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Carter's Inc  (NYSE:CRI)
Q1 2019 Earnings Call
April 30, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

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 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.

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

Michael D. Casey -- Chairman & Chief Executive Officer

Thanks very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I'd like to share some thoughts on our business with you. 2019 is off to a good start. We exceeded the first quarter sales and earnings goals 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 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 combined 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're 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 3 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 and gain 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've 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 center, 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 Crazy8 mall 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 Top 2 favorite places to shop for young children's apparel. Our latest market data also suggests that our Carter's brand is the best selling children's apparel brand online in the United States. Consumers rank Amazon and carters.com as their Top 2 favorite places to shop for baby apparel online. In a survey last year, nearly 90% of millennials shopping for baby apparel said they purchased our Carter's brands. We are uniquely positioned with the strength of our multi-channel model to sell our brands through 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 3 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've been fortunate in the years past to have a high mix of international guests shopping for our brands on our US website. In 2017, which is the latest data available, Carter's ranked in the Top 4 most popular US websites for international shoppers together with Amazon, Ralph Lauren, and Gap. As the US dollar strengthened 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 forecasted exchange rates suggests a tougher comparison for international demand in 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 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 the consumer's home for free. Both of these omni-channel capabilities have contributed to Carter's ranking Number 1 last year in net promoter scores 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 will 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 5 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 replacement 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 of 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. Mexico is a new market opportunity for us. Like Canada, we were 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 include a 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 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 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.

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

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

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 include reconciliations of our GAAP basis 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 the 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 US and Canada, and Gymboree -- Gymboree liquidation activity in the marketplace. Our profitability was down in the quarter, but again by less than we had expected. The decline in profitability tracks to lower topline sales 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 at $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 US 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 worked 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; US Retail, US 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 US Wholesale business and higher inventory provisions and e-commerce shipping costs. We expect stronger gross margin performance as we move through 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 benefited from lower bad debt expense in Wholesale and the elimination of operating expenses in China as our business 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 market 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 transaction and we achieved one of the best interest rate and covenant packages in what has been a fairly choppy high yield debt market. We utilized the proceeds of the transaction to pay off our existing senior notes and to pay down a portion 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 on plan 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 a modest increase in product costs.

We believe we've hit the peak of year-over-year inventory growth for the year and are forecasting only mid single-digit increases in net 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 had the effect of 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 new accounting standard did not have a material P&L impact. I'd also note that we've always considered 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're 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 dividends. As we announced on 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 7 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 segments 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 US Retail segment on Page 8. Total US Retail segment sales declined 2% in the first quarter. Our total Retail comp 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 2 comp points. We also believe that cold weather across the country likely suppressed consumer demand for warmer weather apparel, which is the focus of our assortments early in the year. Gymboree liquidation activity delayed tax refunds and lower international consumer demand were also likely factors weighing 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 US were up in the high teens. On a year-to-date basis, US Retail comps are currently at 1.7%. In the first quarter we opened four new stores and closed 14 ending the quarter with 834 stores in the United States. For the full year, we now plan to open approximately 45 stores and close 25. US 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're 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 full-year 2019, we're planning US Retail segment's net sales to grow in the low single-digits with good growth in earnings as well. On Page 9, we've included a photo of a 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 from 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 the 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 were introduced recently and are off to a good start. The zoo toddler 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 the 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 results for our US Wholesale business in the first quarter. Sales in US Wholesale declined 2% driven by growth in our exclusive brands that was offset by the loss of sales to Toys "R" Us and Bon-Ton, which totaled approximately $13 million in sales in the first quarter of 2018.

Many of our wholesale customers planned their spring inventory commitments conservatively, which combined with good sell-throughs in Q1 resulted in earlier demand for spring product, which we were able to satisfy with additional Q1 shipments. 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 US Wholesale business namely improving in-store presentation, furthering our age up strategy to expand assortments beyond our core baby offering, and supporting our customers' 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 low single-digit topline growth in our US -- US 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 relaunch. Little Baby Basics is the core of our Carter's brand providing the everyday essentials for a newborn 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 a high margin replenishment business for our wholesale customers and for our own retail businesses. Complementing the apparels assortment, which we think looks great, this year Little Baby Basics relaunch 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 and 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's 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 US 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 a 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 stand-alone store in this market and our 10th store in Central America.

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

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 repurchases. 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 US Retail businesses including possible disruptions along the 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.

Michael D. Casey -- Chairman & Chief Executive Officer

Ian?

Questions and Answers:

Operator

Yes. Thank you. (Operator Instructions) And we'll take our first question, comes from Ike Boruchow of Wells Fargo. Please go ahead.

Matt -- Wells Fargo Securities, LLC -- Analyst

Yes. Hey, guys. 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 D. Casey -- Chairman & Chief Executive Officer

So on the exclusive brands, I guess the way to think about it is probably, the first -- the point to understand, first quarter is one of the lightest quarters of the year. I would look more to the year. And what we're encouraged by with respect to the TR you recapture 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. We also had a good business with Bon-Ton. And in 2019 we won't be doing any business with Toys "R" Us, Bon-Ton, and we'll be doing a lot less business with Sears. But we've seen -- we've seen an acceleration particularly with our exclusive brands for Walmart, Target, and Amazon.

Amazon now is one of our Top 5 customers in a relatively short amount of time and we'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, will be better than 2017 was -- 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?

Matt -- Wells Fargo Securities, LLC -- Analyst

Just any color on the new structure of the partnership over there. Qualitatively or quantitatively how you're thinking about that going forward now?

Michael D. Casey -- Chairman & Chief Executive Officer

So, the high view here is that we moved away from a 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 had first class licensees in Canada and Mexico and over time as we monitored the business and gave them support, they knew how to operate good businesses in countries where they grew up and gave 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.

There are certain product modifications they believe are 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 are launching our brands with Walmart and Costco later this year. The new partner's taken over the Tmall 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 as we see it today is they're hopeful they'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. The whole focus on China is build a stronger foundation. It's a good long-term opportunity. It's -- the big benefit won't come in the first five years. We're hopeful over the next 10, 20 years we have a meaningful source of sales and earnings coming from China.

Matt -- Wells Fargo Securities, LLC -- Analyst

Okay. That's very helpful. And if I could just sneak in one more on margins. Can you just discuss briefly why they'll be under more pressure in 2Q when sales are better? Is it more of the mix impact you alluded to earlier from the lower margin exclusive brands business or is it just plan to have your spend in the quarter?

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Matt, I would say from a gross margin point of view, we are expecting gross margin rate to be down year-over-year, perhaps not quite as much as it was in the first quarter. To your point, it really has a lot to do with 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 it's depressive to margins. 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 do have some higher interest expense from the refinancing that -- that I mentioned in my comments. Those are probably the principal effect -- factors that are affecting the outlook for earnings in the second quarter.

Matt -- Wells Fargo Securities, LLC -- Analyst

Great. thanks. Congrats on a good quarter.

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Thank you.

Michael D. Casey -- Chairman & Chief Executive Officer

Thank you.

Operator

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

Heather Balsky -- Bank of America Merrill Lynch -- Analyst

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 the late Easter impact and how we should think about the impact to your gross margin with demand falling later in the season?

Michael D. Casey -- Chairman & Chief Executive Officer

Heather, I would say the promotional environment, the focus in January and February always is on clearance and then we had colder and wetter weather, tax refunds, 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 -- across the business based on their liquidation. We think that's largely behind us. We were able to grow our AURs despite those challenges 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 the pricing and cost. We think that we've largely offset the cost increases that we're going to have going forward. In terms of Wholesale, good strong business. We do have a mix there that's impacting our margins as Richard spoke of. But overall, our intent is to have gross margins similar to last year for the year and improve profitability on the operating margin line.

Heather Balsky -- Bank of America Merrill Lynch -- Analyst

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

Michael D. Casey -- Chairman & Chief Executive Officer

I'd say a few things, Heather. We're expecting a greater mix of retail as a percent of the total Wholesale will be a less significant component of revenue. The retail businesses are the 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 not being quite as present as we had planned. So, we're forecasting less of that -- that clearance activity. We're assuming that we have a bit more progress even building on what Brian said, the good progress we made in pricing in the first half, we're assuming we make a bit more progress on that in the second half of the year as well.

Heather Balsky -- Bank of America Merrill Lynch -- Analyst

Thank you very much.

Michael D. Casey -- Chairman & Chief Executive Officer

Sure.

Operator

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

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

Hi. Good morning. Nice job on the quarter. I wanted to maybe touch a little bit on kind of what you're expecting for the rest of the second quarter. Sounds like April's off to 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 turn.

Michael D. Casey -- Chairman & Chief Executive Officer

Yes. May is a tougher comparison. April was particularly good for us. May is a tougher comparison, but we factor that into our forecasts and I think right now we're assuming comps in the second quarter up some portion of 3% to 4%. And so we feel good about that outlook based on what we know today.

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

Great, so something. 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?

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Well, we would look for expansion in the second half of the year, Susan. That's what's reflected in our forecast. I'd say that the margins were under some pressure a year ago as it related to some of that liquidation activity that I mentioned. We've also had 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, Inc. -- Analyst

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 there is any pockets of higher inventory? It sounds like you're going to have a little bit more off-price sales, but are there any pockets out there that kind of need to be clearing or you feel pretty good about the inventory all around?

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

I think we feel good about it. I think we were up high singles in the first quarter. We had growth inventory based on forward demand and some of the cost increases we have. So if we look across the businesses, the retail stores our inventory is comparable to last year. We think it's better quality inventory. Wholesale is in good shape. We had strong selling in the first 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, Inc. -- Analyst

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

Michael D. Casey -- Chairman & Chief Executive Officer

Thanks very much.

Operator

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

Kelly Krager -- Citigroup Inc. -- Analyst

Hi. This is Kelly Krager (ph) on for Paul. Could you provide any additional color on how stores co-located with Gymboree performed before and after the Gymboree store closings and how did the impact of Gymboree liquidations play out relative to your plan? And of that $100 million market share opportunity, can you provide a little bit more detail on where you expect to see that share gain from a channel basis, retail versus wholesale? Thanks.

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

I think to just to review where we are with Gymboree. We did have some impact in the first quarter mostly in playwear. We actually saw benefit in the stores where we were co-located I think probably because of traffic and liquidation promotions that they were running. And where we were further from there, 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 a $100 million opportunity. We have by far the Number 1 market share in toddler. We're growing with kids in 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 a mall model right now that we hope to launch later this year. And we think that there are some unique opportunities to gain some of that business in the malls with Gymboree going out. There'll still be -- long term probably still less than 25 -- 20% of our doors will be in malls. But we do think there's an opportunity and we've quantified it at $100 million between pick up in existing doors 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 playwear in particularly toddler with our wholesale accounts going forward.

Kelly Krager -- Citigroup Inc. -- Analyst

Great. Thanks. And if we exclude the impact of Toys "R" Us and Bon-Ton on -- in 1Q, US 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 2H?

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

I think we said that we're going to be up low single digits for the year. I think in terms of halfs, we're planning the first half up low single digits despite that $13 million of non-comp value with last year. Our replenishment businesses, we're planning up low single digits for the year. And then second half probably more comparable to last year. We did have -- we have most of our bookings if not all. Some of the accounts did buy a lot more conservatively based on pricing action. So, we're planning second half more comparable to last year. And in terms of seasonal demand, replenishment businesses in the second half we do believe will increase.

Kelly Krager -- Citigroup Inc. -- Analyst

Right. Thank you.

Operator

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

Jim Chartier -- Monness, Crespi, Hardt -- Analyst

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

Michael D. Casey -- Chairman & Chief Executive Officer

Yes, Jim. Just from my perspective, Gymboree was largely a non-event. I mean when you're closing all the stores and liquidating the inventory, you'd expect to see a bit of a dip. But when I look at where we're co-located in about 200 centers, mostly outlet 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 year-to-date 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 biased toward strip centers because it was mostly like outlets and our history has been in outlets so we had a higher comfort level with strip centers and have had good experience in those strip centers. That said, we have moved into malls because the economics have become much more attractive. And so, Gymboree stores are all closed. I think any impact we had was short-lived and is behind us.

Jim Chartier -- Monness, Crespi, Hardt -- Analyst

Right. And then on the new mall stores you're contemplating, are the lease terms shorter than they have been historically? What's the risk associated with looking at these stores?

Michael D. Casey -- Chairman & Chief Executive Officer

The lease terms would be consistent with our other site selections, 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, rarely do we have to take advantage of them because our stores are highly profitable if you get the model right. And I think the opportunity we have, the discussions we've had with 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 is we look at the our wholesale customer base, it's probably fair to assume that there -- 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 caution for all the right reasons and we're going to be very selective in the sites that we choose.

I think our real estate team has done an outstanding job finding good sites for us with good economics and given the strong comps that we've been 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 be 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 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 they're declining centers. So, we took about -- a population of about 1,000 centers. We've analyzed and we narrowed it down to there's probably about 100 that are worthy of exploring. So, that's what we'll do and we'll do -- we'll do some this year and if those do work well and we're happy with those, we'll do more. And if not, then we'll develop other plans.

Jim Chartier -- Monness, Crespi, Hardt -- Analyst

Right. And then 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 market for you five years down the road?

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Jim, I'd say no plans to open stores at the moment. Right now we have a nice Wholesale business with the department store Riachuelo that I mentioned and then this is a relatively nascent opportunity that we've begun with a website operation that's also a wholesale relationship for us. So, it's a big market. They have a high birth rate. I'd say we're more in the exploration and learning mode. We've been historically serving those customers in our own US Retail business with a fair amount of success. We think over time it makes sense to develop a stronger presence in Brazil and I'll hold on commenting on the five-year potential till we just know a bit more.

Jim Chartier -- Monness, Crespi, Hardt -- Analyst

Great. Thanks and best of luck.

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Thank you.

Michael D. Casey -- Chairman & Chief Executive Officer

Thank you.

Operator

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

Omar Saad -- Evercore ISI -- Analyst

Thanks for taking my question. Nice quarter, guys. I wanted -- two quick questions. I wanted to ask maybe if you could expand upon and give us a little bit more detail around some of your omni-channel buy online, pickup in store initiatives. It sounds like you're trying to push into 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.

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Okay. Omar, just in terms of e-commerce, we're excited about our e-commerce business. It continues to grow, it's the fastest growing part of the Company. We continue to invest in that. We're going to refresh and relaunch our website this year. We're expanding our product offerings and we continue to look at the -- the shipping model's more free and faster and really driving traffic with digital marketing. We're promotional -- we have promotions, we will continue to have promotions. But we think we've done a good job with digital marketing, with our rewards program, and a lot of ways to attract the eyeballs to our site and the customers into our stores and our website. In terms of omni-channel initiatives, I think Mike covered some of these, but we've had buy 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 and picked them up and when they did, about a quarter 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're out of stock in a store, the sales associate can order it 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, and order that from the store and have it shipped to home for free. The two new things that we worked on this year in first quarter are that buy online, pickup in store which is the same day pickup. We tested that in two markets in Atlanta and Seattle with good success. A meaningful portion of our online orders in those markets were fulfilled from the store.

So, we're really excited about that. It's ramping nicely and we're planning to roll that out nationwide in the balance of the year. And then of course the deliver from store is something that we're testing at this point and want to make sure that we monitor the customer response to that. The impact of the cost to serve and -- and with the intent to improve our customer satisfaction while improving profitability. So, a number of initiatives to drive our omni-channel business and our e-commerce strategy. 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've said before, is 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 -- Analyst

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

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

I think there's a percent penetration, I think last year that was probably high single digits and we're up to 12% on that. And then I didn't -- 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 consumer's excited about and can help us again with customer satisfaction and cost to serve.

Michael D. Casey -- Chairman & Chief Executive Officer

And Omar, the principal -- the partner we have in China, the firm's name is Wing Luen -- LUEN. It's one of the principals in a -- probably a three party group that are operating the business for us today.

Omar Saad -- Evercore ISI -- Analyst

Thanks for all the information guys. Nice work.

Michael D. Casey -- Chairman & Chief Executive Officer

Our pleasure, Omar. Thank you.

Operator

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

Jay Sole -- UBS Securities LLC -- Analyst

Great. Thanks so much. Can you talk about just the age up strategy? What the dollar contribution was this quarter in Q1, where it was last quarter, and what you see happening over the next couple of quarters?

Brian J. Lynch -- President

Yes. That age up strategy, Jay, we launched that in fall where we're offering the Carter's brand up to size 14 with differentiated product and creative and marketing for each age segment. We had really good selling in the fall. We're seeing meaningful growth this spring. I don't know if we're 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 in sizes 10 to 14. And also in our key wholesale accounts, I think I mentioned that we're going to be expanding our -- we are expanding our toddler presence. Some of the strongest sales we had in Q1 were from toddler. So, continues to ramp. It's the first spring season that we've had it and 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've noted before, we capture about 80 -- 85%, 90% of the new moms buy Carter's, over 90% now. And if we can increase the number of years that she stays with our brands, that just increases lifetime value and its ability to drive our business going forward.

Jay Sole -- UBS Securities LLC -- Analyst

Got it, OK. 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 that now starting April -- in April?

Michael D. Casey -- Chairman & Chief Executive Officer

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

Jay Sole -- UBS Securities LLC -- Analyst

Got it OK. Thank you so much.

Michael D. Casey -- Chairman & Chief Executive Officer

Pleasure.

Operator

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

Laurent Vasilescu -- Macquarie Capital (USA) Inc. -- Analyst

Good morning and thanks for taking my questions. I wanted to follow up on Slide 20, which calls for change in the wholesale customer mix impacting Q2 '19. Can you talk about the dynamics at play and are you still expecting for the Top 5 wholesale customers to grow about 5% this year?

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

We'll have good growth with the Top 5, yes.

Laurent Vasilescu -- Macquarie Capital (USA) Inc. -- Analyst

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

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

As I said, it's a bit unusual for us to have spending down in absolute terms year-over-year, which was our result in Q1. So, there was some measure of spending timing that I would say benefited first quarter. That's probably on 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 and such, related to the Easter holiday. We are expecting some favorability around bad debt expense. That has been a bit of a burden in last year's quarter as we were taking some of those reserves for the troubled wholesale customers. So on balance, I am expecting SG&A to be up in the second quarter although only modestly.

Laurent Vasilescu -- Macquarie Capital (USA) Inc. -- Analyst

Okay. Very helpful. And the last question. I believe you called out that e-commerce shipping cost pressured your US Retail margin in 1Q. Can you parse out what the US e-commerce operating margin is currently? Is it a 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?

Brian J. Lynch -- President

E-commerce continues to be an extremely margin rich business for us. It's a very profitable business. I'd say over the last 12 to 18 months, we have seen increases in the cost to serve that e-commerce customer. There's a greater proportion of free shipping in that business. The small parcel carriers have all pushed through rate increases. So it's been an issue not just for us, but for anybody who's shipping items directly to the consumer. Those costs are expected to continue to be pressures on our margin, but it's still a very rich margin business. I won't comment on specifically the margin of e-commerce discreetly, but it is a component of our overall retail margins.

As it relates to the omni-channel capabilities, we do think that that's an opportunity for us over time particularly for customers who are further away on the West Coast or in the Northeast who it's taking a bit longer to deliver parcels to them. We do think that being able to have those orders picked up in the store and also perhaps to deliver those orders from the store inventory, that's a capability that we'll have online later this year, we think that is perhaps part of the cost equation long term to address some of the cost pressures we're seeing in that part of the business. But e-commerce continues to be a great business growing rapidly on the topline and still very very attractive margin.

Laurent Vasilescu -- Macquarie Capital (USA) Inc. -- Analyst

Great to hear. Thank you very much and best of luck.

Brian J. Lynch -- President

Thank you.

Operator

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

Michael D. Casey -- Chairman & Chief Executive Officer

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.

Duration: 59 minutes

Call participants:

Michael D. Casey -- Chairman & Chief Executive Officer

Richard F. Westenberger -- Executive Vice President & Chief Financial Officer

Matt -- Wells Fargo Securities, LLC -- Analyst

Heather Balsky -- Bank of America Merrill Lynch -- Analyst

Susan Anderson -- B. Riley FBR, Inc. -- Analyst

Kelly Krager -- Citigroup Inc. -- Analyst

Jim Chartier -- Monness, Crespi, Hardt -- Analyst

Omar Saad -- Evercore ISI -- Analyst

Jay Sole -- UBS Securities LLC -- Analyst

Brian J. Lynch -- President

Laurent Vasilescu -- Macquarie Capital (USA) Inc. -- Analyst

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