Carter's Inc

NYSE:CRI

Earnings Call Transcript 2019-Q1

[Operator]

Welcome to Carter's First Quarter 2019 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer.

After today's prepared remarks, we will take questions as time allows. Carter's issued its first quarter 2019 earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted on the Investor Relations section of the company's website at ir.carters.com.

Before we begin, let me remind you that statements made on this conference call and in the company's presentation materials about the company's outlook, plans, and future performance are forward-looking statements. Actual results may differ materially from those projected.

For a discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the company's most recent annual report filed with the Securities and Exchange Commission and the presentation materials posted on the company's website. On this call, the company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the company's earnings release and presentation materials. Also, today's call is being recorded.

I would now like to turn the call over to Mr. Casey.

[Michael Casey, Chairman and CEO]

Thanks very much. Good morning everyone. Thank you for joining us on the call. Before I walk you through the presentation on our website, I'd like to share some thoughts in our business with you. 2019 is off to a good start. We exceeded the first quarter sales and earnings calls that we shared with you on our last call. Stronger-than-expected demand in our Wholesale segment largely offset lower retail sales.

In recent years, many of our wholesale customers have run lean on inventories preferring to chase demand. Thankfully we were in a good inventory position and able to support better than planned wholesale demand for our spring product offerings.

Our retail sales were lower than planned, over 70% of that shortfall occurred in February. As you may know, most of our stores are located in outdoor shopping centers not indoor malls. We believe the unusually cold and snowy weather in certain parts of the country in February impacted the traffic to our stores.

As we've seen over the years, when weather turned more spring-like, our retail sales improved meaningfully. That favorable trend continued through April. And in our International segment, sales in the first quarter were in line with our plan.

As expected, first quarter sales and earnings were lower than last year. Our sales in the first quarter reflect a shift in the Easter holiday, which occurred three weeks later this year. Our comparable retail sales for the combine March and April periods normalizing the shift in the Easter holiday were up over 5%. Our earnings in the first quarter reflect a lower gross profit margin compared to last year. We're comping up against high margin sales to Toys “R” Us in 2018.

We believe the disruption caused by Toys “R” Us last year is largely behind us.

We are forecasting 2019 wholesale sales at a level higher than 2017, the year prior to the Toys “R” Us and Bon-Ton closures. We saw a higher mix of sales of our exclusive brands to Target, Walmart and Amazon in the first quarter. We believe these retailers were the largest beneficiaries of the Toys “R” Us closure.

Our exclusive brand margins are lower than our flagship Carter's brand. The higher mix of exclusive brand sales and related margins have been reflected in our forecasts for the year. In the weeks leading up to Easter, we saw a significant increase in the demand for our brands and are encouraged by the improved trends in our business. Easter is one of our top three shopping holidays. During our 10-day Easter holiday marketing event, sales were up over 8%.

Given the current trends in our business we are expecting good growth in sales and earnings in the balance of the year, and we are reaffirming our previous guidance for 2019. Our growth in sales this year is expected to be driven by our Retail segment, which is the largest segment of our business with sales expected to exceed $1.9 billion.

Our co-branded stores continue to be our best performing stores in terms of traffic, comparable sales growth, returns on investment and Net Promoter Scores. As we shared with you earlier this year, we plan to continue opening co-branded stores located closer to families with young children. And we plan to close our more remotely-located stores in declining outlet centers. This has been a multi-year evolution in our retail store strategy, which has enabled us to grow engage share, despite the closure of some of our legacy wholesale customers.

We've been tracking the Gymboree store closure process interestingly where we are co-located in about 200 shopping centers. We have seen a nice lift in our sales driven by higher traffic and conversion rates. When given a choice of brands in the same centers more often than not consumers choose Carter's over Gymboree. Where our stores were not co-located in the same centers, but within a short drive we saw a temporary dip in store sales though not material to our first quarter results.

We believe the Gymboree store closures provide a new $100 million growth opportunity for us. We have evaluated every Gymboree and Crazy 8 more store location. Most of those centers would not meet our site criteria. Historically, we have focused our store growth on non-mall locations with good results. That said, today we have about 50 mall-based stores, which have been a good source of growth for us.

Given our success with malls, we plan to very selectively pursue new mall opportunities, given favorable rent arrangements being offered to us by mall owners. We plan to pursue this new opportunity beginning this year.

We are the largest specialty retailer of children's apparel in North America. We believe our stores provide the very best presentation of our brands.

Our market data suggests that Target stores and our Carter's stores are mom's two top, two favorite places to shop for young children's apparel. Our latest market data also suggests that our Carter's brand is the bestselling children's apparel brand online in the United States. Consumers rank Amazon and carters.com as their top two favorite places to shop for baby apparel online. In a survey last year, nearly 90% of millennials shopping for baby apparel since they purchased our Carter's brands.

We are uniquely positioned with the strength of our multi-channel model to sell our brand to some of the largest retailers of children's apparel in the world. On a combined basis stores and online, Carter's ranks as one of the top three retailers of young children's apparel in the United States together with Walmart and Target.

For the year, we are forecasting e-commerce to be our fastest growing highest margin business. Our e-commerce sales are forecasted to grow about 10% this year, which is consistent with the market rate of growth. Demand from consumers living in the United States is driving the growth in our e-commerce sales.

We have been fortunate in years past to have a higher mix of international guests shopping for our brands in our U.S. website. In 2017 which is the latest data available, Carter's ranked in the top four most popular U.S. websites for international shoppers together with Amazon, Ralph Lauren and Gap. As the U.S. dollar strengthen in recent years, we saw a corresponding decrease in demand from our guests shopping from Brazil, Argentina and Russia, three of the largest sources of international demand for our brands.

Our analysis of forecast exchange rates, suggest a tougher comparison for international demand of the first half this year and an easier comparison in the second half. In recent years, we've made significant investments in technology to improve the consumer's experience in shopping with us. These investments have enabled us to offer free shipping every day on all orders, no threshold, when consumers shop online and choose to pick up their order in one of our stores located close to their home.

We also provide access to the full scope of our online product offering to consumers shopping with us in our stores. If for some reason we are temporarily out of stock in our stores, we are able to service the consumer from our online inventories, complete the transaction in our store and then ship the product to a consumer's home for free.

Both of these omni-channel capabilities have contributed to Carter's ranking number one last year in Net Promoter Score's, meaning, consumers are more likely to recommend our Carter's brand to a friend than any other brand in young children's apparel.

This year we are testing two new capabilities. The first, we'll enable consumers to pick up their online orders the same day in our stores, typically within a few hours after their purchase. The second, new capability will enable the fulfillment of online orders from our stores. These new capabilities are designed to expedite the delivery of online orders and lower the cost of fulfilling those orders.

With respect to our Wholesale business, we are forecasting good growth in sales this year and earnings comparable to last year. Spring selling is ramping up with warmer weather arriving in more parts of the country and replenishment sales are also trending better than last year. Our latest forecasts reflect growth with four of our top five wholesale customers this year.

We are currently launching the annual refresh of our Little Baby Basics product offering in all channels of distribution. This is our high-margin replenishment product line for our Carter's brand. We believe it's the best-selling baby apparel product offering in North America. It offers the everyday essentials purchased frequently by consumers given the rapid growth of children in those first two years of life. Little Baby Basics will be fully set across all business segments in time to benefit from the upcoming Memorial Day holiday and summer break traffic.

International sales and profitability are forecasted up this year. Canada is the largest component of our international business. We have the largest share in the young children's apparel market in Canada. It's a good multi-channel model. We expect growth in Canada to be led by its Retail segment the fastest growth driven by e-commerce.

Next goes the new market opportunity for us. Like Canada, we're fortunate to acquire a former licensee to enter this market. We're forecasting good growth in Mexico this year, including the benefit of opening co-branded stores and launching e-commerce capabilities in the second half of the year. As we shared with you in prior updates, we have a new path forward in China. We have completed the transition to a licensing model with a partner we have worked with for the past 20 years.

Our partner is also one of our largest baby apparel suppliers and manages other businesses that included very successful retail operation in China focused on children's apparel. They have assumed control of our former Tmall relationship and have begun to source products tailored to the needs of consumers in China. Our licensee also plans to launch our brands with Walmart and Costco in China later this year. We believe this new model enables us to better serve the needs of families with young children in China and to do so more profitably.

For the first time since transitioning to Asia-based sourcing 20 years ago, China is no longer our largest country of origin for apparel. Our suppliers including those based in China have built a new capacity for us in Cambodia, Vietnam, Indonesia and Bangladesh. Cambodia historically our largest source for sleepwear is now our largest country of origin for apparel. We are also securing new sourcing capabilities in India, Africa and the Western hemisphere.

Our supply chain has done a good job working with our suppliers, strengthening our product offerings and mitigating our exposure to cost increases. Our latest forecast for 2019 reflect low single-digit growth in both product costs and pricing. Product margins this year are expected to be comparable year-over-year. We continue to monitor the risk of new tariffs on China imports. Thankfully the tone of those negotiations seems to have improved. Tariffs imposed last year on China imports have not been material to our business.

In summary, we're pleased with our progress so far this year. We have multiple opportunities to strengthen our business and gain market share. We're fortunate to own two of the best-known brands in young children's apparel. And we have the most extensive distribution of any children's apparel brand in over 19,000 store locations in North America, nearly 800 store locations in other international markets. And we have with the broadest online distribution of children's apparel through our global wholesale partners.

I'm grateful to our over 20,000 employees throughout the world, who are committed to providing families with young children a great experience with our brands. With their support, we expect 2019 will be another good year of growth for us.

Rich will now walk you through the presentation on our website.

[Richard Westenberger, EVP and CFO]

Thank you Mike. Good morning everyone. I'll begin on page 2 with our GAAP income statement for the first quarter. Our first quarter GAAP results for this year and last year included some unusual items, which are detailed in our press release and presentation material. Notable adjusting items this year related to the refinancing of our senior notes, organizational restructuring and the transition of our business model in China.

First quarter 2018 adjustments principally related to the Toys “R” Us bankruptcy. Our adjusted results exclude these unusual items in both periods for greater comparability. Today's presentation and earnings release includes reconciliations of our GAAP business results to the adjusted basis of presentation. Please review this information as you evaluate our results.

Moving to page 3 with some highlights for the first quarter. As expected, consolidated net sales declined year-over-year, although sales were better than we had planned mostly due to stronger demand in wholesale channel. We believe sales in the quarter were affected by several factors including the later Easter holiday this year, persistent cold weather across the U.S. and Canada and Gymboree liquidation equity in the marketplace.

Our profitability was down in the quarter, but again by less than we had expected. The decline of profitability tracked to lower top line sale. And changes in channel and customer mix as last year's first quarter included sales to Toys “R” Us and Bon-Ton, which were good high-margin relationships for us.

Adjusted EPS of $0.87 was stronger than we had forecasted, reflecting the higher than planned sales in wholesale and good control of spending, which helped to offset lower than planned sales in our U.S. and Canadian retail businesses.

Moving to our adjusted P&L for the first quarter on page 4. Net sales in the quarter were $741 million, down about 2% versus last year. Movements in foreign currency exchange rates were against us in the quarter reducing our net sales by approximately $3 million. We saw modest year-over-year sales declines in each of our three business segments; U.S. retail, U.S. Wholesale and international, which I'll cover in some more detail in a few minutes.

Adjusted gross margin was 42.3% compared to 44% in the first quarter of 2018. This principally reflects customer mix changes within our U.S. wholesale business and higher inventory provisions and e-commerce shipping costs. We expect stronger gross margin performance as we move to the balance of the year, particularly in the second half.

Adjusted SG&A was approximately 2% lower than last year. Our retail businesses in particular did a good job controlling spending given sales trends, especially earlier in the quarter. We also benefit from lower bad debt expense in wholesale and the elimination of operating expenses in China as our businesses in this market has now transitioned to the new licensing model.

First quarter net interest and other expense was $9 million compared to $7 million last year. This increase reflects higher margin interest rates versus a year ago and some incremental interest expense related to the refinancing of our senior notes. Our first quarter effective tax rate increased to 21.2%, compared to 19.7% in the first quarter of 2018, principally due to a greater tax benefit from stock-based compensation a year ago.

Our average share count declined 4% compared to last year reflecting our share repurchase activity. So again on the bottom line, first quarter adjusted EPS was $0.87 compared to $1.09 last year.

Turning to page 5 with a recap of our balance sheet and cash flow. We took steps in the quarter to further bolster our already strong balance sheet by refinancing our senior notes. We saw outstanding demand for our transactions and we achieved one of the best interest rate and covenant packages in what has been a very choppy high-yield debt market.

We utilized the proceeds of the transaction to pay off our existing senior notes and to pay down unfortunate of our outstanding revolver borrowings. Our debt maturity profile has been extended meaningfully and we have substantial current liquidity with cash on hand and available capacity under our credit facility of approximately $775 million.

Our net inventory position at the end of the quarter was unplanned up 8% versus last year. This increase reflects higher inventory on hand due to planned Q2 demand in part due to the later Easter holiday, a higher retail store count compared to a year ago and the modest increase in product cost. We believe we've hit the peak of the year-over-year inventory growth for the year and are forecasting only mid single-digit increases in that inventories for each of the remaining quarters in 2019.

As noted in our press release this morning, we've now adopted the new lease accounting standard, which has have the effect of the grossing up the balance sheet for our lease liabilities and related right-of-use assets. The vast majority of our leases relate to our retail store locations.

Adoption of this a new accounting standard did not have a material P&L impact and also note that we always consider lease obligations as part of our overall leverage, which stood at about 2.5 times at the end of the first quarter.

Operating cash flow in the first quarter was $37 million compared to $64 million last year. The decline principally reflects our higher inventory balance at quarter end in support of planned Q2 demand, including the Easter shift and lower net income.

For fiscal 2019, we're forecasting strong operating cash flow in the range of $375 million to $400 million. We are also planning another good year of investment in the business, with full year capital expenditures of approximately $85 million.

In the first quarter, we returned a total of $63 million to shareholders comprised of $40 million in share repurchases and $23 million in dividend. As we announced in our last call, our Board authorized an 11% increase in our quarterly dividend to $0.50 per share for the dividend which was paid this past March.

Now turning to page seven with an overview of our business segment results in the first quarter. Overall, our consolidated adjusted operating margin was 8.1% compared to 9.6% in last year's first quarter. Each of our business segments posted reductions in sales and operating income in the first quarter.

I'll go through first quarter performance for each of the segment in some more detail, but it's important to look at our expectations for the balance of the year. We expect each of our segments to deliver solid improved operating margin performance in the second half of the year. We expect we'll see improvement in our consolidated operating margin for the full year as well.

Turning to the U.S. Retail segment on page eight. Total U.S. Retail segment sales declined 2% in the first quarter. Our total retail comps declined 3.7%, reflecting growth in e-commerce and down comps in our retail stores.

We believe comps in the first quarter were challenged by a number of factors most notably the timing of the Easter holiday which we estimate adversely affected first quarter comparable sales by about two comp points. We also believe that cold weather across the country likely suppressed consumer demand for warmer weather apparel which the focus of our assortments earlier in the year.

Gymboree liquidation activity delayed tax refunds and lower and international consumer demand were also likely factors weighing in on our first quarter results. With the arrival of warmer weather and Easter, we've seen a significant improvement in consumer demand. April retail comps in the U.S. were up in the high teens. On the year-to-date basis U.S. Retail comps are currently up 1.7%.

In the first quarter we opened four new stores and closed 14 ending the quarter with a 34 stores in the United States. For the full year, we now planned to open approximately 45 stores and close 25.

U.S. Retail segment margin was 6.3% compared to 7.6% in the first quarter of 2018. This performance reflects expense deleverage from negative comparable store sales, as well as higher shipping costs in e-commerce.

On the bottom of the page we've listed several of our current omni-channel initiatives that we're excited about. In the first quarter, we successfully tested our buy online, pickup in store service. This new capability provides our customers with same-day in-store fulfillment of their online orders. Initial customer reaction has been encouraging. And we are planning to roll this service out nationally in the second half of the year.

We're also developing capabilities to fulfill online orders directly from our retail stores. This initiative is intended to leverage our nationwide store base to shorten delivery times for e-commerce orders, especially for customers who live furthest away from our e-commerce distribution center which is located here in Georgia. We plan to conduct initial testing of this capability beginning in the second half of this year. For the fully year 2019, we're planning U.S. Retail segment net sales to grow in the low single digit, with good growth in earnings as well.

On page nine, we have included a photo of our relatively new co-branded store in San Diego. We continue to be pleased with the performance of our co-branded stores and expect to open another 40 locations this year.

Page 10 features a photo of one of our mall stores on Long Island. As Mike noted, we've seen good performance in the 50 or so mall stores that we've opened over the past few years. And believe there's potential for us to selectively add more store locations in malls going forward. We will report on our progress on this initiative as we gain additional experience and insight into our performance.

On pages 11 and 12, we've included some of our summer marketing for Carter's and OshKosh. On page 11, we highlight our industry-leading pajamas. Carter's is known for its PJs with consumers recognizing our strong value, quality, and adorable designs.

On page 12, these images are of new OshKosh B'gosh product for summer. Oshkosh is an iconic American brand, rooted in denim and possessing authentic heritage. We think red, white and blue is a natural fit for Oshkosh brand, especially heading into summer.

On page 13 Skip Hop continues to bring great product innovation to the market. And we show three new products here. The Activity Center and Travel Crib, we introduced recently and are off to a good start. The Zoo Topper Scooter will launch very shortly. Each of these products have unique and innovative design features.

Demand for Skip Hop products in the first quarter was strong with sales up double-digits compared to Q1 last year. For 2019, we're forecasting good growth for Skip Hop brand with forecasted sales, up approximately 20% along with a meaningful improvement in the brand's profit contribution.

Turning to page 14 with the results for our U.S. Wholesale business in the first quarter, sales in U.S. Wholesale declined 2% driven by growth in our exclusive brands that was offset by the loss of sales to Toys “R” Us, Bon-Ton, which totaled approximately $13 million in sales in the first quarter of 2018.

Plenty of our wholesale customers plan their spring inventory commitments conservatively, which combined with good sell-through in Q1, resulted in earlier demand for spring product, which we were able to sell with additional Q1 shipment.

Segment operating profit was $55 million compared to $63 million last year. Segment operating margin was 20.1% versus 22.4% in the first quarter of last year. This margin performance reflects changes in the mix of customer sales, some higher inventory provisions and lower bad debt expense.

For the balance of 2019, we're focused on several key areas to drive the U.S. Wholesale business, namely improving in-store presentation furthering our age-up strategy to expand assortments beyond our core Baby offering, and supporting our customer's e-commerce growth.

We're also focused on improving the profit contribution of our relatively new Skip Hop and Simple Joys growth initiatives. For the full year 2019, we're planning a low-single-digit top line growth in our U.S. Wholesale business with roughly comparable earnings.

On page 15, we've included images from the latest Little Baby Basics assortment, which is coming up on its annual market re-launch. Little Baby Basics is the core of our Carter's brand providing the everyday essentials for a new born to 24-month old child.

As Mike said, we believe Little Baby Basics is the best-selling baby apparel product in the United States, and represents the high-margin replenishment business for our wholesale customers and for our own retail businesses.

Complementing the apparel assortment which we think looks great. This year's Little Baby Basics re-launch will be accompanied by a comprehensive multi-channel marketing campaign, which will include new store fixtures, updated in-store branding and imagery, and a refreshed online site experience at carters.com.

Moving to page 16, an International segment results for the first quarter. International segment net sales declined 3% on a reported basis, and grew modestly on a constant currency basis. Our operations in Canada, which represent the lion share of our international business, posted a sales decline in the first quarter. Total retail comparable sales declined in the mid-single digits.

E-commerce was a bright spot for Canada in the first quarter with comparable sales growth of over 30%. Similar to our experience in the U.S. in the first quarter, persistent cold-weather adversely affected store traffic as did the timing of the Easter holiday. Consumer demand has improved significantly in Canada in April with comparable sales up in the mid-teens for the month.

On the year-to-date basis, Canada retail sales are comparable to last year. We saw good growth in net sales in Mexico in the first quarter. Our 42 company-operated stores in Mexico had comps up in the mid-teens. We're looking forward to opening some new stores in Mexico later this year which will mirror the co-branded format which has proven so successful in the United States and Canada.

International segment adjusted operating income was $3 million, compared to $4 million in the first quarter of 2018. Segment operating margin was 3.2% compared to 4.1% last year. This performance reflects a lower contribution from Canada which was somewhat offset by the absence of losses in China. For 2019, we expect net sales in our international business to grow in the low single digits with improved profitability.

Pages 17 and 18 highlight the growing distribution of our brands globally. On page 17, we've included a photo of a new Carter's store in Panama opened by one of our global wholesale partners. This is the first Carter's standalone store in this market and our 10th store in Central America.

On page 18, we've recently initiated e-commerce operations in Brazil with our wholesale partners. This page is a screenshot of the website. It's still early, but site traffic and demand so far have been encouraging. Brazil is the large and attractive market for children apparel. For the past several years, we've partnered with [indiscernible], a leading retailer in Brazil to present the Carter's brand in about 180 of its retail stores throughout Brazil. We mentioned a number of times over the years the significant demand that consumers from Brazil have represented in our U.S. retail stores and on carters.com.

Moving now to our second quarter and full year outlook for 2019 on page 20. For the second quarter, we expect net sales to increase approximately 4% to 6% with good sales growth forecasted in all three of our business segments. We're planning second quarter adjusted earnings per share to be comparable to last year the. Factors influencing profitability in the second quarter include changes in wholesale customer mix, the timing of spending and higher interest expense due to our debt refinancing.

For the full year 2019, we are reaffirming our previous guidance. We expect net sales growth of approximately 1% to 2% and adjusted earnings per share growth of approximately 4% to 6%. This outlook contemplates sales growth in all segments, gross margin expansion in the second half, SG&A leverage, improvement in our operating margin and continued share repurchase.

Risks that we're monitoring include the success of our marketing and pricing strategies over the balance of the year. The performance of our wholesale customers the level of international consumer demand in our U.S. retail businesses including profitable disruptions along with southern border and the status of trade negotiations between the United States and China.

And with these remarks, we're ready to take your questions.

[Operator]

[Operator Instructions] And we'll take our first question from Ike Boruchow of Wells Fargo. Please go ahead.

[Unidentified Analyst]

This is Matt on for Ike. Congrats on a good quarter. Two quick questions on sales and then one follow-up on margins. It sounds like there continues to be strong momentum with the exclusive brands. Can you guys give us an update on sales recaptured in 1Q or year-to-date for the overall business? And then now that China is under a fully licensed model that was completed in 1Q. If you can provide any color on the new structure of the partnership qualitatively and quantitatively going forward? That would be great.

[Michael Casey, Chairman and CEO]

So on the exclusive brands. I guess the way to think about is probably the first - it's important to understand. The first quarter is the - one of the lightest quarter of a year. I would look more to the year. And what we're encouraged by with respect to the TRU recaptured is our wholesale sales this year are planned at a level higher than 2017. So in 2017 Toys “R” Us was one of our better customers, high-margin customer. Those had a good business with Bon-Ton. And in 2019 we won't be doing any business with Toys “R” Us, Bon-Ton. We will do a lot less business with Sears. But we've seen an acceleration particularly with our exclusive brands for Walmart, Target and Amazon. Amazon now is one of our top five customers in a relatively short amount of time. And they're also seeing good growth with our core Carter's brand customers. So we're encouraged by the sales this year - for wholesale will be good. It will be better than 2017 which was a year when we were doing a good amount of business with Toys “R” Us and others. So we would say if we're successful with our wholesale forecast this year, I would say the disruption caused by Toys “R” Us is largely behind us. And your question with respect to China?

[Unidentified Analyst]

Yes, just any color on the new structure of the partnership over there? Qualitatively, qualitatively how are you're thinking about that going forward now? That's the point.

[Michael Casey, Chairman and CEO]

So the high view here is that we moved away from our wholesale and e-commerce model. We moved to a licensing model. We hope to replicate the success that we have had through licensing models up in Canada and Mexico. So that's how those relationships started. We have first-class licensees in Canada and Mexico and overtime as we monitor the business and gave them support they knew how to operate good businesses in countries where they grow up and give us an opportunity to acquire those businesses once they got to a certain level of performance.

We hope the same is true in China. We're working with a partner who we have known for over 20 years. Have great respect for him. He and his colleagues have demonstrated success in children's apparel in China. They are very excited about this new opportunity. They will be sourcing all the product, they have a point of view on what are the specific needs of families with young children or certain product modifications. They believe - needed to have our brands appeal more broadly to the Chinese consumer. They are very excited about the opportunity to do business with Walmart and Costco. They're launching our brands with Walmart and Costco later this year. The new partners taken over the team our relationship. And if all goes according to plan, they'll focus initially on e-commerce and the wholesale relationships. And then if all goes according to plan, they will explore store openings beginning next year. The five year view is we see it today is they're hopeful that we'll be doing at least $70 million in consumer sales by 2023. And we'll earn some portion of $4 million to $5 million in royalties on that business compared to the nearly $12 million we lost last year under the old model. So we're encouraged. Our focus on China is to build a strong foundation. It's a good long-term opportunity. The big benefit won't come in the first five years. But we're hopeful over the next 10 years, 20 years. We have a meaningful source of sales and earnings coming from China.

[Unidentified Analyst]

Okay. That's very helpful and if I could just make a one more on margins. Can you just discuss briefly, and why they'll be under more pressure in 2Q when sales are better. Is it more than mixed impact you alluded to earlier from the lower margin exclusive brands business. Or is it just planned to have your spend in the quarter?

[Richard Westenberger, EVP and CFO]

Matt I would say from a gross margin point of view we are expecting gross margin rate to be year-over-year, perhaps not quite as much as it was in the first quarter. To your point, it really has a lot of the mix of customers within the Wholesale segment.

We're also planning for a bit more off price channel activity in the second quarter relative to first quarter. It was unusually low in the first quarter. And that normalizes a bit in the second quarter but its depressive to the margin. Spending does tick up.

SG&A is forecasted up year-over-year modestly in the second quarter it was down. In the first quarter which I'd say is unusual, so that comes back into a little bit more normal alignment.

And then we have some higher interest expense on the refinancing that I mentioned in my comments. So there's probably the principal effects - factors that are affecting the outlook for earnings in the second quarter.

[Unidentified Analyst]

Great thanks. Congratulate on quarter.

[Operator]

Thank you. And we'll now take our next question from Heather Balsky of BOA. Please go ahead.

[Heather Balsky, BOA]

Hi. Good morning. Thank you for taking my question. I guess first, can you comment on the promotional environment right now, especially with what we've seen with weather and delayed Easter impacts? And how should we think about the impact to your gross margin with demand falling later in the season?

[Michael Casey, Chairman and CEO]

Yeah. Heather I would say, that promotional environment, the focus in January and February always is on clearance. And then, we get colder and wetter weather tax refunds a bunch of stuff that happened.

And the other noise I would say, in Q1 was the Gymboree liquidation. So that drove some increased promotional activity across the business based on their liquidation. We think that's largely behind us. We were able to grow our AURs despite those changes in Q1.

And we felt good about that. So, in terms of impact going forward, we feel good about the business. We've talked about pricing and costs. We think that we've largely offset the cost increases that we're have going forward.

In terms of wholesale good strong business, so we do have a mix of their - that's impacting our margins as Richard spoke up. And overall our intent is to have gross margins somewhere in the last year for the year. And improve profitability on the operating margin line.

[Heather Balsky, BOA]

And as a follow-up. The gross margin improvement you're expecting in the back half. What's driving that?

[Michael Casey, Chairman and CEO]

I'd say a few things, Heather. We're expecting a greater mix of retail and the percent of the total wholesale will be a less significant competent of revenue. The retail business is our higher gross margin businesses.

A year ago we had a significant amount of clearance and liquidation activity particularly in the second half of the year from Toys “R” Us related reasons from those international consumers and are being acquired. And as we have planned, so we are forecasting place of that clearance activity.

We're assuming that we have bit more progress even dealing in the prime side to good progress we've made on p ricing, in the first half. We're assuming we'll make a bit more progress on that in the second half of the year as well.

[Heather Balsky, BOA]

Okay thank you very much.

[Michael Casey, Chairman and CEO]

Sure.

[Operator]

And our next question comes from Susan Anderson of B. Riley FBR.

[Susan Anderson, B. Riley FBR]

Hi. Good morning. Nice job on the quarter. I want you maybe touch a little bit on, kind of what you're expecting for the rest of the second quarter?

It sounds like an April result is a very strong start given the weather and then the Easter shift. I guess how do you see that playing out as we look out to May and June? I think May was pretty strong last year as we saw finally the weather turned?

[Michael Casey, Chairman and CEO]

Yeah. May is a tougher comparison. April was particularly good for us. May is a tougher comparison, but we factored that into our forecast. And I think right now, we're assuming comps in the second quarter up some fortunate 3% to 4%. So we feel good about that outlook based on what we know today.

[Susan Anderson, B. Riley FBR]

Great. That sounds good. And then, maybe if you could just touch a little bit on the retail segment margins, it looks like they've - there's kind of been puts and takes each quarter. But it's still down. It seems like year-over-year. So maybe if you could just talk about maybe stabilization in those when you expect to start expanding retail operating margins again?

[Michael Casey, Chairman and CEO]

Where we look for expansion in the second half of the year, Susan. That's reflected in our forecast. I'd say the margins were under some pressure a year ago as it relates to some of that liquidation activity that I mentioned. We also have heavy investment in the business around some of the omni-channel capabilities, some of the technology spend. But we are forecasting for margin improvement in the second half in retail.

[Susan Anderson, B. Riley FBR]

Got it. That makes sense. And then lastly, it sounds like there were some shifts in inventory driving the growth greater than sales this quarter. I guess do you feel like if there's any pockets of higher inventory. It sounds like you're going to have somewhat more off-price sales? But, are there any pockets out there that need to be clearing. Are - you feel pretty good about the inventory all around?

[Michael Casey, Chairman and CEO]

I think we feel good about it. We are up high-singles in the first quarter. We have growth inventory based on forward demand and some of the costs increases we have. If we look across the businesses, the retail stores are - our inventories are comparable to last year. We think it's a better quality inventory. Wholesale is in good shape. We had strong selling in the second quarter. We're optimistic about Q2. And we're planning inventory to track relatively close to the sales growth for the rest of the year in terms of off-price sales. Quarter-to-quarter, there are differences. I think for the year, we're hopeful that our off-price sales will be at or below last year's levels.

[Susan Anderson, B. Riley FBR]

Great. That's helpful. Nice job in the quarter. Good luck next quarter.

[Michael Casey, Chairman and CEO]

Thanks very much.

[Operator]

Thank you. And we'll take our next question from Paul Lejuez of Citi. Please go ahead.

[Karen Calderon, Citi]

Hi. This is Karen Calderon on for Paul. Could you provide any addition color on how stores co-locate with Gymboree's performance before and after the Gymboree store closing? Then, how did they impact of Gymboree liquidations play out relative to your plan? And other $100 million market share opportunity, can you provide a little bit more detail on when you expect to see that share gain from a channel basis retail versus wholesale? Thanks.

[Richard Westenberger, EVP and CFO]

I think to just to review where we are on Gymboree. We did have some impact in the first quarter mostly in playwear. We actually saw a benefit in the stores where we're co-located. I think probably because of traffic and liquidation promotions that they were running, and where we're further from here. We saw an impact in our playwear business.

But looking forward, we do think we can capture some of that business. We've quantified it as the $100 million opportunity, where we have by far the number one market share in toddler. And we're growing with kids and kid sizes with age-up strategy. We are overlapped in the outlet centers by-and-large, so we feel good about that.

But the closures are an opportunity for us to look at our mall business. Our 50 mall stores are doing very well. We're developing more mall right now that we hope to launch later this year. And we think that there's some unique opportunities to gain some of that business in the malls with Gymboree going out.

But still be a long-term probably still less than 20% of our doors will be in malls. But we do think there's an opportunity, and we've quantified it as of $100 million between pickup in existing those we have and new doors that we may build going forward in the malls.

And then thirdly, wholesale. We're working really closely with our wholesale accounts to grow their businesses. I think some of our key wholesale accounts see a key opportunity in toddler. And they had good toddler business in Q1. So we hope to have a deeper penetration in play particular toddler with our wholesale accounts going forward.

[Karen Calderon, Citi]

Great, thanks. And if you exclude the impact of Toys "R" Us and Bon-Ton in 1Q, U.S. wholesale increased 3%. Is that how we should be thinking about the growth in that channel for the remainder of the year? Is there any differences between 2Q and QH?

[Michael Casey, Chairman and CEO]

Particular as we said that we're going to be up low single digits from the year. I think in terms of half, we're planning the first half up low single digits despite that $13 million of non-comp value over the last year. Our replenishment business is playing up low single digit last year. And then second half, probably more comparable than the last year. We did have - most of our bookings is not all some of the accounts, did by a little more conservatively based on pricing action. So we're planning second half more comfortable than last year. In terms of seasonal demand, replenishment business in the second half, we do believe will increase.

[Karen Calderon, Citi]

Thank you.

[Operator]

Thank you. And we'll take our next question from Jim Chartier of Monness, Crespi, Hardt.

[Jim Chartier, Monness, Crespi, Hardt]

Good morning. Thanks for taking my questions. Just wanted to follow-up on the last question, so where - has Gymboree closed all its stores? If not how many have they closed?

[Michael Casey, Chairman and CEO]

Yes. Jim just from my perspective, Gymboree was largely a non-event. When you're closing all the stores and liquidating the inventory, you would expect to see a bit of a dip. But when I look at we're co-located in about 200 centers mostly outward centers. We actually saw a lift in our store sales because those store closures brought more people into the center. And we probably have some portion of about 50 mall stores, probably some portion of 50 comping at least.

The comps here today in our mall stores are up about 6%. So that's why we're encouraged by the mall store opportunities. We've always had a preference, a biased toward strip centers because it was mostly like outlets. And our history has been in outlets. So we had a higher comfort with our strip centers and had good experience in those in strip centers. With that said, we've moved into malls because the economic have become much more attractive. And so Gymboree stores are all closed. I think any impact we have was short-lived and is behind us.

[Jim Chartier, Monness, Crespi, Hardt]

Great. And on the new mall stores you're contemplating, are the lease term shorter than they have been historically? What's the risk associated with it?

[Michael Casey, Chairman and CEO]

The lease terms would be consistent with our other site selection, typically 10 year leases with kick outs and our experience over the years, even though we've had kick outs in substantially all of our leases, where we do, we have to take advantage of them because our stores are highly profitable if you get the model right.

I think the opportunity we have, the discussions we have with the mall owners, they view our brands as traffic drivers. Our brands drive young families with young children into those centers. And so the economics have become much more attractive. The other thing as we look at the wholesale customer basis, probably fair to assume that some of the mall-based customers we have will have a smaller presence in the malls five years from now. That creates an additional opportunity for us.

So we're going to proceed with question for all the right reasons. We're going to be very selective in the sites that we choose. We've got real estate team has done an outstanding job, finding good sites for us with good economics and given the strong comps that we're experiencing.

And so over the next five years, we hope to open up some portion of 100 mall stores and if we do the mall store mix of our total portfolio would still less than 20% of our total stores. So we'll take one at a time. On average our stores do $1 million or more. We've looked at probably a 1,000 mall locations. Most of those locations would not be attractive to us given co-tenancy, unfavorable demographics meaning not a lot of families with young children in that area or the declining centers. So we took about a population of about 1,000 centers. We've analyzed and we narrowed it down to this probably about a 100 that are worthy of exploring. So that's what we will do. And we will do some this year and if those work well and we are happy with those we will do more. And if not then we will develop other plans.

[Jim Chartier, Monness, Crespi, Hardt]

Right. And just on Brazil. What's the store opening plan for Brazil? Are you continuing to open up more stores there? And then - what's the potential size of that - walk it for you five years down the road?

[Michael Casey, Chairman and CEO]

Jim, I said no plans to open stores at the moment. Right now, we have a nice wholesale business with department store risk [ph] that I mentioned. And then this is the relatively nascent opportunity that we'll begin with the website operation that's also whole relationship for us. So it's a big market. They have a high birthrate. I'd say we're more in the exploration and learning. Now we have been historically serving those customers in our own U.S. retail business with a fair amount of success. We think overtime it make sense to develop a stronger presence in Brazil and I hold on commenting on five potential until we just know it bit more.

[Jim Chartier, Monness, Crespi, Hardt]

Great. Thanks and best of luck.

[Michael Casey, Chairman and CEO]

Thank you.

[Operator]

Thank you. And we will now take our next question from Omar Saad of Evercore ISI.

[Omar Saad, Evercore ISI]

Thanks for taking my question. Nice quarter guys. I wanted - two quick questions. I wanted to ask maybe if you can expand upon, give us a little bit more detail around some of your omni-channel buy online, pickup at store initiatives? It sounds like you're trying to push in to more same-day, next-day type delivery and also - I'm trying to understand how much of that business - how much of your business now is being driven by that kind of omni-channel consumer experience? Is it the faster piece - faster growing piece of the business versus traditional kind of store transactions or pure online transactions? And then what kind of incentives have you been using to drive consumers into the stores, if any to choose that option instead of having to deal with the shipping and returns that comes with pure e-commerce? And then I also have a follow-up on China.

[Michael Casey, Chairman and CEO]

Okay, Omar just in terms of e-commerce. We're excited about e-commerce business. It continues to grow with the fastest growing part of the company. We continue to invest in that. We're going to refresh. We launched our website this year. We are expanding our product offerings. And we continue to look at the - shipping models more free and faster and really driving traffic with digital marketing. We are promotional. We have promotions. We will continue our promotions, but we think, we've done a good job with digital marketing, with our rewards program in a lot of ways to attract all the eye-balls to our site and customers into our stores and our website.

In terms of omni-channel initiatives, I think, Mike covered some of these. But we've had buying online ship to store for over a year now. About 12% of our orders, in Q1 were shipped to our stores for free and customers came in to pick them up. And when they did about a one-fourth of those folks actually bought additional products when they were in our stores. And then we've got the endless aisle strategy that we deployed which is if we go out of stock and if store - the sales associate can order for that consumer and ship it to their home for free. And they also have the ability to look at anything we have online which is a much broader assortment in order to that from a store and have that shipped at home for free.

The two new things that we worked on this year in first quarter that buy online pick-up in store which is the same-day pickup, we tested that in two markets in Atlanta and Seattle with good success. Meaningful portion of our outline orders in those markets were fulfilled from the store. So we're really excited about that. It's ramping nicely. We're planning to roll that out nationwide in the balance of the year. And then of course the deliver from store, something that we're testing at this point and wanted to make sure that we monitor until the customer response to that. The impact of the cost to serve and with the intent to improve our customer satisfaction, while improving profitability.

So a number of initiatives to drive our omni-channel business, our e-commerce. Glad, we've got a great team working on that. We're investing significant resources and it continues to grow our retail business. I think we said before, it's going to grow about $300 million over the next five years. And the vast majority of that will be through e-commerce and omni-channel initiatives.

[Omar Saad, Evercore ISI]

That 12% you mentioned. Can you give us a sense of maybe what that was about a year ago? And I'm also wondering if you could say - if you didn't - if you could who your new China partner is?

[Michael Casey, Chairman and CEO]

I think that the percent penetration I think last year that was probably high single-digits and we're up to 12% in that. I didn't quote the portion because the test markets in Atlanta and Seattle of the same day pick up. But that was north of 10% as well of those orders just out of the gate.

So we think that those are initiatives that the consumers are excited about. And it can help us again with customer satisfaction and cost to serve.

[Richard Westenberger, EVP and CFO]

And Omar the principal - the partner we have in China. The firm's name is Wing Luen. L-U-E-N. It's one of the principles in a probably a three party group that are operating the business for us today.

[Omar Saad, Evercore ISI]

Thanks for the information guys. Nice work.

[Richard Westenberger, EVP and CFO]

Our pleasure Omar. Thank you.

[Operator]

And our next question comes from Jay Sole of UBS. Please go ahead.

[Jay Sole, UBS]

Great. Thanks so much. You talked about just the Age Up strategy. What the dollar contribution was this quarter in Q minus where it was last quarter? And what you see happening over the next couple of quarters?

[Richard Westenberger, EVP and CFO]

Yeah, on the Age Up strategy, Jay, we launched that in fall, where we're offering the Carter's brand up to size 14 with differentiated cloak and creative in marketing for each segment. We've had good selling in the fall. We're seeing meaningful growth this spring. I don't know if we've prepared to quantify exactly what it is right now, but I would say that the largest growth in the first quarter in our retail business was from the Age Up strategy and size is 10 to 14.

And also in our key wholesale accounts, I think I mentioned earlier that we're going to expanding our - we are expanding our toddler presence. Some of the strongest sales we had in Q1 were from toddlers. So continues to ramp. It's the first spring season that we have it. We're excited about it. It's a really nice long-term opportunity for us to increase the lifetime value of our customers. As you noted before we captured about 85% 90% of the new moms by Carter's, over 90% now. And if we can increase the number of years that she stays with our brand that just increases lifetime value and its ability to drive our business going forward.

[Jay Sole, UBS]

Got it. And then just on modeling 2Q. In terms of the Wholesale business, is there any impact left from Bon-Ton and Toys “R” Us? Or are we completely lapping it right now starting April - in April?

[Richard Westenberger, EVP and CFO]

And those customers are behind us. We shipped some probably some portion of $13 million to them in the first quarter last year, but those relationships are behind us.

[Jay Sole, UBS]

Got it. Okay. Thank you so much.

[Richard Westenberger, EVP and CFO]

Pleasure.

[Operator]

Thank you. And we'll take our next question from Laurent Vasilescu of Macquarie. Please go ahead.

[Laurent Vasilescu, Macquarie]

Good morning and thanks for taking my questions. I wanted to follow-up on slide 20, which calls for changing the wholesale customer mix impacting 2Q 2019. Can you tell by the dynamics at play? And are you still expecting for the top five wholesale customers to grow about 5% this year?

[Richard Westenberger, EVP and CFO]

That's - we'll have good growth of the top five, yes.

[Laurent Vasilescu, Macquarie]

Okay. Okay, very helpful. And then switching to SG&A. I think in that same slide talks about some impact on expenses. Is that a shift between 1Q to 2Q? Or shift from 3Q to 2Q? And then can you maybe quantify the magnitude of the shift?

[Michael Casey, Chairman and CEO]

Hi. As I said, it's a bit unusual for us to have spending down in absolute terms of year-over-year which is itself in Q1. So, there was some measure of spending timing that I would say benefited first quarter. That's probably in the order of $3 million or $4 million that will flip around in the second quarter.

You have some additional spending in Q2 related to marketing insights, related to the Easter holiday. We're expecting some favorability around bad debt expense that has been a bit of a burden in last year's quarter as we were doing some of those results for the top of wholesale customers. So, on balance, I'm expecting SG&A to be up in the second quarter although, only modestly.

[Laurent Vasilescu, Macquarie]

Okay. It's very helpful. And the last question I believe you called out, that e-commerce shipping cost pressure in U.S. retail margins in 1Q. Can you part that whether U.S. e-commerce operating margin is currently? Is it mid-single-digit rate? And how should we think about that margin, structure as you roll out your buy online pickup in store strategy for nationally, going forward?

[Richard Westenberger, EVP and CFO]

Our e-commerce continues to be an extremely margin rates business for us. So it's a very profitable business. I would say over the last 12 to 18 months we have seen increases in the cost to serve the e-commerce customer.

There's a greater proportion of free shipping in that business. The small parts of carriers have all push through rate increases. So it's been initially not just for us for anybody who is shipping items directly to the consumer.

Those costs are expected to continue to be pressures on our margin, but still a very rich margin business. I won't comment on specifically the margin of e-commerce discretely but it is a competent of our overall retail margins.

As it relates to the omni-channel capabilities, we do think that there's an opportunity for us overtime particularly for our customers who are further away on the West Coast to run the Northeast who is taking a bit longer to deliver parcels to them.

We do think that being able to have those on course to pick up in the store and also perhaps to deliver those orders from the store inventory. That's a capability that we have online later this year.

We think there is, perhaps part of pasta question long-term to adjust some of the cost pressures we are seeing in that part of the business. But e-commerce continues to be a great business is growing rapidly on the top line and still very, very attractive margin.

[Laurent Vasilescu, Macquarie]

Thank you. Thank you very much. And best of luck.

[Richard Westenberger, EVP and CFO]

Thank you.

[Operator]

That concludes our question-and-answer session for today. Mr. Casey, I would like to turn the call back to you for any additional or closing remarks.

[Michael Casey, Chairman and CEO]

Okay thank you. Thank you all for joining us on the call this morning. We appreciate your questions and your interest in our business. We look forward to updating you again on our progress in July. Goodbye, everybody.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.