B.V., as Dutch borrower, have each guaranteed the obligations of the other.

As of June 30, 2018, the Company had $286.0 million in outstanding borrowings under its secured revolving credit facility, exclusive of $4.5 million of outstanding letters of credit. As of June 30, 2018, approximately $459.5 million remained available for future borrowing. All outstanding borrowings under the Company's secured revolving credit facility are classified as non-current liabilities on the Company's consolidated balance sheet because of the contractual repayment terms under the credit facility.

As of June 30, 2018, the interest rate applicable to the secured revolving credit facility were 1.375% for LIBOR (London Interbank Offered Rate) rate loans (which may be adjusted based on a leverage-based pricing grid ranging from 1.125% to 1.875%) and 0.375% for base rate loans (which may be adjusted based on a leverage-based pricing grid ranging from 0.125% to 0.875%).

As of June 30, 2018, U.S. dollar borrowings outstanding under the secured revolving credit facility accrued interest at a LIBOR rate plus the applicable base rate, which resulted in a weighted-average borrowing rate of 3.38%. All outstanding Canadian dollar borrowings were repaid during the first quarter of fiscal 2017.

As of June 30, 2018, the Company was in compliance with the financial and other covenants under the secured revolving credit facility.


Senior Notes

As of June 30, 2018, TWCC had outstanding $400 million principal amount of senior notes bearing interest at a fixed rate of 5.25% per annum and maturing on August 15, 2021. The senior notes are unsecured and are fully and unconditionally guaranteed by Carter's, Inc. and certain subsidiaries of TWCC. On the Company's consolidated balance sheet, the senior notes are reported net of certain unamortized issuance-related costs, as shown in the table above.


NOTE 9 – STOCK-BASED COMPENSATION
    
The Company recorded stock-based compensation expense as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(dollars in thousands)
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
Stock options
$
1,112

 
$
955

 
$
2,456

 
$
2,199

Restricted stock:
 
 
 
 
 
 
 
   Time-based awards
3,027

 
2,832

 
5,311

 
5,144

   Performance-based awards
1,183

 
1,080

 
2,499

 
2,303

Total
$
5,322

 
$
4,867

 
$
10,266

 
$
9,646



16


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


NOTE 10 – INCOME TAXES

As of June 30, 2018, the Company had gross unrecognized income tax benefits of approximately $14.9 million, of which $12.6 million, if ultimately recognized, may affect the Company's effective income tax rate in the periods settled.  The Company has recorded tax positions for which the ultimate deductibility is more likely than not, but for which there is uncertainty about the timing of such deductions.  

Included in the reserves for unrecognized tax benefits at June 30, 2018 were approximately $1.8 million of reserves for which the statute of limitations is expected to expire within the next fiscal year.  If these tax benefits are ultimately recognized, such recognition, net of federal income taxes, may affect the annual effective income tax rate for fiscal 2018 or fiscal 2019 along with the effective income tax rate in the quarter in which the benefits are recognized. 

The Company recognizes interest related to unrecognized tax benefits as a component of interest expense and recognizes penalties related to unrecognized income tax benefits as a component of income tax expense.  During the fiscal quarters ended June 30, 2018 and July 1, 2017, interest expense recorded on uncertain tax positions was not significant. The Company had approximately $1.3 million, $1.0 million, and $1.0 million of interest accrued on uncertain tax positions as of June 30, 2018, December 30, 2017, and July 1, 2017, respectively.

For the full fiscal year 2018, the Company estimates that its consolidated effective income tax rate will be approximately 22.0%.


U.S. Tax Reform

The provision for income taxes recognized by the Company during the fiscal fourth quarter of 2017 reflected certain provisional estimates for the accounting of the December 22, 2017 enactment of income tax law changes commonly known as the U.S. Tax Cuts and Jobs Act of 2017 (the "2017 Act"). The provisional accounting for the 2017 Act is permitted by SEC Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, issued in late December 2017. Subsequent adjustments, if any, to the provisional accounting estimates must be reflected in income tax provisions/benefits during one or more periods in fiscal 2018.

During the fourth quarter of fiscal 2017, the Company recorded a provisional tax expense estimate for the one-time transition tax liability for all of its foreign subsidiaries, resulting in an increase in income tax expense of approximately $10.4 million related to foreign earnings. The one-time transition tax is based on the Company's total post-1986 earnings and profits ("E&P") that the Company previously deferred from United States income taxes. The Company has not yet completed its calculation of the total post-1986 E&P for these foreign subsidiaries. No adjustments were made to this provisional tax expense estimate during the first two quarters of fiscal 2018. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when the Company finalizes the calculation of post-1986 foreign E&P previously deferred from U.S. federal taxation and finalizes the amounts held in cash or other specified assets. No additional income taxes have been provided for any remaining undistributed foreign earnings not subject to the transition tax, or any additional outside basis difference inherent in these entities, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any remaining undistributed foreign earnings not subject to the transition tax and additional outside basis difference in these entities (i.e., basis difference in excess of that subject to the one-time transition tax) is not practicable, but the related cumulative temporary difference as of December 30, 2017 and June 30, 2018 would not result in a material incremental deferred tax liability.



NOTE 11 – FAIR VALUE MEASUREMENTS

The following table summarizes assets and liabilities that are remeasured at fair value each reporting period:


17


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 
June 30, 2018
 
 
December 30, 2017
 
 
July 1, 2017
(dollars in millions)
Level 1
 
Level 2
 
Level 3
 
 
Level 1
 
Level 2
 
Level 3
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments (1)
$
16.9

 

 

 
 
$
16.7

 

 

 
 
$
15.3

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration (2)

 

 

 
 

 

 

 
 

 

 
$
3.6


(1) Included in Other assets on the Company's consolidated balance sheet.
(2) Included in Other current liabilities on the Company's consolidated balance sheet.


INVESTMENTS

The Company invests in marketable securities, principally equity-based mutual funds, to mitigate the risk associated with the investment return on employee deferrals of compensation. Gains on the investments in marketable securities were $0.2 million for both the second fiscal quarter and the two fiscal quarters ended June 30, 2018, and were $0.5 million and $1.2 million for the fiscal quarter and two fiscal quarters ended July 1, 2017, respectively. These amounts are included in Other expense (income), net on the Company's consolidated statement of operations.


CONTINGENT CONSIDERATION

The estimated fair value of contingent consideration related to the Skip Hop acquisition was based on a weighted payout probability at the measurement date. Facts and circumstances that occurred subsequent to the acquisition indicated that the contingent earn out arrangement would not be achieved, and therefore approximately $3.6 million was credited to the Company's earnings during fiscal 2017.


BORROWINGS

As of June 30, 2018, the fair value of the Company's $286.0 million in outstanding borrowings under its secured revolving credit facility approximated carrying value.

The fair value of the Company's senior notes at June 30, 2018 was approximately $406 million. The fair value of these senior notes with a notional value and carrying value (gross of debt cost) of $400 million was estimated using a quoted price as provided in the secondary market, which considers the Company's credit risk and market related conditions, and is therefore within Level 2 of the fair value hierarchy.

18


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


NOTE 12 – EARNINGS PER SHARE

The following is a reconciliation of basic common shares outstanding to diluted common and common equivalent shares outstanding:
 
Fiscal quarter ended
 
Two fiscal quarters ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
 
 
 
 
 
 
 
 
Weighted-average number of common and common equivalent shares outstanding:
 
 
 
 
 
 
 
Basic number of common shares outstanding
46,437,093

 
47,863,618

 
46,604,599

 
48,093,155

Dilutive effect of equity awards
509,545

 
550,726

 
563,137

 
552,866

Diluted number of common and common equivalent shares outstanding
46,946,638

 
48,414,344

 
47,167,736

 
48,646,021

 
 
 
 
 
 
 
 
Basic net income per common share (in thousands, except per share data):
 
 
 
 
 
 
 
Net income
$
37,268

 
$
37,793

 
$
79,737

 
$
84,388

Income allocated to participating securities
(276
)
 
(290
)
 
(600
)
 
(659
)
Net income available to common shareholders
$
36,992

 
$
37,503

 
$
79,137

 
$
83,729

 
 
 
 
 
 
 
 
Basic net income per common share
$
0.80

 
$
0.78

 
$
1.70

 
$
1.74

 
 
 
 
 
 
 
 
Diluted net income per common share (in thousands, except per share data):
 
 
 
 
 
 
 
Net income
$
37,268

 
$
37,793

 
$
79,737

 
$
84,388

Income allocated to participating securities
(274
)
 
(288
)
 
(596
)
 
(654
)
Net income available to common shareholders
$
36,994

 
$
37,505

 
$
79,141

 
$
83,734

 
 
 
 
 
 
 
 
Diluted net income per common share
$
0.79

 
$
0.77

 
$
1.68

 
$
1.72

 
 
 
 
 
 
 
 
Anti-dilutive awards excluded from diluted earnings per share computation
332,448

 
663,531

 
254,417

 
596,297







19


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 13 – OTHER CURRENT AND LONG-TERM LIABILITIES

Other current liabilities that exceeded five percent of total current liabilities, at the end of any comparable period, were as follows:
(dollars in thousands)
June 30, 2018
 
December 30, 2017
 
July 1, 2017
Accrued bonuses and incentive compensation
$
5,231

 
$
27,566

 
$
5,959

Accrued employee benefits
10,663

 
21,735

 
10,227

Accrued and deferred rent
18,702

 
18,213

 
17,767

    
Other long-term liabilities that exceeded five percent of total liabilities, at the end of any comparable period, were as follows:
(dollars in thousands)
June 30, 2018
 
December 30, 2017
 
July 1, 2017
Deferred lease incentives
$
75,431

 
$
75,104

 
$
74,344



NOTE 14 – COMMITMENTS AND CONTINGENCIES

The Company is subject to various claims and pending or threatened lawsuits in the normal course of business. The Company is not currently a party to any legal proceedings that it believes would have a material adverse impact on its financial position, results of operations, or cash flows.


NOTE 15 – SEGMENT INFORMATION

The table below presents certain information for our reportable segments and unallocated corporate expenses for the periods indicated.
 
Fiscal quarter ended
 
Two fiscal quarters ended
(dollars in thousands)
June 30,
2018
 
% of
Total Net Sales
 
July 1,
2017
 
% of
Total Net Sales
 
June 30,
2018
 
% of
Total Net Sales
 
July 1,
2017
 
% of
Total Net Sales
Net sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Retail
$
402,021

 
57.7
%
 
$
391,457

 
56.6
%
 
$
785,762

 
54.1
%
 
$
755,299

 
53.0
%
U.S. Wholesale
209,476

 
30.1
%
 
217,710

 
31.5
%
 
490,309

 
33.8
%
 
510,265

 
35.8
%
International    
84,700

 
12.2
%
 
82,584

 
11.9
%
 
175,912

 
12.1
%
 
159,014

 
11.2
%
Total net sales
$
696,197

 
100.0
%
 
$
691,751

 
100.0
%
 
$
1,451,983

 
100.0
%
 
$
1,424,578

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss):
 
 
% of
Segment
Net Sales
 
 
 
% of
Segment
Net Sales
 
 
 
% of
Segment
Net Sales
 
 
 
% of
Segment
Net Sales
U.S. Retail (a) (e)
$
45,428

 
11.3
%
 
$
42,133

 
10.8
%
 
$
74,947

 
9.5
%
 
$
71,922

 
9.5
%
U.S. Wholesale (b) (e)
30,338

 
14.5
%
 
35,805

 
16.4
%
 
80,610

 
16.4
%
 
105,501

 
20.7
%
International (e)
4,312

 
5.1
%
 
7,597

 
9.2
%
 
8,073

 
4.6
%
 
11,282

 
7.1
%
Corporate expenses (c) (d)
(23,108
)
 
 
 
(21,224
)
 
 
 
(46,351
)
 
 
 
(45,938
)
 
 
Total operating income
$
56,970

 
8.2
%
 
$
64,311

 
9.3
%
 
$
117,279

 
8.1
%
 
$
142,767

 
10.0
%

(a)
Two fiscal quarters ended June 30, 2018 includes insurance recoveries of approximately $0.4 million associated with storm-related store closures in 2017.
(b)
Includes approximately $12.8 million of charges related to a customer bankruptcy for the two fiscal quarters ended June 30, 2018.
(c)
Corporate expenses include expenses related to incentive compensation, stock-based compensation, executive management, severance and relocation, finance, office occupancy, information technology, certain legal fees, consulting, and audit fees.

20


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(d) Includes the following charges:
 
 
Fiscal quarter ended
 
Two fiscal quarters ended
(dollars in millions)
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Direct sourcing initiative
 
$

 
$
0.1

 
$

 
$
0.3

Acquisition-related costs
 
$

 
$
0.8

 
$

 
$
2.5


(e) A total of $0.4 million of certain costs related to inventory acquired from Skip Hop is included in operating income between U.S. Wholesale, U.S. Retail, and International for the fiscal quarter and two fiscal quarters ended July 1, 2017.



NOTE 16 – PENDING ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS


Leases (ASU 2016-02)

In February 2016, the FASB issued new lease accounting guidance in ASU No. 2016-02, Leases-Topic 842, which has been codified in ASC 842, Leases ("ASC 842"). Under this new guidance, lessees will be required to recognize for all leases (with the exception of short-term leases): 1) a lease liability equal to the lessee's obligation to make lease payments arising from a lease, measured on a discounted basis and 2) a right-of-use asset which will represent the lessee's right to use, or control the use of, a specified asset for the lease term. The new standard will be effective for the Company at the beginning of fiscal 2019, including interim periods within the year of adoption. The Company is assessing the implications of applying the practical expedients and accounting policy elections, implementing software to meet the reporting requirements of the new standard, and identifying changes to its business processes and controls to support the adoption of the new standard. The Company believes the adoption will have a material impact on the total assets and total liabilities reported on the Company's consolidated balance sheets, but is not able to quantify the difference at this time. However, the Company does not believe adoption of this standard will have a material impact on the Company's consolidated results of operations or cash flows.


Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02)

In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("ASU 2018-02"). ASU 2018-02 permits a company to reclassify the income tax effects of the U.S. Tax Cuts and Jobs Act of 2017 (the "2017 Act") on items within accumulated other comprehensive income or loss ("AOCI-L") to retained earnings. Because most items that are charged to AOCI-L are recorded net of applicable income taxes, the subsequent reclassification of these items from AOCI-L to the statement of operations will be at different income tax rates due to the 2017 Act, thereby leaving a "stranded" tax balance within AOCI-L. ASU 2018-02 will allow a company to transfer these "stranded" amounts from AOCI-L to retained earnings. ASU 2018-02 will be effective for the Company at the beginning of fiscal 2019, with early adoption permitted. The Company has amounts in its AOCI-L for defined benefit retirement plans that were recorded net of applicable income taxes, thus the Company anticipates the transfer of "stranded" tax amounts from its AOCI-L to retained earnings upon the adoption of ASU 2018-02. The effect of the adoption of ASU 2018-02 will not be material to the Company's financial position, and the adoption will have no impact on the Company's results of operations or cash flows.


Credit Losses (ASU 2016-13)

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). This new guidance will change how entities account for credit impairment for trade and other receivables, as well as for certain financial assets and other instruments. ASU 2016-13 will replace the current "incurred loss" model with an "expected loss" model. Under the "incurred loss" model, a loss (or allowance) is recognized only when an event has occurred (such as a payment delinquency) that causes the entity to believe that a loss is probable (i.e., that it has been "incurred"). Under the "expected loss" model, an entity will recognize a loss (or allowance) upon initial recognition of the asset that reflects all future events that will lead to a loss being realized, regardless of whether it is probable that the future event will occur. The "incurred loss" model considers past events and current conditions, while the "expected loss" model includes expectations for the future which have yet to occur. ASU 2016-13 will be effective for the Company at the beginning of fiscal 2020 with early adoption permitted for fiscal 2019, including interim periods therein. The

21


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

standard will require entities to record a cumulative-effect adjustment to the balance sheet as of the beginning of the first reporting period in which the guidance is effective. The Company is currently evaluating the potential impact that ASU 2016-13 may have on the timing of recognizing future provisions for expected losses on the Company's accounts receivable.


Goodwill Impairment Testing (ASU 2017-04)

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU 2017-04 will eliminate the requirement to calculate the implied fair value of goodwill (step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit's carrying amount over its fair value (i.e., measure the charge based on the current step 1). Any impairment charge will be limited to the amount of goodwill allocated to an affected reporting unit. ASU 2017-04 will not change the current guidance for completing Step 1 of the goodwill impairment test, and an entity will still be able to perform the current optional qualitative goodwill impairment assessment before determining whether to proceed to Step 1. Upon adoption, ASU 2017-04 will be applied prospectively. Adoption for the Company will be effective for annual and interim impairment tests performed beginning in fiscal 2020. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The impact that ASU 2017-04 may have on the Company's financial condition or results of operations will depend on the circumstances of any goodwill impairment event that may occur after adoption.



22


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 17 – GUARANTOR UNAUDITED CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

The Company’s senior notes constitute debt obligations of its wholly-owned subsidiary, The William Carter Company ("TWCC" or the "Subsidiary Issuer"), are unsecured and are fully and unconditionally guaranteed by Carter’s, Inc. (the "Parent"), by certain of the Parent's current domestic subsidiaries (other than TWCC), and, subject to certain exceptions, future restricted subsidiaries that guarantee the Company’s secured revolving credit facility or certain other debt of the Company or the subsidiary guarantors.

For additional information, refer to the Company's Annual Report on Form 10-K for the 2017 fiscal year ended December 30, 2017.
The condensed consolidating financial information for the Parent, the Subsidiary Issuer, and the guarantor and non-guarantor subsidiaries has been prepared from the books and records maintained by the Company. The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10. The financial information may not necessarily be indicative of the financial position, results of operations, comprehensive income (loss), and cash flows, had the Parent, Subsidiary Issuer, guarantor or non-guarantor subsidiaries operated as independent entities.
Intercompany revenues and expenses included in the subsidiary records are eliminated in consolidation. As a result of this activity, an amount due to/due from affiliates will exist at any time. The principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions. The Company has accounted for investments in subsidiaries under the equity method. The guarantor subsidiaries are 100% owned directly or indirectly by the Parent and all guarantees are joint, several, and unconditional.


23


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

CARTER’S, INC.
Condensed Consolidating Balance Sheets (unaudited)

As of June 30, 2018
(dollars in thousands)

 
Parent
 
Subsidiary
Issuer
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$

 
$
99,928

 
$
13,529

 
$
69,745

 
$

 
$
183,202

Accounts receivable, net

 
114,728

 
31,779

 
6,010

 

 
152,517

Intercompany receivable

 
70,001

 
105,309

 
60,536

 
(235,846
)
 

Finished goods inventories

 
385,000

 
224,323

 
76,949

 
(23,009
)
 
663,263

Prepaid expenses and other current assets

 
19,393

 
20,202

 
12,360

 

 
51,955

Total current assets

 
689,050

 
395,142