ITEM 1A. RISK FACTORS
You should carefully consider each of the following risk factors as well as the other information contained in this Annual Report on Form 10-K and our other filings with the SEC in evaluating our business. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impact our business operations. If any of the following risks actually occur, our operating results may be affected.
Risks Related to Global and Macroeconomic Conditions
The ongoing COVID-19 pandemic and other global crises have had and may in the future have a significant adverse effect on our business, financial condition, and results of operations.
Global crises, including political instability or other global events that result in the disruption of trade, the production and distribution of our products, or our sales operations, have had and may in the future have a significant adverse effect on our business, financial condition, and results of operations.
In March 2020, the World Health Organization declared the outbreak of a new strain of coronavirus (including variants, “COVID-19”) a pandemic. National, state, and local governments and private entities mandated and continue to mandate various restrictions as new waves of the pandemic and new strains of the virus spread across the globe, including travel restrictions, restrictions on public gatherings, stay at home orders and advisories, and quarantining of people who may have been exposed to the virus. The response to the COVID-19 pandemic negatively affected the global economy, disrupted global supply chains, and created significant disruption in financial and retail markets, including increased unemployment rates and a disruption in consumer demand for baby and children’s clothing and accessories. As a result, the COVID-19 pandemic and related measures taken to contain the spread of COVID-19 have had, and may likely continue to have, a significant adverse effect on our business, financial condition, and results of operations. For example, temporary store closures and the disruption of global supply chains in 2020 and 2021 significantly impacted our operations at that time. While the business recovery and adjustments to how we operate our business have mitigated that impact, a further spread of COVID-19, especially in regions that produce our products or raw materials, may have a material impact on our business. The extent to which COVID-19 impacts our business, results of operations, and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including a resurgence of COVID-19, including new variants, the effectiveness and availability of vaccines and boosters, and the efficacy, scope, and duration of other actions to limit the spread of COVID-19 or treat its impact, among others.
Our business is sensitive to overall levels of consumer spending, particularly in the young children’s apparel market.
Both retail and wholesale consumer demand for young children’s apparel and accessories, specifically brand name apparel products, is affected by the overall level of consumer spending. Overall spending in the market is affected by a number of global and macroeconomic factors, such as overall economic conditions and employment levels, gasoline and utility costs, business conditions, availability of consumer credit, tax rates, the availability of tax credits, interest rates, inflationary pressures and general uncertainty regarding the overall future political and economic climate, levels of consumer indebtedness, foreign currency exchange rates, weather, and overall levels of consumer confidence. We have experienced many of these factors due to the ongoing COVID-19 pandemic and the related responses of national, state, and local government and public health officials. For example, the U.S. economy is being negatively impacted by historically high inflation rates, which have negatively impacted and may continue to negatively impact consumer demand. Additionally, birth rate fluctuations, which in turn affect the number of customers that are acquired and retained, can have a material impact on consumer spending and our business. For instance, in recent years we have seen a reduction in the birth rate in the United States and a reduction in the size of the market for young children’s apparel and accessories. Reductions, or lower-than-expected growth, in the level of discretionary or overall consumer spending may have a material adverse effect on our sales and results of operations.
Our business could be negatively impacted by political or economic risks that we are exposed to as a result of our global operations.
We are subject to general political and economic risks in connection with our global operations, including political instability (both in the United States and globally, including the ongoing conflict between Russia and Ukraine and the related economic and retaliatory measures), terrorist attacks, and changes in diplomatic and trade relationships, any of which may have a significant adverse effect on our business, financial condition, and results of operations. In recent months, we have observed increased economic uncertainty in the United States and abroad. These developments have led to growing concerns about the systemic impact of a potential global economic recession, energy costs, geopolitical issues, or the availability and cost of credit and higher interest rates, which could further lead to increased market volatility, decreased consumer confidence, and diminished growth expectations in the U.S. economy and abroad. As our customers react to recent global economic conditions
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we have seen and may see customers reduce spending on our products and take additional precautionary measures to limit or delay expenditures and preserve capital and liquidity, thereby adversely affecting our customers’ ability or willingness to purchase our products.
Risks Related to Our Brands and Product Value
The acceptance of our products in the marketplace is affected by consumer tastes and preferences, along with fashion trends.
We believe that our continued success depends on our ability to create products that provide a compelling value proposition for our consumers in all of our distribution channels. There can be no assurance that the demand for our products will not decline, or that we will be able to successfully and timely evaluate and adapt our products to changes in consumer tastes and preferences or fashion trends. If demand for our products declines, promotional pricing may be required to sell out-of-season or excess merchandise, and our profitability and results of operations could be adversely affected.
Our failure to protect our intellectual property rights could diminish the value of our brand, weaken our competitive position, and adversely affect our results.
We currently rely on a combination of trademark, unfair competition, and copyright laws, as well as licensing and vendor arrangements, to establish and protect our intellectual property assets and rights. The steps taken by us or by our licensees and vendors to protect our proprietary rights may not be adequate to prevent either the counterfeit production of our products or the infringement of our trademarks or proprietary rights by others. In addition, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our proprietary rights and where third parties may have rights to conflicting trademarks, and it may be more difficult for us to successfully challenge the use of our proprietary rights by other parties in those countries. If we fail to protect and maintain our intellectual property rights, the value of our brands could be diminished, and our competitive position may suffer. Further, third parties may assert intellectual property claims against us, particularly as we expand our business geographically or through acquisitions, and any such claim could be expensive and time consuming to defend, regardless of their merit. Successful infringement claims against us could result in significant monetary liability or prevent us from selling some of our products, which could have an adverse effect on our results of operations.
The value of our brands, and our sales, could be diminished if we are associated with negative publicity, including through actions by our employees, and our vendors, marketing partners, third-party manufacturers, and licensees, over whom we have limited control.
Although we maintain policies with our employees, vendors, marketing partners, third-party manufacturers, and licensees that promote ethical business practices, and our employees, agents, and third-party compliance auditors periodically visit and monitor the operations of these entities, we do not control our vendors, third-party manufacturers, or licensees, or their practices. A violation of our vendor policies, licensee agreements, health and safety standards, labor laws, anti-bribery laws, privacy laws or other policies or laws by these employees, vendors, third-party manufacturers, or licensees could damage the image and reputation of our brands and could subject us to liability. As a result, negative publicity regarding us or our brands or products, including licensed products, could adversely affect our reputation and sales. Further, while we take steps to ensure the reputations of our brands are maintained through license and vendor agreements, there can be no guarantee that our brand image will not be negatively affected through its association with products or actions of our licensees, vendors, or third-party manufacturers.
We may experience delays, product recalls, or loss of revenues or incur additional costs if our products do not meet our quality standards.
From time to time, we receive shipments of product from our third-party vendors that fail to conform to our quality control standards. A failure in our quality control program may result in diminished inventory levels and product quality, which in turn may result in increased order cancellations and product returns, decreased consumer demand for our products, or product recalls, any of which may have a material adverse effect on our results of operations and financial condition. In addition, products that fail to meet our standards, or other unauthorized products, may be sold by third-parties without our knowledge or consent. This could materially harm our brand and our reputation in the marketplace.
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Risks Related to Operating a Global Business
We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can.
The global baby and young children’s apparel and accessories market is highly competitive and includes both branded and private label manufacturers. Because of the fragmented nature of the industry, we also compete with many other manufacturers and retailers including in certain instances some of our wholesale accounts. Some of our competitors have greater financial resources and larger customer bases than we have. As a result, these competitors may be able to adapt to changes in customer requirements and preferences more quickly, take advantage of acquisitions and other opportunities more readily, devote greater resources to the marketing and sale of their products, and adopt more aggressive pricing strategies than we can.
Financial difficulties for, or the loss of one or more of, our major wholesale customers could result in a material loss of revenues.
A significant amount of our business is with our wholesale customers. For fiscal 2022, we derived approximately 34% of our consolidated net sales from our U.S. Wholesale segment, approximately 33% of our consolidated net sales from our top ten wholesale customers, and approximately 27% of consolidated net sales from our top five wholesale customers, which includes net sales from our exclusive brands sold, in alphabetical order, at Amazon, Target, and Walmart. As of the end of fiscal 2022, approximately 81% of our gross accounts receivable were from our ten largest wholesale customers, with three of these customers having individual receivable balances in excess of 10% of our total accounts receivable. Furthermore, we do not enter into long-term sales contracts with our major wholesale customers, relying instead on product performance, long-standing relationships, and our position in the marketplace.
As we have experienced in the past, we face the risk that if one or more of these customers significantly decreases their business or terminates their relationship with us as a result of financial difficulties (including bankruptcy or insolvency), competitive forces, consolidation, reorganization, changes in merchandising strategies, or other reasons, then we may have significant levels of excess inventory that we may not be able to place elsewhere, a material decrease in our sales, or material impact on our operating results. In addition, our reserves for estimated credit losses resulting from the inability of our customers to make payments may prove not to be sufficient if any one or more of our customers are unable to meet outstanding obligations to us, which could materially adversely affect our operating results. If the financial condition or credit position of one or more of our customers were to deteriorate, or such customer fails, or is unable to pay the amounts owed to us in a timely manner, this could have a significant adverse impact on our business and results of operations. For instance, the parent company of buybuy BABY, Bed Bath & Beyond, Inc., previously issued a business update on January 5, 2023 about its substantial doubt to continue as a going concern. This customer comprised approximately 23% of Skip Hop brand wholesale sales in fiscal 2022, and reduced demand from this customer may adversely impact Skip Hop wholesale sales volumes.
Our retail success is dependent upon identifying locations and negotiating appropriate lease terms for retail stores.
We derive a significant portion of our revenues is through our retail stores in leased retail locations across the United States, Canada, and Mexico. Successful operation of a retail store depends, in part, on the overall ability of the retail location to attract a consumer base sufficient to generate profitable store sales volumes. A significant number of our stores are located in malls and other shopping centers, and many of these malls and shopping centers have been experiencing declines in customer traffic. If we are unable to identify new retail locations with consumer traffic sufficient to support a profitable sales level, our retail growth may be limited. Some new stores may be located in areas where we have existing sales channels. Increasing the number of stores in these markets may result in inadvertent diversion of customers and sales from our existing sales channels in the same market, thereby negatively affecting our results of operations. Further, if existing stores do not maintain a sufficient customer base that provides a reasonable sales volume or we are unable to negotiate appropriate lease terms for the retail stores, there could be a material adverse impact on our sales, gross margin, and results of operations. In addition, if consumer shopping preferences transition more from brick-and-mortar stores to online retail experiences, with us or other retailers, any increase we may see in our eCommerce sales may not be sufficient to offset the decreases in sales from our brick-and-mortar stores.
We also must be able to effectively renew our existing store leases on acceptable terms. In addition, from time to time, such as we have done in response to the ongoing COVID-19 pandemic, we may seek to renegotiate existing lease terms or downsize, consolidate, reposition, or close some of our real estate locations, which in most cases requires a modification of an existing store lease. Failure to renew existing store leases, secure adequate new lease terms, or successfully modify existing locations, or failure to effectively manage the profitability of our existing fleet of stores, could have a material adverse effect on our results of operations.
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Additionally, the economic environment may at times make it difficult to determine the fair market rent of real estate properties within the United States and internationally. This could impact the quality of our decisions to exercise lease options and renew expiring leases at negotiated rents. Any adverse effect on the quality of these decisions could impact our ability to retain real estate locations adequate to meet our profit or growth targets or efficiently manage the profitability of our existing fleet of stores and could have a material adverse effect on our results of operations.
Our eCommerce business faces distinct risks, and our failure to successfully manage it could have a negative impact on our profitability.
The successful operation of our eCommerce business as well as our ability to provide a positive shopping experience that will generate consumer demand and drive subsequent visits depends on efficient and uninterrupted operation of our order-taking and fulfillment operations. Risks associated with our eCommerce business in the United States, Canada, and Mexico include:
•the failure of the computer systems, including those of third-party vendors, that operate our eCommerce sites and mobile applications, including, among others, inadequate system capacity, service outages, computer viruses, human error, changes in programming, security breaches, system upgrades or migration of these services to new systems;
•disruptions in telecommunications services or power outages;
•reliance on third parties for computer hardware and software, as well as delivery of merchandise to our customers on-time and without damage;
•limitations of shipping volumes which may be imposed by service providers;
•rapid technology changes;
•the failure to deliver products to customers on-time and within customers’ expectations;
•credit or debit card, or other electronic payment-type, fraud, or disruptions in payment systems;
•the diversion of sales from our physical stores;
•natural disasters or adverse weather conditions;
•changes in applicable federal, state and international regulations;
•liability for online content; and
•consumer privacy concerns and regulation.
Problems in any of these areas could result in a reduction in sales, increased costs and damage to our reputation and brands, which could adversely affect our business and results of operations. In addition, in fiscal 2022 we experienced a decrease in net sales in our eCommerce channel compared to fiscal 2021. Our eCommerce business may continue to be negatively impacted if consumers shift back to traditional brick-and-mortal retail after the COVID-19 pandemic, and any increase we may see in net sales from brick-and-mortal retail may not be sufficient to offset the decreases in net sales from eCommerce.
Profitability and our reputation and relationships could be negatively affected if we do not adequately forecast the demand for our products and, as a result, create significant levels of excess inventory or insufficient levels of inventory.
There can be no assurance that we will be able to successfully anticipate changing consumer preferences and product trends or economic conditions and, as a result, we may not successfully manage inventory levels to meet our future order requirements. If we fail to accurately forecast consumer demand, we may experience excess inventory levels or a shortage of product required to meet the demand. Inventory levels in excess of consumer demand have resulted and may continue to result in inventory write-downs and the sale of excess inventory at discounted prices, which could have an adverse effect on the image and reputation of our brands and negatively impact profitability. On the other hand, if we underestimate demand for our products, our third-party manufacturers may not be able to produce enough products to meet consumer requirements, and this could result in delays in the shipment of products and lost revenues, as well as damage to our reputation and relationships. These risks could have a material adverse effect on our brand image, as well as our results of operations and financial condition.
Our profitability may decline as a result of lower margins, such as through deflationary pressures on our selling prices and increases in production costs and costs to serve.
The global apparel industry is subject to pricing pressure caused by many factors, including intense competition, the promotional retail environment, and changes in consumer demand. The demand for baby and young children’s apparel and accessories in particular may also be subject to other external factors, such as general inflationary pressures, as well as the costs of our products, which are driven in part by the costs of raw materials (including cotton and other commodities), labor, fuel, transportation and duties, any increases in mandatory minimum wages, and the costs to deliver those products to our customers.
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If external pressures, including deflation, cause us to reduce our sales prices and we fail to sufficiently reduce our product costs or operating expenses, or if we are unable to fully optimize prices or pass on increased costs to our customers, our profitability could decline. Additionally, while deflation could positively impact our product costs, it could have an adverse effect on our average selling prices per unit, resulting in lower sales and operating results. This could have a material adverse effect on our results of operations, liquidity, and financial condition.
We may not be able to increase prices to fully offset inflationary pressures on costs, such as raw materials, labor, and transportation costs, which may impact our expenses and profitability.
We rely on vendors, distribution resources and transportation providers. In fiscal 2021 and 2022, the costs of raw materials, packaging materials, labor, energy, fuel, transportation, and other inputs necessary for the production and distribution of our products increased significantly. We also expect the pressures of certain input cost inflation to continue in 2023.
Our attempts to offset these cost pressures, such as through increases in the selling prices of some of our products, may not be successful. Higher product prices may result in reductions in sales volume, as consumers may choose less expensive options, or forego some purchases altogether, during an economic downturn. To the extent that price increases are not sufficient to offset these increased costs adequately or in a timely manner, and/or if they result in significant decreases in sales volume, our business, financial condition, or operating results may be adversely affected.
Our revenues, product costs, and other expenses are subject to foreign economic and currency risks due to our operations outside of the United States.
We have operations in Canada, Mexico, and Asia, and our vendors, third-party manufacturers, and licensees are located around the world. The value of the U.S. dollar against other foreign currencies has experienced significant volatility in recent years. While our business is primarily conducted in U.S. dollars, we source substantially all of our production from Asia, and we generate significant revenues in Canada. Cost increases caused by currency exchange rate fluctuations could make our products less competitive or have a material adverse effect on our profitability. Currency exchange rate fluctuations could also disrupt the businesses of our third-party manufacturers that produce our products by making their purchases of raw materials or products more expensive and more difficult to finance. Additionally, fluctuations in currency exchange rates impact the amount of our reported sales and expenses, which could have a material adverse effect on our financial position, results of operations, and cash flows.
Our business could suffer a material adverse effect from unseasonable or extreme weather conditions, or other effects of climate change.
Our business is susceptible to unseasonable weather conditions, which could influence customer demand, consumer traffic, and shopping habits. For example, extended periods of unseasonably warm temperatures during the winter season or cool temperatures during the summer season have in the past and could in the future affect the timing of and reduce or shift demand for our products, and thereby could have an adverse effect on our operating results, financial position, and cash flows. In addition, extreme weather conditions in the areas in which our stores are located could negatively affect our business, operating results, financial position, and cash flows. For example, frequent or unusually heavy or intense snowfall, flooding, hurricanes, heat stress and sea level rise, or other extreme weather conditions over an extended period have caused and could in the future cause our stores to close for a period of time or permanently, and could make it difficult for our customers and employees to travel to our stores or to receive products shipped to them, which in turn could negatively impact our operating results.
In addition, there is concern that climate changes could cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. These changes may increase the effects described above, and changing weather patterns could result in decreased agricultural productivity in certain regions, which may limit availability and/or increase the cost of certain key materials, such as cotton. Public expectations and internal goals for reductions in greenhouse gas emissions could result in increased energy, transportation, and raw material costs, and may require us to make additional investments in facilities and equipment. In addition, the failure to meet or properly report progress on our Science-Based Target Initiative targets, public expectations or regulatory requirements may result in reputational damage or other adverse effects. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.
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Risk Relating to Litigation
We are and may become subject to various claims and pending or threatened lawsuits, including as a result of investigations or other proceedings related to previously disclosed investigations.
We are subject to various claims and pending or threatened lawsuits in the course of our business, including claims that our designs infringe on the intellectual property rights of third parties. We are also affected by trends in litigation, including class action litigation brought under various laws, including product liability, consumer protection, employment, and privacy and information security laws. In addition, litigation risks related to claims that technologies we use infringe intellectual property rights of third parties have been amplified by the increase in third parties whose primary business is to assert such claims. When appropriate, reserves are established based on our best estimates of our potential liability. However, we cannot accurately predict the ultimate outcome of any such proceedings due to the inherent uncertainties of litigation. Regardless of the outcome or whether the claims are meritorious, legal and regulatory proceedings may require that management devote substantial time and expense to defend the Company. In the event we are required or determine to pay amounts in connection with any such claims or lawsuits, such amounts could exceed applicable insurance coverage, if any, or contractual rights available to us. As a result, such lawsuits could be significant and have a material adverse impact on our business, financial condition, and results of operations. Product safety concerns may also require us to recall selected products at a substantial cost to us, which may lead to a lack of consumer trust and reputational harm to the affected brand. Product safety concerns, or the failure to manage recalls or defects, could also result in governmental fines, product liability litigation, lost sales and increased costs.
In addition, as previously reported, in 2009 the SEC and the U.S. Attorney’s Office began conducting investigations, with which we cooperated, related to customer margin support provided by us, including undisclosed margin support commitments and related matters. In December 2010, we entered into a non-prosecution agreement with the SEC pursuant to which the SEC agreed not to charge us with any violations of federal securities laws, commence any enforcement action against us, or require us to pay any financial penalties in connection with the SEC investigation of customer margin support provided by us, conditioned upon our continued cooperation with the SEC’s investigation and with any related proceedings. We have incurred, and may continue to incur, substantial expenses for legal services due to SEC and U.S. Attorney’s Office investigations and any related proceedings. These matters may continue to divert management’s time and attention away from operations. We also expect to bear additional costs pursuant to our advancement and indemnification obligations to directors and officers under the terms of our organizational documents in connection with proceedings related to these matters. Our insurance may not provide coverage to offset all of the costs incurred in connection with these proceedings.
Risks Related to Cybersecurity, Data Privacy, and Information Technology
Our systems, and those of our third-party vendors, containing personal information and payment data of our retail store and eCommerce customers, employees, and other third parties could be breached, which could subject us to adverse publicity, costly government enforcement actions or private litigation, and expenses.
We rely on the security of our networks, databases, systems, and processes to protect our proprietary information and information about our customers, employees, and vendors, including customer payment information. We have established physical, electronic, and organizational measures to safeguard and secure our systems to prevent data compromise and rely on commercially available systems, software, tools, and monitoring to provide security for our IT systems and the processing, transmission and storage of digital information. However, our IT systems are vulnerable to damage or interruption from a variety of sources, including physical damage, telecommunications or network failures or interruptions, system malfunction, natural disasters, malicious human acts, terrorism, and war, and we have experienced interruptions in the past. These systems, including our servers, are also vulnerable to physical or electronic break-ins, security breaches from inadvertent or intentional actions by our employees, third-party service providers, contractors, consultants, business partners, and/or other third parties, or from cyber-attacks by malicious third parties (including the deployment of harmful malware, ransomware, denial-of-service attacks, social engineering, and other means to affect service reliability and threaten the confidentiality, integrity, and availability of information). We have outsourced elements of our IT systems, including to cloud-based solution vendors, and use third-party vendors in other aspects of our operations and, as a result, a number of third-party vendors may or could have access to confidential information. Our third-party vendors have experienced service interruptions and cyber-attacks in the past, and we expect they may continue.
Cyber criminals are constantly devising schemes to circumvent information technology security safeguards and other retailers have suffered serious data security breaches. The risk of a security breach or disruption, particularly through cyber-attacks or cyber intrusion, including by computer hackers, foreign governments, and cyber terrorists, has generally increased as the number, intensity, and sophistication of attempted attacks and intrusions from around the world have increased. We may not be able to anticipate all types of security threats, and we may not be able to implement preventive measures effective against all such security threats. The techniques used by cyber criminals change frequently, may not be recognized until launched, and can
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originate from a wide variety of sources, including outside groups such as external service providers, organized crime affiliates, terrorist organizations, or hostile foreign governments or agencies. It is possible that we or our third-party vendors may experience cybersecurity and other breach incidents that remain undetected for an extended period. Even when a security breach is detected, the full extent of the breach may not be determined immediately. The costs to us to mitigate network security issues, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant and, while we have implemented security measures to protect our IT and data security infrastructure, our efforts to address these issues may not be successful.
If unauthorized parties gain access to our networks or databases, or those of our vendors, they may be able to steal, publish, delete, modify, or block our access to our private and sensitive internal and third-party information, including payment information and personally identifiable information. In such circumstances, we could be held liable to our customers, other parties, or employees as well as be subject to regulatory or other actions for breaching privacy law (including the E.U. GDPA, CCPA, and the CPRA) or failing to adequately protect such information. This could result in costly investigations and litigation exceeding applicable insurance coverage or contractual rights available to us, civil or criminal penalties, operational changes, or other response measures, loss of consumer confidence in our security measures, and negative publicity that could adversely affect our financial condition, results of operations, and reputation. Further, if we are unable to comply with the security standards established by banks and the payment processing industry, we may be subject to fines, restrictions, and expulsion from payment acceptance programs, which could adversely affect our retail operations. In addition, we may be required to incur significant costs to protect against damage caused by these disruptions or security breaches in the future. If our IT systems fail and our redundant systems or disaster recovery plans are not adequate to address such failures, or if our business interruption insurance does not sufficiently compensate us for any losses that we may incur, our revenues and profits could be reduced and the reputation of our brand and our business could be materially and adversely affected.
We are also reliant on the security practices of our third-party service providers, which may be outside of our direct control. The services provided by these third parties have been, and will likely continue to be, subject to the same risk of outages, other failures and security breaches described above. If these third parties fail to adhere to adequate security practices, or experience a breach of their systems, the data of our employees and customers may be improperly accessed, used or disclosed. In addition, our third-party providers may take actions beyond our control that could harm our business, including discontinuing or limiting our access to one or more services, increasing pricing terms, terminating, or seeking to terminate our contractual relationship altogether, or altering how we are able to process data in a way that is unfavorable or costly to us. Although we expect that we could obtain similar services from other third parties, if our arrangements with our current providers were terminated, we could experience interruptions in our business, as well as delays and additional expenses in arranging for alternative cloud infrastructure services. Any loss or interruption to our systems or the services provided by third parties would adversely affect our business, financial condition, and results of operations.
Failure to implement new information technology systems or needed upgrades to our systems, including operational and financial systems, could adversely affect our business.
As our business continues to grow in size, complexity, and geographic footprint, we have enhanced and upgraded our information technology infrastructure and we expect there to be a regular need for additional enhancements and upgrades as we continue to grow. Failure to implement new systems or upgrade systems, including operational and financial systems, as needed or complications encountered in implementing new systems or upgrading existing systems could cause disruptions that may adversely affect our business and results of operations. Further, additional investments needed to upgrade and expand our information technology infrastructure may require significant investment of additional resources and capital, which may not always be available or available on favorable terms.
Risks Related to our Global Supply Chain and Labor Force
We source substantially all of our products through foreign production arrangements. Our dependence on foreign supply sources are subject to risks associated with global sourcing and manufacturing which could result in disruptions to our operations.
We source substantially all of our products through a network of vendors primarily in Asia, principally coordinated by our Hong Kong sourcing office. Our global supply chain could be negatively affected due to a number of factors, including:
•political instability or other global events resulting in the disruption of operations or trade in or with foreign countries from which we source our products;
•the occurrence of a natural disaster, unusual weather conditions, or a disease epidemic in foreign countries from which we source our products;
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•financial instability, including bankruptcy or insolvency, of one or more of our major vendors, including our transportation providers and carriers;
•the imposition of new laws and regulations relating to imports, duties, taxes, and other charges on imports, including those that the U.S. government has implemented and may further implement on imports from China, such as the Uyghur Forced Labor Prevention Act and other sanctions and trade regulations issued by the U.S. government related to forced labor in the Xinjiang Uyghur Autonomous Region of China and other regions which may affect our sourcing operations and the availability of raw materials, including cotton, used by the vendors from which we purchase goods;
•increased costs of raw materials (including cotton and other commodities), labor, fuel, and transportation;
•interruptions in the supply of raw materials, including cotton, fabric, and trim items;
•increases in the cost of labor in our sourcing locations;
•changes in the U.S. customs procedures concerning the importation of apparel products, durable goods and accessories;
•unforeseen delays in customs clearance of any goods;
•disruptions in the global transportation network, such as a port strikes or delays, work stoppages or other labor unrest, capacity withholding, world trade restrictions, acts of terrorism, or war;
•the application of adverse foreign intellectual property laws;
•the ability of our vendors to secure sufficient credit to finance the manufacturing process, including the acquisition of raw materials;
•potential social compliance concerns resulting from our use of international vendors, third-party manufacturers, and licensees, over whom we have limited control;
•manufacturing delays or unexpected demand for products may require the use of faster, but more expensive, transportation methods, such as air-freight services; and
•other events beyond our control that could interrupt our supply chain and delay receipt of our products into the United States, Canada, and Mexico, as well as the ninety additional countries in which our international partners and international wholesale customers operate.
The occurrence of one or more of these events could result in disruptions to our operations, which in turn could increase our cost of goods sold, decrease our gross profit, or impact our ability to deliver to our customers. The COVID-19 pandemic has impacted and continues to impact global supply chain operations, causing delays in the production and transportation of our product. For example, in fiscal 2020 and 2021 the COVID-19 pandemic had a material adverse effect on our sourcing operations, particularly in China and the rest of Asia, and has slowed our ability to import products into North America. In addition, in fiscal 2021 and 2022, we experienced increased inbound transportation and freight costs as compared to prior periods, and we expect that we may experience increased costs in the future that may adversely impact our financial and operating results in fiscal 2023 and further periods.
A relatively small number of vendors supply a significant amount of our products, and losing one or more of these vendors could have a material adverse effect on our business.
In fiscal 2022, we purchased approximately 57% of our products from ten vendors, with three vendors representing nearly one half of the purchases made from our top ten vendors. Additionally, we estimate that approximately 74% of the fabric that is used in the manufacture of our products is sourced from China. We expect that we will continue to source a significant portion of our products from these vendors. We do not have agreements with our major vendors that would provide us with assurances on a long-term basis as to adequate supply or pricing of our products. If any of our major vendors decide to discontinue or significantly decrease the volume of products they manufacture for us, raise prices on products we purchase from them, or become unable to perform their responsibilities (e.g., if our vendors become insolvent or experience financial difficulties, manufacturing capacity constraints, significant labor disputes, or restrictions imposed by foreign governments) our business, results of operations, and financial condition may be adversely affected.
Labor or other disruptions along our supply chain may adversely affect our relationships with customers, reputation with consumers, and results of operations.
Our business depends on our ability to source and distribute products in a timely manner. Labor disputes at third-party factories where our goods are produced, the shipping ports we use, or within our transportation carriers create significant risks for our business, particularly if these disputes result in work slowdowns, lockouts, strikes, or other disruptions during our peak
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manufacturing and importing times. For example, we source a significant portion of our products through a single port on the West Coast of the United States. Work slowdowns and stoppages relating to labor agreement negotiations involving the operators of this west coast port and unions have in the past resulted in a significant backlog of cargo containers entering the United States. We, along with other companies, have also shifted a significant amount of our product deliveries to ports of entry on the East Coast of the United States, which have experienced volume increases that created, and may continue to create, delays at these ports that did not exist before we, and others, shifted significant volume to them. Further, in the past, the insolvency of a major shipping company has also had an effect on our supply chain. As a result, we have in the past experienced delays in the shipment of our products. In the event that these slow-downs, disruptions or strikes occur in the future in connection with labor agreement negotiations or otherwise, it may have a material adverse effect on our financial position, results of operations, or cash flows.
Our inability to effectively source and manage inventory could negatively impact our ability to timely deliver our inventory supply and disrupt our business, which may adversely affect our operating results.
We source all of our products from a global network of third-party suppliers. If we experience significant increases in demand, or need to replace an existing vendor or shift production to vendors in new countries, there can be no assurance that additional manufacturing capacity will be available when required on terms that are acceptable to us or that any vendor would allocate sufficient capacity to us in order to meet our requirements. In addition, for any new vendors, we may encounter delays in production and added costs as a result of the time it takes to train our vendors in producing our products and adhering to our quality control standards. In the event of a significant disruption in the supply of the fabrics or raw materials (including cotton) used by our vendors in the manufacture of our products, such as an inability to source from a particular vendor or geographic region, our vendors might not be able to locate alternative suppliers of materials of comparable quality at an acceptable price. Any delays, interruption, or increased costs in the manufacture of our products could have a material adverse effect on our operating results or cash flows.
Additionally, the nature of our business requires us to carry a significant amount of inventory, especially prior to the peak holiday selling season when increase our inventory levels, and to support our retail omni-channel strategies, including our buy on-line and pick-up in store program. Merchandise usually must be ordered well in advance of the season and frequently before apparel trends are validated by customer purchases. We must enter into contracts for the purchase and manufacture of merchandise well in advance of the applicable selling season. As a result, we are vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases and allocations to our sales channels. In the past, we have not always predicted our customers’ preferences and acceptance levels of our trend items with accuracy. If sales do not meet expectations, too much inventory may cause excessive markdowns and, therefore, lower-than-planned margins, and too little inventory may result in lost sales.
Our Braselton, Georgia distribution facility handles a large portion of our merchandise distribution. If we encounter problems with this facility, our ability to deliver our products to the market could be adversely affected.
We handle a large portion of our merchandise distribution for our U.S. stores and our eCommerce operations from our facility in Braselton, Georgia. Our ability to meet consumer expectations, manage inventory, complete sales, and achieve objectives for operating efficiencies depends on proper operation of this facility. If we are not able to distribute merchandise to our stores or customers because we have exceeded our capacity at our distribution facility (such as a high level of demand during peak periods) or because of natural disasters, health issues, accidents, system failures, disruptions, or other events, our sales could decline, which may have a materially adverse effect on our earnings, financial position, and our reputation. Additionally, we have experienced significant competition in hiring employees for this facility, which we attribute to the impacts of governmental stimulus related to COVID-19 and to increased competition and rising wages. To address this, we have increased wages and implemented other policies in order to retain existing employees and attract additional employees. These wage increases impacted our operating results. We are likely to continue to face challenges in hiring employees for this facility due to increased competition and we may incur additional employee-related costs, when necessary, which would impact our operating results. These staffing difficulties have caused and may in the future cause additional capacity constraints. Additionally, if we are unable to adequately staff this facility to meet demand, or if the cost of such staffing is higher than projected due to competition, mandated wage increases, regulatory changes, or other factors, our operating results may be further harmed.
In addition, we use automated systems that manage the order processing for our eCommerce business. In the event that one of these systems becomes inoperable for any reason, we may be unable to ship orders in a timely manner, and as a result, we could experience a reduction in our direct-to-consumer business, which could negatively impact our sales and profitability.
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Risks Relating to Our International Expansion
We may be unsuccessful in expanding into international markets.
We cannot be sure that we can successfully complete any planned international expansion or that new international business will be profitable or meet our expectations. We do not have significant experience operating in markets outside of North America. Consumer demand, behavior, tastes, and purchasing trends may differ in international markets and, as a result, sales of our products may not be successful or meet our expectations, or the margins on those sales may not be in line with those we currently anticipate. We may encounter differences in business culture and the legal environment that may make working with commercial partners and hiring and retaining an adequate employee base more challenging. We may also face difficulties integrating foreign business operations with our current operations. Significant changes in foreign laws or relations, such as political uncertainty and potential trade wars between nations in which we operate, may also hinder our success in new markets. Our entry into new markets may have upfront investment costs that may not be accompanied by sufficient revenues to achieve typical or expected operational and financial performance and such costs may be greater than expected. If our international expansion plans are unsuccessful, our results could be materially adversely affected.
Risks Related to Governmental and Regulatory Changes
Failure to comply with the various laws and regulations as well as changes in laws and regulations could have an adverse impact on our reputation, financial condition, or results of operations.
We are subject to laws, regulations and standards set by various governmental authorities around the world, including in the United States, Canada, and Mexico, including:
•those imposed by the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC, and the NYSE;
•the U.S. Foreign Corrupt Practices Act, and similar world-wide anti-bribery laws;
•health care, employment and labor laws;
•product and consumer safety laws, including those imposed by the U.S. Consumer Product Safety Commission and the Americans with Disabilities Act of 1990;
•data privacy laws, including the E.U. GDPA and the CCPA;
•trade, transportation and logistics related laws, including tariffs and orders issued by Customs and Border Protection; and
•applicable environmental laws.
Our failure to comply with these various laws and regulations could have an adverse impact on our reputation, financial condition, or results of operations. In addition, these laws, regulations, and standards may change from time to time, and the complexity of the regulatory environment in which we operate may increase. Although we undertake to monitor changes in these laws, if these laws change without our knowledge, or are violated by importers, designers, manufacturers, distributors, or agents, we could experience delays in shipments and receipt of goods or be subject to fines or other penalties under the controlling regulations, any of which could negatively affect our business and results of operations. Also, our inability, or that of our vendors, to comply on a timely basis with regulatory requirements could result in product recalls, or significant fines or penalties, which in turn could adversely affect our reputation and sales, and could have an adverse effect on our results of operations. Issues with respect to the compliance of merchandise we sell with these regulations and standards, regardless of our culpability or customer concerns about such issues, could result in damage to our reputation, lost sales, uninsured product liability claims or losses, product recalls, and increased costs.
Risks Related to Executing Our Strategic Plan
Our failure to properly manage strategic initiatives in order to achieve our objectives may negatively impact our business.
The implementation of our business strategy periodically involves the execution of complex initiatives, such as acquisitions, which may require that we make significant estimates and assumptions about opportunities and initiatives that we may pursue. These projects could place significant demands on our accounting, financial, information technology, and other systems, and on our business overall. We are dependent on our management’s ability to oversee these projects effectively and implement them successfully. If our estimates and assumptions about a project are incorrect, or if we miscalculate the resources or time we need to complete a project or fail to implement a project effectively, our business and operating results could be adversely affected.
Given the trend of declining customer traffic in malls and shopping centers, our multi-channel business model is an important pillar of our strategic plan. Our multi-channel global business model, which includes retail store, eCommerce, and wholesale
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sales channels, enables us to reach a broad range of consumers around the world. However, to be effective, this strategy has and will continue to require significant investment in cross-functional operations and management focus, along with investment in supporting technologies. Omni-channel retailing is rapidly evolving and we must anticipate and meet changing customer expectations and address new developments and technology investments by our competitors. Our omni-channel retailing strategy includes implementing new technology, software, and processes to be able to fulfill customer orders from any point within our system of stores and distribution centers, which is extremely complex and may not meet customer expectations for timely and accurate deliveries. If we are unable to attract and retain employees or contract with third-parties having the specialized skills needed to support our multi-channel efforts, implement improvements to our customer-facing technology in a timely manner, allow real-time and accurate visibility to product availability when customers are ready to purchase, quickly and efficiently fulfill our customers' orders using the fulfillment and payment methods they demand, or provide a convenient and consistent experience for our customers regardless of the ultimate sales channel, our ability to compete and our results of operations could be adversely affected. In addition, if our retail eCommerce sites or our other customer-facing technology systems do not appeal to our customers, reliably function as designed, or maintain the privacy of customer data, or if we are unable to consistently meet our brand and delivery promises to our customers, we may experience a loss of customer confidence or lost sales, or be exposed to fraudulent purchases, which could adversely affect our reputation and results of operations.
Additionally, our pricing and other strategies for growing profitability may not achieve their objectives, may adversely affect our business, inventory units sold, results of operations, and cash flows.
A failure to properly execute our plans and business strategies, delays in executing our plans and business strategies, increased costs associated with executing on our plans and business strategies, or failure to identify alternative strategies could have a material adverse effect on our business, financial position, results of operations, and cash flows.
Our success is dependent upon retaining key individuals within the organization to execute our strategic plan.
Our ability to attract and retain qualified executive management, marketing, merchandising, design, sourcing, technology, operations, including distribution center and retail store, and support function staffing is key to our success. We cannot be sure that we will be able to attract, retain, and motivate a sufficient number of qualified personnel in the future, or that the compensation costs of doing so will not adversely affect our operating results. We have paid special bonuses across our workforce and have increased, and may continue to increase, our employee compensation and benefits levels in response to competition, as necessary. Our inability to retain personnel could cause us to experience business disruption due to a loss of historical knowledge and a lack of business continuity and may adversely affect our results of operations, financial position, and cash flows.
We may be unable to grow through acquisitions or successfully integrate acquired businesses, and such acquisitions may fail to achieve the financial results we expected.
From time to time we may acquire other businesses as part of our growth strategy, such as our acquisitions of the Skip Hop brand and our Mexican licensee in fiscal 2017, and we may partially or fully fund future acquisitions by taking on additional debt. We may be unable to continue to grow through acquisitions if we are not able to identify suitable acquisition candidates or acquire them on favorable terms, and potential acquisitions may be abandoned or delayed if necessary financing is not available or regulatory approvals cannot be obtained. For completed acquisitions, we may be unable to successfully integrate businesses we acquire and such acquisitions may fail to achieve the financial results we expected. Integrating completed acquisitions into our existing operations, particularly larger acquisitions, involves numerous risks, including harmonizing divergent technology platforms, diversion of our management attention, failure to retain key personnel and customers, and failure of the acquired business to be financially successful. In addition, we cannot be certain of the extent of any unknown or contingent liabilities of any acquired business, including liabilities for failure to comply with applicable laws, such as those relating to product safety, anti-bribery or anti-corruption. We may incur material liabilities for past activities of acquired businesses. Also, depending on the location of the acquired business, we may be required to comply with laws and regulations that may differ from those of the jurisdictions in which our operations are currently conducted. Our inability to successfully integrate businesses we acquire, or if such businesses do not achieve the financial results we expect, may increase our costs and have a material adverse impact on our financial condition and results of operations.
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Risks Related to Financial Reporting, Our Debt, and Tax
We may not achieve sales growth plans, profitability objectives, and other assumptions that support the carrying value of our intangible assets.
The carrying values of our goodwill and tradename assets are subject to annual impairment reviews as of the last day of each fiscal year or more frequently, if deemed necessary, due to any significant events or changes in circumstances. Estimated future cash flows used in these impairment reviews could be negatively affected if we do not achieve our sales plans and planned profitability objectives. Other assumptions that support the carrying value of these intangible assets, including a deterioration of macroeconomic conditions which would negatively affect the cost of capital and/or discount rates, could also result in impairment of the remaining asset values. For example, in fiscal 2022, we recorded pre-tax intangible asset impairments of $9.0 million, reflecting the effect of increased discount rates and lower forecasted sales and profitability. In addition, in the first quarter of fiscal 2020, we recorded intangible asset impairments of $26.5 million and a goodwill impairment of $17.7 million based on forecasted financial information derived from the information reasonably available to us at the time given the unknown future impact of the COVID-19 pandemic.
We have substantial debt, which could adversely affect our financial health and our ability to obtain financing in the future and to react to changes in our business.
As of the end of fiscal 2022, we had $620.0 million aggregate principal amount of debt outstanding (excluding $3.5 million of outstanding letters of credit), and $726.5 million of undrawn availability under our senior secured revolving credit facility after giving effect to $3.5 million of letters of credit issued under our senior secured revolving credit facility. As a result, our ability to obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements, or general corporate or other purposes may be limited, and we may be unable to renew or refinance our debt on terms as favorable as our existing debt or at all.
If our liquidity, cash flows, and capital resources are insufficient to fund our debt service obligations and other cash requirements, we could be forced to reduce or delay investments and capital expenditures or to sell assets or operations, seek additional capital, or restructure or refinance our indebtedness. We may not be able to effect any such alternative measures, if necessary, on commercially reasonable terms or at all and, even if successful, such alternative actions may not allow us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations.
In addition, both our senior secured revolving credit facility and, in certain circumstances, the indenture that governs the senior notes contain restrictive covenants that, subject to specified exemptions, restrict our ability to incur indebtedness, grant liens, make certain investments (including business acquisitions), pay dividends or distributions on our capital stock, engage in mergers, dispose of assets and use the proceeds from any such dispositions, and raise debt or equity capital to be used to repay other indebtedness when it becomes due. These restrictions may limit our ability to engage in acts that may be in our long-term best interests, and may make it difficult for us to execute our business strategy successfully or effectively compete with companies that are not similarly restricted. In particular, we cannot guarantee that we will have sufficient cash from operations, borrowing capacity under our debt documents, or the ability to raise additional funds in the capital markets to pursue our growth strategies as a result of these restrictions or otherwise. We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility.
We may experience fluctuations in our tax obligations and effective tax rate.
We are subject to income taxes in federal and applicable state and local tax jurisdictions in the United States, Canada, Hong Kong, Mexico, and other foreign jurisdictions. Our taxable income in each jurisdiction is affected by certain transfer pricing arrangements between affiliated entities. Challenges to the arms-length nature of these transfer prices could materially affect our taxable income in a taxing jurisdiction, and therefore affect our income tax expense. We record tax expense based on our estimates of current and future payments, which include reserves for estimates of uncertain tax positions. At any time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may impact the ultimate settlement of these tax positions. As a result, there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are re-evaluated. Further, our effective tax rate in any financial statement period may be materially affected by changes in the geographic mix and level of earnings.
During the requisite service period for compensable equity-based compensation awards that we may grant to certain employees, we recognize a deferred income tax benefit on the compensation expense we incur for these awards for all employees other than our named executive officers. At time of subsequent vesting, exercise, or expiration of an award, the difference between our
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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 and can consequently raise or lower our effective tax rate for the period. Such differences are largely dependent on changes in the market price for our common stock.
We cannot predict whether quotas, duties, taxes, or other similar restrictions will be imposed by the United States or foreign countries upon the import or export of our products in the future, or what effect any of these actions would have, if any, on our business, financial condition, or results of operations.
Changes in regulatory, geopolitical, social or economic policies, treaties between the United States and other countries, and other factors may have a material adverse effect on our business in the future or may require us to exit a particular market or significantly modify our current business practices. For example, our taxable income may be affected by new laws, rulings, initiatives, and other events, which may affect our business, financial condition, or results of operations in future periods, including:
•the CARES Act, which was enacted in March 2020, and which significantly affects U.S. taxation by providing a retention credit and eases limitations on certain deductions including interest due to potential volatility in 2020 taxable income;
•a 2018 U.S. Supreme Court ruling, under which states may have additional ability to tax entities operating in their state, but lacking physical presence;
•mandatory country by country reporting of revenue, employees and profits, and certain international initiatives (such as the Organisation for Economic Co-operation and Development (OECD)’s Base Erosion and Profit Shifting (BEPS)) that are focused on the equity of international taxation, which may ultimately result in a worldwide minimum tax, or more defined approach around global profit allocation between related companies operating in jurisdictions with disparate income tax rates; and
•tax revenue reductions as a result of the economic impact of the pandemic, which may lead to increases in state tax rates or the expansions of their tax base.
General Risks
Quarterly cash dividends and share repurchases are subject to a number of uncertainties, and may affect the price of our common stock.
Quarterly cash dividends and share repurchases under our share repurchase program have historically been part of our capital allocation strategy. Although we reinstated our share repurchase program in August 2021 and resumed payment of a quarterly dividend in the third quarter of fiscal 2021, in the first quarter of fiscal 2020 we suspended both our quarterly cash dividends and our share repurchase program due to the effects of the COVID-19 pandemic, and we are not required to declare dividends or make any share repurchases under our share repurchase program in the future. Decisions with respect to future dividends and share repurchases are subject to the discretion of our Board of Directors and will be based on a variety of factors, including restrictions under our secured revolving credit facility, market conditions, the price of our common stock, the nature and timing of other investment opportunities, changes in our business strategy, the terms of our financing arrangements, our outlook as to the ability to obtain financing at attractive rates, the impact on our credit ratings and the availability of domestic cash. A subsequent reduction or elimination of our cash dividend, or subsequent suspension or elimination of our share repurchase program could adversely affect the market price of our common stock. Additionally, there can be no assurance that any share repurchases will enhance shareholder value because the market price of our common stock may decline below the levels at which we repurchased shares of common stock, and short-term stock price fluctuations could reduce the program’s effectiveness.
The market price of our comment stock may be volatile.
The market price of our common stock may fluctuate substantially. Future announcements concerning us or our competitors’, financial results, quarterly variations in operating results or comparable sales, updates on strategic initiatives, failure to meet analyst or investor expectations, failure of investors or analysts to understand our business strategies or fundamental changes in our business or sector, among other factors, could cause these fluctuations. In addition, stock markets have experienced periods of significant price or volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many public companies for reasons frequently unrelated to the operating performance of the specific companies. Stock price volatility may also impact our decisions with respect to future dividends and share repurchases.
Our amended and restated bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our shareholders, which could limit our shareholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents.
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Our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees, or agents to us or our shareholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our certificate of incorporation or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. This exclusive forum provision is not intended to apply to actions arising under the Exchange Act or the Securities Act of 1933, as amended. The Court of Chancery of the State of Delaware has held that a Delaware corporation can only use its constitutive documents to bind a plaintiff to a particular forum where the claim involves rights or relationships that were established by or under the DGCL.
Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the forum selection provision of our amended and restated bylaws. The choice of forum provision may limit a shareholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find this provision of our amended and restated bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The following is a summary of our principal owned and leased properties as of December 31, 2022.
Our corporate headquarters occupies 278,000 square feet of leased space in a building in Atlanta, Georgia. Our lease for that space expires in April 2030. In addition, we occupy leased space in a building in Mississauga, Ontario, which serves as our regional headquarters for Canada, and we occupy leased space in Hong Kong, which serves as our principal sourcing office in Asia. We also lease other space in Georgia and New York, as well as in Bangladesh, Cambodia, China, Mexico, and Vietnam that, depending on the site, serves as a sourcing, sales, or administrative office. We also own a 224,000 square foot facility in Griffin, Georgia.
Our largest distribution centers, which we lease, are located in Braselton, Georgia, Stockbridge, Georgia, and Jonesboro, Georgia and are 1.1 million, 0.5 million, and 0.2 million square feet, respectively. The distribution centers in Braselton, Georgia and Stockbridge, Georgia support all of our operating segments, and the distribution center in Jonesboro, Georgia supports our U.S. Wholesale segment. We also lease additional space in or use third-party logistics providers in California, Canada, China, Mexico and Vietnam for warehousing and distribution purposes.
We also operate the following number of leased retail stores: 757 in the United States, 187 in Canada, and 49 in Mexico. Our average remaining lease term for retail store leases in the United States, Canada, and Mexico is approximately 3.3 years, excluding renewal options.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims and pending or threatened lawsuits in the normal course of our business. The Company is not currently a party to any legal proceedings that it believes would have a material adverse effect on its financial position, results of operations, or cash flows.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock
Our common stock trades on the New York Stock Exchange (NYSE) under the trading symbol CRI. As of February 17, 2023, there were 184 holders of record of our common stock. A substantially greater number of holders of our common stock are “street name” or beneficial holders, whose shares of record are held by banks, brokers, and other financial institutions.
Open Market Share Repurchases
The following table provides information about shares repurchased during the fourth quarter of fiscal 2022:
(*)Includes shares of our common stock surrendered by our employees to satisfy required tax withholding upon the vesting of restricted stock awards. There were 1,085 shares surrendered between October 30, 2022 and November 26, 2022.
Share Repurchase Program
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 aggregate remaining capacity under outstanding repurchase authorizations as of December 31, 2022 was $749.5 million. The share repurchase authorizations have no expiration dates.
We repurchased and retired shares in open market transactions in the following amounts for the fiscal periods indicated:
For the fiscal year ended
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 revolving credit facility and considerations given to market conditions, stock price, other investment priorities, excise taxes, and other factors.
Dividends
On February 23, 2023, the Company's Board of Directors authorized a quarterly cash dividend payment of $0.75 per common share, payable on March 17, 2023 to shareholders of record at the close of business on March 7, 2023.
In fiscal 2022, the Board of Directors declared and the Company paid quarterly cash dividends of $0.75 per common share during all four quarters. In fiscal 2021, the Board of Directors declared and the Company paid quarterly cash dividends of $0.40 per common share in each of the second and third quarters of fiscal 2021 and $0.60 per common share in the fourth quarter of fiscal 2021. As a result of actions taken in connection with the COVID-19 pandemic, the Board of Directors did not declare and the Company did not pay cash dividends for the first quarter of 2021. Our Board of Directors will evaluate future dividend
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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 8, Long-Term Debt, to the consolidated financial statements.
Recent Sales of Unregistered Securities
None.
ITEM 6. [RESERVED]
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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, including statements with respect to the potential effects of macroeconomic conditions, the COVID-19 pandemic, consumer habits and the Company’s future outlook, financial results and sales growth, operational challenges, liquidity, strategy, financings, and investments. 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 2021 to our results for fiscal year 2020 and other financial information related to fiscal year 2020, refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2021 Annual Report on Form 10-K, filed with the SEC on February 25, 2022.
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 2022, which ended on December 31, 2022, contained 52 weeks. Fiscal 2021, which ended on January 1, 2022, contained 52 weeks. Fiscal 2020, which ended on January 2, 2021, contained 53 weeks.
The 53rd week in fiscal 2020 contributed approximately $32.1 million of incremental consolidated revenue. Consolidated gross margin for revenue in the 53rd week was slightly lower than consolidated gross margin for fiscal 2021 and fiscal 2022 due to increased promotional activity during the 53rd week.
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, exclusive Carter’s brands developed for specific wholesale customers, and Little Planet, a brand focused on organic fabrics and sustainable materials.
Established in 1865, our Carter’s brand is recognized and trusted by consumers for high-quality apparel, sleepwear, and accessories for children in sizes newborn to 14.
Established in 1895, OshKosh is a well-known brand, trusted by consumers for high-quality apparel and accessories for children in sizes newborn to 14, with a focus on playclothes for toddlers and young children. We acquired OshKosh in 2005.
Established in 2003, the Skip Hop brand re-thinks, re-energizes, and re-imagines durable necessities to create higher value, superior quality, and top-performing products for parents, babies, and toddlers. We acquired Skip Hop in 2017.
Additionally, Child of Mine, anexclusive Carter’s brand, is available only at Walmart; Just One You, an exclusive Carter’s brand, is available only at Target, and Simple Joys, an exclusive Carter’s brand, is available only on Amazon.
Launched in 2021, the Little Planet brand focuses on sustainable clothing through the sourcing of mostly organic cotton as certified under the GOTS, a global textile processing standard for organic fibers. This brand includes a wide assortment of baby and toddler apparel, accessories, and sleepwear.
Our corporate purpose is to inspire the generations raising the future. Our mission is to serve the needs of all families with young children, with a vision to be the world’s favorite brands in young children’s apparel and related products. We believe our brands are complementary to one another in product offering and aesthetic. Each brand is uniquely positioned in the marketplace and offers great value to families with young children. The baby and young children’s apparel market ages zero to 10 in the U.S. is approximately $29 billion. In this market, our Carter’s brands, including our exclusive brands, hold the #1 position with approximately 10% market share and our OshKosh brand has approximately 1% market share as of December 2022.
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Our multi-channel, 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 2022, our channels included 993 company-owned retail stores, approximately 19,350 wholesale locations, and eCommerce websites in North America, as well as our international wholesale accounts and licensees who operate in over 90 countries.
We have extensive experience in the young children’s apparel and accessories market and focus on delivering products that satisfy our consumers’ needs. Our long-term growth strategy focuses on four key strategic priorities:
•Lead in eCommerce;
•Win in Baby;
•Age Up; and
•Expand Globally.
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 14, 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 less adverse purchase commitments (inventory and raw materials), net. 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 costs, purchasing and receiving costs, 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.
Recent Developments
The Company has continued to navigate through unprecedented disruptions in the marketplace over the past few years while we have continued to serve the needs of all families with young children, invest in our business, reduce debt, and return capital to our shareholders.
Macroeconomic Factors, Consumer Demand, and Inventories
Macroeconomic factors, including inflationary pressures, decreased U.S. gross domestic product in the first half of fiscal 2022, increased interest rates, increased credit card debt and increased risks of a recession continued to create a complex and challenging environment for our business in fiscal 2022. We believe these macroeconomic factors have resulted in lower consumer sentiment and negatively impacted demand for our products and will likely continue to negatively impact demand in future quarters. These factors, along with a lapping of government stimulus payments that did not reoccur in fiscal 2022, contributed to reduced net sales and operating income compared to fiscal 2021.
Compared to the end of fiscal 2021, our inventories increased $96.8 million, or 14.9%, to $744.6 million, primarily due to longer holding periods for inventory to be sold in future periods, planned earlier inventory ownership to offset transportation delays, increased product costs, and lower than projected net sales. Inventory held to be sold in future periods, or “pack and hold” inventory, increased $70.1 million, or 240.6% to $99.2 million. These increased inventory levels are being experienced throughout much of the retail industry, resulting in an increase in promotional activity as companies sell off their excess inventories. We have taken action to align inventory with planned demand, including canceling and/or reducing inventory purchases, selectively utilizing a pack and hold strategy to sell through inventory profitably in later periods, and continuing to
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use our own retail channels to sell through excess inventory profitably. Inventory levels during fiscal 2023 are expected to be lower than those in fiscal 2022, and we expect these levels to normalize by the end of fiscal 2023.
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. These inflationary pressures of input costs may persist in fiscal 2023. We have 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, leveraging a mix of longer-term shipping container contracts and spot market purchases, and reductions in discretionary spending. However, our pricing actions could have an adverse impact on demand and may not be sufficient to cover all increased costs that we may experience.
Supply Chain Disruptions
Geopolitical factors continue to impact supply chain operations, causing delays in the production and transportation of our product. To help mitigate production delays and meet consumer demand for our products, we have leveraged our strong relationships with our suppliers to shift production schedules when possible. We have also moved more shipments to East Coast ports to hedge against more unpredictable transportation delays and potential labor disruptions in West Coast ports. In the second half of fiscal 2022, East Coast ports also experienced delays. However, we believe that a potential global slowdown in consumer demand may result in improved deliveries and lower product and transportation costs beginning in fiscal 2023.
Fiscal Year 2022 Highlights
Our financial results in fiscal 2022 were meaningfully impacted by significant comparability issues with prior periods such as macroeconomic headwinds, including record high inflation, which impacted our cost structure, lower consumer sentiment, decreased consumer spending in the overall retail industry, and the lapping of government stimulus payments in fiscal 2021 that did not reoccur in fiscal 2022.
Despite these challenges, we were able to meet our pricing objectives, increasing average selling prices per unit by 5%, maintain strong gross margins, effectively manage our variable expenses, increase our store count, and return capital to our shareholders.
Unless otherwise stated, comparisons are to fiscal 2021.
•Consolidated net sales decreased $273.7 million, or 7.9%, to $3.21 billion, primarily due to macroeconomic factors, including inflationary pressures, driving lower consumer demand and the lapping of government stimulus payments that did not reoccur in fiscal 2022.
◦U.S. Retail segment net sales decreased $219.1 million, or 11.5%, to $1.68 billion, primarily driven by lower traffic as macroeconomic conditions adversely affected demand. Demand for our exclusive Carter’s brands increased as a result of favorable timing of customer orders and product availability.
◦U.S. Wholesale segment net sales decreased $45.9 million, or 4.1%, to $1.08 billion, primarily due to lower consumer replenishment demand during the year as macroeconomic conditions adversely affected demand. Instead of selling certain products through off-price channels, we are utilizing a pack and hold strategy to aim to sell through inventory profitably in fiscal 2023.
◦International segment net sales decreased $8.7 million, or 1.9%, to $452.1 million, primarily driven by decreased net sales to our multinational wholesale accounts and decreased sales through our Canadian eCommerce channel. Our international wholesale partners and Mexican retail stores continued to see growth in fiscal 2022.
•Average selling prices per unit increased approximately 5% due to improved price realization and decreased promotions.
•Consolidated gross margin remained strong at 45.8%, down 190 bps from fiscal 2021, due to improved price realization and decreased air freight, which were offset by inflationary pressures on our product and transportation costs. As a result of actions taken and a potential global slowdown in consumer demand, we believe that we may experience lower product and transportation costs beginning in fiscal 2023.
•We were able to effectively manage our selling, general, and administrative expenses (“SG&A”). SG&A as a percentage of consolidated net sales remained fairly consistent, increasing approximately 40 bps to 34.6% in fiscal
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2022. 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 and opening new retail stores.
•Consolidated operating income decreased $117.9 million, or 23.7%, to $379.2 million, and adjusted operating income, a non-GAAP financial measure, decreased $112.6 million, or 22.5%, to $388.2 million. The decrease in consolidated operating income is primarily due to the factors discussed above and the recognition of a $9.0 million non-cash pre-tax impairment charge related to the Skip Hop tradename in fiscal 2022.
•Diluted net income per common share decreased $1.47, or 18.8%, to $6.34, and adjusted diluted net income per common share decreased $0.97, or 12.3%, to $6.90.
•With our focus on fewer, better, higher profit margin product choices, better inventory management, and pricing capabilities, our store unit economics have improved relative to prior years enabling more profitable store opening opportunities. During fiscal 2022, we have opened 25 stores and closed 19 stores in the United States. We are projecting approximately 50 store openings and 10 store closures in fiscal 2023.
•During the second half of fiscal 2022, we rolled out a refreshed branding campaign for our exclusive brands at Target and Walmart stores to more prominently highlight the Carter’s brand.
•Our Mexican retail stores continue to see growth and reinforce plans for further expansion into Mexico.
•As a result of our strong financial position and recovery from the effects of the COVID-19 pandemic, on April 4, 2022, the Company, through its wholly-owned subsidiary, The William Carter Company (“TWCC”) redeemed its $500 million principal amount of senior notes, bearing interest at a rate of 5.500% per annum, and originally maturing on May 15, 2025, which will reduce annual cash interest expense by $27.5 million through May 2025. Additionally, on April 11, 2022, the Company, through TWCC, increased the borrowing capacity of its secured revolving credit facility from $750 million to $850 million (combined U.S. dollar and multicurrency facility borrowings), extended the maturity from September 2023 to April 2027, and reduced the number of financial maintenance covenants from two to one.
•As a result of our strong financial position and available liquidity, we returned $417.8 million to our shareholders, comprised of $299.7 million in share repurchases and $118.1 million in cash dividends. Compared to fiscal 2021, the return of capital to our shareholders increased 16.2%.
•We issued our second CSR report in fiscal 2022, in which we highlighted our three strategic pillars that guide our long-term CSR commitments: People, Product, and Planet. In furtherance of these commitments, we discussed our efforts to invest in our employees and our communities, grow our sustainable offerings, and reduce our environmental footprint.
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RESULTS OF OPERATIONS
2022 FISCAL YEAR ENDED DECEMBER 31, 2022 COMPARED TO 2021 FISCAL YEAR ENDED JANUARY 1, 2022
The following table summarizes our results of operations. All percentages shown in the below table and the discussion that follows have been calculated using unrounded numbers.
Fiscal year ended
Gross profit as % of consolidated net sales 45.8 % 47.7 % (190) bps
Royalty income as % of consolidated net sales 0.8 % 0.8 % 0 bps
SG&A expenses as % of consolidated net sales 34.6 % 34.2 % 40 bps
Intangible asset impairment 9,000 — 9,000 nm
Operating income as % of consolidated net sales 11.8 % 14.3 % (250) bps
Basic net income per common share $ 6.34 $ 7.83 $ (1.49) (19.0) %
Diluted net income per common share $ 6.34 $ 7.81 $ (1.47) (18.8) %
Dividend declared and paid per common share $ 3.00 $ 1.40 $ 1.60 114.3 %
(*)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 $273.7 million, or 7.9%, to $3.21 billion. This decrease was primarily driven by macroeconomic factors, including inflationary pressures, driving lower consumer demand and the lapping of government stimulus payments that did not reoccur in fiscal 2022 and resulted in decreased net sales in our U.S. Retail and U.S. Wholesale segments. These decreases were partially offset by increased net sales in our exclusive Carter’s brands, growth with our international wholesale partners and in our Mexican retail stores, and increased average selling prices per unit due to improved price realization and decreased promotions. Average selling prices per unit increased approximately 5% and units sold decreased 13%. Changes in foreign currency exchange rates used for translation in fiscal 2022 had an unfavorable effect on our consolidated net sales of approximately $11.2 million.
Gross Profit and Gross Margin
Our consolidated gross profit decreased $189.9 million, or 11.4%, to $1.47 billion and consolidated gross margin decreased 190 bps to 45.8%. The decrease in consolidated gross profit and gross margin was primarily driven by increased average cost per unit, the nonrecurrence of a benefit in fabric purchase commitment charges and inventory provisions in fiscal 2021, increased inventory provisions as a result of increased excess inventory balances, and unfavorable customer and channel mix. While
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improved pricing covered increases to product input costs, increases to transportation and other costs resulted in average cost per unit sold increasing approximately 9%. This included increased product costs of approximately $100 million and increased supply chain costs, including an increase of approximately $53 million in inbound transportation costs, exclusive of inbound air freight. While we expect these increased product costs to continue in fiscal 2023 due to inflationary pressures, we expect inbound transportation rates to decrease in the second half of fiscal 2023 and into fiscal 2024.
These factors were partially offset by a decrease of approximately $27 million in air freight and increased average selling prices per unit mentioned above. Air freight costs normalized in fiscal 2022 after a large increase in air freight use in fiscal 2021 in order to help mitigate transportation delays.
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 $2.9 million, or 10.0%, to $25.8 million, primarily due to decreased licensee sales volume.
Selling, General, and Administrative Expenses
Consolidated SG&A expenses decreased $83.9 million, or 7.0%, to $1.11 billion in fiscal 2022 while the SG&A expenses as a percentage of consolidated net sales (“SG&A rate”) increased approximately 40 bps to 34.6%. The increase in SG&A rate was primarily driven by fixed cost deleverage on decreased sales and increased transportation costs. Outbound freight as a percentage of sales increased 40 bps, or $8.6 million. These factors were partially offset by decreased performance-based compensation expense and decreased costs related to productivity initiatives. Performance-based compensation expense as a percentage of net sales decreased 150 bps, or $54.8 million, primarily due to a lower-than-expected financial performance in fiscal 2022 following an outsized expense in fiscal 2021 due to a record financial performance.
Intangible Asset Impairment
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 to continue as a going concern in the first quarter of fiscal 2023, 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. Based upon the results of the impairment test, we recognized a non-cash pre-tax impairment charge of $9.0 million during the fourth quarter of fiscal 2022 related to our Skip Hop indefinite-lived tradename asset.
Operating Income
Consolidated operating income decreased $117.9 million, or 23.7%, to $379.2 million, and consolidated operating margin decreased as a percentage of net sales by approximately 250 bps to 11.8%, primarily due to the factors discussed above.
Interest Expense
Interest expense decreased $17.5 million, or 29.0%, to $42.8 million due to a decrease in weighted-average borrowings. Weighted-average borrowings were $738.7 million at an effective interest rate of 5.84%, compared to weighted-average borrowings for fiscal 2021 of $1.00 billion at an effective interest rate of 6.02%.
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, partially offset by increased borrowings under our secured revolving credit facility. The decrease in the effective interest rate was primarily due to increased borrowings under our secured revolving credit facility, which bore a lower interest rate for most of fiscal 2022 than our senior notes.
Loss on Extinguishment of Debt
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 in the second quarter of fiscal 2022.
Income Taxes
Our consolidated income tax provision decreased $31.8 million, or 32.3%, to $66.7 million, and the effective tax rate decreased approximately 140 bps to 21.1%. The decreased effective tax rate primarily relates to a lower proportion of income generated in the United States, which is a higher tax jurisdiction relative to our international operations.
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Net Income
Our consolidated net income decreased $89.7 million, or 26.4%, to $250.0 million, primarily due to the factors previously discussed.
Results by Segment - Fiscal Year 2022 compared to Fiscal Year 2021
The following table summarizes net sales and operating income, by segment, for the fiscal years ended December 31, 2022 and January 1, 2022:
Fiscal year ended
Net sales:
Operating income: % of segment net sales % of segment net sales
Comparable Sales Metrics
We present comparable sales metrics because we consider them an important supplemental measure of our U.S. Retail performance, and the Company uses such information to assess the performance of U.S. Retail. 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 $219.1 million, or 11.5%, to $1.68 billion. The decrease in net sales was primarily driven by macroeconomic factors, including inflationary pressures, driving lower consumer demand and the lapping of government stimulus payments that did not reoccur in fiscal 2022. This decreased demand resulted in lower traffic in our eCommerce channels and in our retail stores, as well as decreased units per transaction. This decrease was partially offset by increased average selling prices per unit due to improved price realization and decreased promotions. Units sold decreased approximately 17%, while average selling prices per unit increased approximately 6%.
Comparable net sales, including retail store and eCommerce, decreased 10.1% primarily driven by the factors mentioned above. As of December 31, 2022, we operated 757 retail stores in the U.S. compared to 751 in fiscal 2021.
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U.S. Retail segment operating income decreased $115.7 million to $252.5 million, and operating margin decreased 440 bps to 15.0%. Operating income in fiscal 2022 included an intangible asset impairment charge of $0.4 million related to the Skip Hop tradename. The primary drivers of the decrease in operating margin were a 100 bps decrease in gross margin and a 340 bps increase in SG&A rate. The decrease in gross margin was primarily due to increased average cost per unit sold. While improved pricing covered increases to product input costs, increases to transportation and other costs resulted in average cost per unit sold increasing approximately 8%. The increase in the SG&A rate was primarily due to fixed cost deleverage on decreased sales and increased transportation costs. These decreases were partially offset by decreased performance-based compensation expense, which as a percentage of net sales decreased 80 bps, .
U.S. Wholesale
U.S. Wholesale segment net sales decreased $45.9 million, or 4.1%, to $1.08 billion. The decrease was primarily driven by macroeconomic factors, including inflationary pressures, driving lower consumer demand and the lapping of government stimulus payments that did not reoccur in fiscal 2022. Lower consumer demand resulted in decreased replenishment orders and customer cancels, leading to decreased sales of our Carter’s and Skip Hop products. This decrease was offset by increased demand for our exclusive Carter’s brands as a result of favorable timing of customer orders and product availability. Units sold decreased approximately 10%, while average selling prices per unit increased approximately 7%.
U.S. Wholesale segment operating income decreased $33.7 million, or 17.3%, to $161.7 million, and operating margin decreased 230 bps to 15.0%. 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 decrease in operating margin were a 140 bps decrease in gross margin, a 20 bps decrease in royalty income, a 30 bps increase in SG&A rate, and the intangible asset impairment charge. The decrease in gross margin was primarily due to increased average cost per unit sold, an unfavorable customer mix, the nonrecurrence of a benefit in fabric purchase commitment charges in fiscal 2021, and increased inventory provisions as a result of increased excess inventory balances. While improved pricing covered increases to product input costs, increases to transportation and other costs resulted in average cost per unit sold increasing approximately 11%. These drivers were partially offset by decreased use of air freight and increased average selling prices per unit mentioned above. Air freight as a percentage of net sales normalized in fiscal 2022, decreasing 240 bps.
The decrease in royalty income was primarily due to the timing of shipments to our licensees and decreased demand. The increase in the SG&A rate was primarily due to increased distribution and transportation costs, partially offset by decreased performance-based compensation expense, which as a percentage of net sales decreased 80 bps.
International
International segment net sales decreased $8.7 million, or 1.9%, to $452.1 million in fiscal 2022. Changes in foreign currency exchange rates, primarily between the U.S. dollar and the Canadian dollar, had an $11.2 million unfavorable effect on International segment net sales. The decrease in net sales was primarily driven by decreased net sales in our Canadian eCommerce channel, decreased net sales for our multinational wholesale accounts, and a strengthening of the U.S. Dollar against other foreign currencies. These decreases were partially offset by growth in sales from our international wholesale partners as these partners recovered from business disruptions as a result of COVID-19, growth in our Mexico retail stores, and increased average selling prices per unit. Units sold decreased approximately 7%, while average selling prices per unit increased approximately 5%.
As of December 31, 2022, we operated 187 retail stores in Canada, compared to 186 at the end of fiscal 2021. As of December 31, 2022, we operated 49 retail stores in Mexico, compared to 43 in fiscal 2021.
International segment operating income decreased $7.2 million, or 11.3%, to $56.6 million, and operating margin decreased 130 bps to 12.5%. Operating income in fiscal 2022 included an intangible asset impairment charge of $3.0 million related to the Skip Hop tradename. The decrease in the operating margin was primarily attributable to a 210 bps decrease in gross margin, a 150 bps decrease in the SG&A rate, and the intangible asset impairment charge. The decrease in gross margin was primarily due to the nonrecurrence of a benefit in fabric purchase commitment charges in fiscal 2021 and increased average cost per unit sold. While improved pricing covered increases to product input costs, increases to transportation and other costs resulted in average cost per unit sold increasing approximately 8%. The decrease in the SG&A rate was primarily due to decreased performance-based compensation expense and other reductions in spending, partially offset by increased transportation costs. Performance-based compensation as a percentage of net sales decreased 180 bps.
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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 decreased $38.7 million, or 29.7%, to $91.6 million in fiscal 2022, and unallocated corporate expenses, as a percentage of consolidated net sales, decreased 80 bps to 2.9%. The decrease as a percentage of consolidated net sales was primarily due to decreased performance-based compensation, decreased employer match of employee contributions for the defined contribution savings plan, decreased consulting fees, and a decrease in other corporate expenses. Performance-based compensation as a percentage of net sales decreased 20 bps.
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 excludes certain items presented below. We believe that this information provides a meaningful comparison of our results and afford investors a view of what management considers to be our core performance. 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 substitution 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
Loss on extinguishment of debt(*) — 4.8 15.2 0.38 — — — —
Intangible asset impairment 9.0 2.1 6.9 0.17 — — — —
(*)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.
Note: Results may not be additive due to rounding.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Our ongoing cash needs are primarily for working capital, 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 will fund our projected requirements for at least the next twelve months. However, these sources of liquidity may be affected by events described in our risk factors, as discussed under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
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As discussed under the heading “Recent Developments” in Part II, Item 7 of this Annual Report on Form 10-K, we expect inflationary pressures and declining consumer sentiment to continue and to adversely impact our financial results in fiscal 2023. We cannot predict the timing and amount of such impact.
As of December 31, 2022, we had approximately $211.7 million of cash and cash equivalents held at major financial institutions, including approximately $44.1 million held at financial institutions located outside of the United States. In April 2022, we redeemed our $500 million principal amount of senior notes, bearing interest at a rate of 5.500% per annum, and originally maturing on May 15, 2025, with cash on hand. Additionally, at various times in fiscal 2022, we borrowed on our secured revolving credit facility to support our working capital requirements. As of December 31, 2022, outstanding borrowings on our revolving credit facility were $120.0 million. 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 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 31, 2022 were $198.6 million compared to $231.4 million at January 1, 2022. The decrease of $32.8 million, or 14.2%, primarily reflects the timing of wholesale customer shipments and associated payments.
Inventories at December 31, 2022 were $744.6 million compared to $647.7 million at January 1, 2022. The increase of $96.8 million, or 14.9%, was primarily due to longer holding periods for inventory to be sold in future periods, planned earlier inventory ownership to offset transportation delays, increased product costs, and lower than projected net sales. Inventory held to be sold in future periods, or “pack and hold” inventory, increased $70.1 million, or 240.6% to $99.2 million. Inventory levels during fiscal 2023 are expected to be lower than those in fiscal 2022, and we expect these levels to normalize by the end of fiscal 2023.
Accounts payable at December 31, 2022 were $264.1 million compared to $407.0 million at January 1, 2022. The decrease of $143.0 million, or 35.1%, is primarily due to the timing of payments for inventory and accruals of freight and duties on incoming inventory shipments.
Cash Flow
Net Cash Provided by Operating Activities
Net cash provided by operating activities decreased $179.9 million, or 67.1%, to $88.4 million. Our cash flow provided by operating activities is driven by net income and changes in our net working capital. The decrease in operating cash flows in fiscal 2022 was primarily due to decreased net income, planned early inventory receipts, longer holding periods for inventory to be sold in future periods, increased product costs, and payment of our fiscal 2021 performance-based compensation.
We facilitate a voluntary supply chain finance (“SCF”) program through participating financial institutions. This SCF program enables our suppliers to sell their receivables due from the Company to participating financial institution at their discretion. As of December 31, 2022, the SCF program has a $70 million revolving capacity. We are not a party to the agreements between the participating financial institution and the suppliers in connection with the SCF program. The range of payment terms we negotiate with our suppliers is consistent, irrespective of whether a supplier participates in the SCF program. No guarantees are provided by the Company or any of our subsidiaries under the SCF program. The amounts payable to the participating financial institutions for suppliers who voluntarily participate in the SCF program are included in Accounts payable on our consolidated statement balance sheets. Payments made under the SCF program, like payments on other Accounts payable, are a reduction to our operating cash flow.
Net Cash Used in Investing Activities
Net cash used in investing activities increased $7.9 million, or 24.4%, to $40.4 million. This increase in net cash used in investing activities is primarily due to proceeds from sales of investments in marketable securities in fiscal 2021, that did not reoccur in fiscal 2022. Capital expenditures in fiscal 2022 primarily included $17.5 million for omni-channel initiatives and our U.S. and international retail store openings and remodels, $12.9 million for information technology, and $7.5 million for our distribution facilities.
We plan to invest approximately $75 million in capital expenditures in fiscal 2023, which primarily relates to U.S. and international retail store openings and remodels, investments in our distribution facilities, and strategic information technology initiatives.
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Net Cash Used in Financing Activities
Net cash used in financing activities increased $466.6 million, or 132.3%, to $819.3 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 and increased cash dividends paid to our shareholders. As a result of actions taken in connection with the COVID-19 pandemic, our common stock share repurchases program was temporarily suspended in the first two quarters of fiscal 2021, and we did not declare or pay cash dividends in the first quarter of fiscal 2021. These drivers were partially offset by increased borrowings under our secured revolving credit facility. We are projecting a decrease in the return of capital to our shareholders for fiscal 2023 due to lower forecasted share repurchases.
Secured Revolving Credit Facility
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 January 1, 2022, we had no outstanding borrowings under our secured revolving credit facility, exclusive of $4.1 million of outstanding letters of credit. As of December 31, 2022 and January 1, 2022, there was approximately $726.5 million and $745.9 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 provision, 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 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
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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, has been capitalized in connection with Amendment No. 4 and is being amortized over the remaining term of the secured revolving credit facility.
Weighted-average borrowings for fiscal 2022 were $106.6 million, and there were no weighted-average borrowings for fiscal 2021. The increase in weighted-average borrowings for fiscal 2022 was due to the absence of borrowings under our secured revolving credit facility during fiscal 2021.
As of December 31, 2022, 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.
As of December 31, 2022, U.S. dollar borrowings outstanding under the secured revolving credit facility accrued interest at an adjusted term SOFR rate plus the applicable margin, which resulted in a weighted-average borrowing rate of 5.80%. There were no Canadian dollar or other foreign currency borrowings outstanding on December 31, 2022. The effective interest rate for borrowings under the secured revolving credit facility during fiscal 2022 was 2.94%. This approximately 300 bps increase in the interest rate would result in an additional $3.6 million of interest expense in fiscal 2023 based $120.0 million of outstanding borrowings under the secured revolving credit facility as of December 31, 2022.
As of December 31, 2022, the Company was in compliance with the financial and other covenants under the secured revolving credit facility.
Senior Notes
As of December 31, 2022, 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 31, 2022 is reported net of $3.4 million of unamortized issuance-related debt costs, and the $1.00 billion of outstanding senior notes as of January 1, 2022 is reported net of $8.6 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.
2022 Redemption of Senior Notes
On April 4, 2022, the Company, through its wholly-owned subsidiary, TWCC redeemed our $500 million principal amount of senior notes, bearing interest at a rate of 5.500% per annum, and originally maturing on May 15, 2025. Pursuant to the optional redemption provisions described in the Indenture dated as of May 11, 2020, TWCC paid the outstanding principal plus accrued interest and an Applicable Premium as defined in the Indenture. This debt redemption resulted in a loss on extinguishment of debt of approximately $19.9 million, primarily consisting of $15.7 million of the Applicable Premium and $4.3 million related to the write-off of unamortized debt issuance costs.
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Share Repurchases
The Company repurchased and retired shares in open market transactions in the following amounts for the fiscal periods indicated:
For the fiscal year ended
Aggregate cost of shares repurchased (dollars in thousands) $ 299,667 $ 299,339
As a result of actions taken in connection with the COVID-19 pandemic, we did not repurchase or retire any shares in open market transactions in the first two quarters of fiscal 2021. We reinstated our common stock share repurchase program in the third quarter of fiscal 2021.
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 31, 2022 was approximately $749.5 million, based on settled repurchase transactions. The share repurchase authorizations have no expiration dates.
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 revolving credit facility and considerations given to market conditions, stock price, other investment priorities, excise taxes, and other factors.
Dividends
On February 23, 2023, the Company's Board of Directors authorized a quarterly cash dividend payment of $0.75 per common share, payable on March 17, 2023 to shareholders of record at the close of business on March 7, 2023.
In fiscal 2022, the Board of Directors declared and the Company paid quarterly cash dividends of $0.75 per common share during all four quarters. In fiscal 2021, the Board of Directors declared and the Company paid quarterly cash dividends of $0.40 per common share in each of the second and third quarters of fiscal 2021 and $0.60 per common share in the fourth quarter of fiscal 2021. As a result of actions taken in connection with the COVID-19 pandemic, the Board of Directors did not declare and the Company did not pay cash dividends for the first quarter of 2021.
Our Board of Directors will evaluate future dividend declarations based on a number of factors, including restrictions under the Company’s revolving credit facility, business conditions, the Company’s 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 8, Long-Term Debt, to the consolidated financial statements.
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Commitments
The following table summarizes as of December 31, 2022, the maturity or expiration dates of mandatory contractual obligations and commitments for the following fiscal years:
Adverse purchase commitments 4,465 — — — — — 4,465
(1)Reflects: i) estimated variable rate interest on obligations outstanding on our secured revolving credit facility as of December 31, 2022 using an interest rate of 5.80%% and ii) a fixed interest rate of 5.625% for the senior notes due 2027.
(2)The minimum lease obligation includes all lease and non-lease components that were included in the measurement of the lease liability.
(3)The table above excludes our reserves for income taxes, as we are unable to reasonably predict the ultimate amount or timing of settlement.
(4)The table above excludes inventory purchase obligations. Our estimate as of December 31, 2022 for commitments to purchase inventory in the normal course of business, which are cancellable (with or without penalty, depending on the stage of production) and span a period of one year or less, was between $400 million and $500 million.
(5)The table above excludes any potential future Company funding for obligations under our defined benefit retirement plans. Our estimates of such obligations as of December 31, 2022 have been determined in accordance with U.S. GAAP and are included in other current liabilities and other long-term liabilities on our consolidated balance sheet, as described in Item 8 “Financial Statements and Supplementary Data” under Note 11, Employee Benefit Plans, to the consolidated financial statements.
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.
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Our retail store revenues, also reported as Net sales, are recognized at the point of sale. Retail sales through our on-line channels are recognized at time of delivery to the customer. Revenue from omni-channel sales, including buy-on-line and pick-up in-store, buy-on-line, ship-to-store, and buy-on-line, 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 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, $0.2 million for fiscal 2021, and $0.5 million for fiscal 2020 as a component of SG&A expenses on our consolidated statements of operations, rather than as a reduction of net sales. 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 our digital marketing advertising arrangements are recorded 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 increased $4.9 million, or 34.0%, to $19.3 million as of December 31, 2022. This increase is primarily due to the increase in inventory balances, longer holding periods for inventory, and increased “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. Due to the materiality of these charges in fiscal 2020, these charges have been presented separately on our consolidated statement of operations.
Goodwill and Tradenames
The carrying values of goodwill and indefinite-lived tradename assets are subject to annual impairment reviews as of the last day of each fiscal year. Between annual assessments, impairment reviews may also be triggered by any significant events or changes in circumstances affecting our business. Factors affecting such impairment reviews include the continued market acceptance of our current products and the development of new products. We use qualitative and quantitative methods to assess for impairment, including the use of discounted cash flows (“income approach”) and relevant data from guideline public companies (“market approach”).
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We perform impairment tests of goodwill at the reporting unit level. A qualitative assessment determines 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 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.
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 rates and selecting the appropriate terminal growth rate, discount rate, and royalty rate.
A deterioration of macroeconomic conditions may not only negatively impact the estimated operating 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 cost of capital and/or discount rates. As a result, the cost of capital and/or discount rates used in our analysis may increase or decrease based on market conditions and trends, regardless of whether our actual cost of capital has changed. Therefore, we may recognize an impairment of an intangible asset or assets even though realized actual cash flows are approximately equal to or greater than our previously forecast amounts.
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 to continue as a going concern in the first quarter of fiscal 2023, 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. Based upon this assessment, there were no impairments on the value of goodwill.
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. 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. The carrying value of the Company’s indefinite-lived Skip Hop tradename asset as of December 31, 2022 was $6.0 million. 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 also indicated that the OshKosh indefinite-lived tradename assets’ 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. Although the Company determined that no further impairment exists for the OshKosh indefinite-lived tradename asset, this asset could be at risk for impairment should macroeconomic factors, including inflationary pressures and declining consumer sentiment, continue to adversely affect the Company’s financial results.
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.
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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 2022, a hypothetical 1% increase in our effective tax rate would have resulted in an increase in our income tax expense of $3.2 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.