Q3 2020 Carter's Inc Earnings Call

Hello, and welcome to Carter's third quarter 2020, <unk> 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 todays prepared remarks, we will take questions as time allows.

Carter's issued its third quarter 2020 earnings press release earlier. This morning, a copy of the release and presentation materials for today's call have been posted to the Investor Relations section of the company's website at IR Dot Carter's Dot 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 and quarterly reports 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 and now I would like to turn the call over to Mr. Casey.

Thank you very much good morning, everyone. Thank you for joining us on the call before we walk you through the presentation on our website like to share some thoughts on our business with you.

Carter's is making good progress recovering from the market disruption caused by the pandemic. Thanks to the support of our employees worldwide, we exceeded our sales and earnings goals in the third quarter.

We achieved a record gross profit margin in the quarter with improved price realization and fewer and better promotions, we reduced our spending in inventories below prior year levels. We also strengthen cash flow and liquidity in the quarter and gained market share.

With respect to business trends, we got off to a good start in July sales running more than 90% of prior year sales, we have substantially all of our stores open heading into the fourth of July weekend, and retail sales or would that holiday shopping period Comped up 7%.

I guess, we saw sales trend to about 87% of prior year sales as schools at the delayed reopening the children starting their school year learning virtually at home there was less of a need to shop for back to school access.

Number was the largest one so far this year in sales and earnings contribution September sales ramped up to 95% of prior year sales. That's the best performance, we've seen since the pandemic began to impact us in March.

Our labor day holiday sales were the strongest in the past three years with comparable retail sales up 15% during that shopping period and in October sales are trending over 90% of prior year sales.

With respect to product performance, we continue to see good demand for our baby apparel and sleep or product offerings, our baby apparel and sleepwear contribute about 70% of our total apparel sales we own five times the share of our nearest competitors in each of these product markets.

Our players sales improved in July is families procured for the beginning of a new school year sales jumped in August when it became clear that schools would not reopen and then rebounded in September as consumers shop for cooler weather outfitting.

We launched our little baby basics product offering in late June to coincide with the store Reopenings. This is the core of our baby product offerings and the best selling newborn apparel in the United States. It's a high margin replenishment program and one of our strongest performing launches in recent years replenishment trends.

Since the launch are much better than last year.

In the third quarter, our retail sales improved to 97% of third.

Third quarter sales last year, that's the strongest recovery in sales relative to our wholesale and international segments.

Understandably the pandemic has accelerated the shift to online purchases with fewer store visits we reduced our hours of store operations by over 20% in the quarter on a per hour basis, our store sales were better than last year.

Oh store traffic was lower we saw higher conversion rates and higher units purchased per transaction.

Believe those better metrics reflect the strength of our product offerings, our compelling value proposition and a high service level provided by our store associates.

Our stores that historically benefited from tourism, including international guests.

The largest decline in traffic.

These stores only represented about 11% of our U.S. stores, but drove about 40% of the decline in comparable sales in the quarter.

Until tourism and cross border travel resumed to free pandemic levels. These stores will likely underperformed our other stores.

Thankfully, what we saw in lower store performance in the quarter was largely offset by stronger growth in E. Commerce sales given the mix and level of E. Commerce inventories, we were less promotional than last year and as a result, we significantly improved price realization and ecommerce profitability in the quarter.

Yes.

Similar to our store experience online demand from international customers continues to trend lower than last year the big.

The biggest declines in demand were from Brazil, Argentina, and Europe. Historically these were three of our best sources of international demand on our U.S. websites. These markets were particularly hard hit by the pandemic and stronger dollar.

We continue to benefit from significant investments made in recent years in our online shopping experience our web sites, where we launched in the third quarter last year.

An improved the presentation of our product offerings ease of search and navigation in speed of checkout experience.

In the third quarter, our stores fulfilled 24% of our E Commerce orders Weve invested in technology that helps us optimize the profitability and speed of delivering those purchases.

To improve the convenience of shopping with US we now offer same day pickup in curbside pickup services in over 600 of our stores in the United States.

These new Omnichannel services are margin accretive relative to shipping from our distribution center to the consumers home.

Our omnichannel customers, those who enjoy both the online and in store experience, our highest value customers with annual spending more than twice that of our single channel customers.

Going forward, we expect our stores will play an important role supporting our ecommerce customers currently about 85% of our stores in the United States are located in an open air centers, which we believe gives us an advantage relative to our mall based competitors.

Open air centers provide a better more convenient experience for same day picked up and curbside pickup of online purchases.

We plan to continue opening stores located in more densely populated areas and plan to close close stores in more remote than declining centers. We currently plan to open less than 100 co branded stores over the next five years. We also plan to close about 25% of our stores as leases.

Spire.

Nearly 60% of those closures may occur by the end of next year, 80% of those closures are planned by the end of 2022. These are generally older lower margin stores and declining centres and less likely to support our focus on high value Omni channel customers.

Ours is an attractive tenant our brands are viewed as traffic drivers and bring families with young children into the shopping centers.

As other retailers struggle and downsize, new and more attractive real estate opportunities become available to us.

It's a buyer's market and we plan to pursue those better opportunities in better centers that provide convenience for our consumers and a high return on investment for our shareholders.

Our wholesale business also showed good progress recovering from store closures earlier this year.

Sales in the third quarter were about 86% of prior year sales the operating margin on those sales was better than last year.

In the third quarter, we had growth with three of our top five wholesale customers.

We continue to see good growth with our exclusive brands with sales collectively up 10%.

E Commerce demand for our brands through our wholesale customers was up over 40% in the third quarter, including triple digit growth rates with some of our exclusive brands the trend in online demand improved each month in the quarter.

Together with our wholesale customers the online purchases of our brands is up over 50% year to date.

Within the next few weeks, we expect to achieve a new milestone for our company with annual online purchases of our brands exceeding $1 billion. This year.

Our Carter's brand wholesale sales were down about 25% in the quarter driven by retailers cautiously planning for second half sales in our decision earlier this year to curtail fall in holiday inventory commitments Jerry.

Generally speaking most of our wholesale customers are lean on inventories seeing better sell throughs higher margins and then a chase mode given better than expected demand for our brands.

Given the pandemic related uncertainty in consumer demand, we believe operating with leaner inventories is a better strategy through the balance of this year, even if it comes at the expense of fewer sales.

Our decision to run leaner on inventories may impact second half wholesale sales by as much as $50 million or less than 3% of our total second half sales.

One benefit of running leaner on inventories. This year is fewer low margin sales to off price retailers, our sales to off price retailers were down 18% in the quarter and down over 50% year to date we.

We use our stores and websites in the United States and Canada to sell through excess inventories, which were caused by store closures and related wholesale order cancellations earlier this year.

As a result, we offer consumers a compelling value through our stores and websites and avoided losses losses that would have been incurred selling the excess inventory to off price retailers.

International sales in the quarter were about 90% of last year's sales and contributed over 13% of our total company sales, which is comparable to last year.

The strength of our international segment is in our direct to consumer business, which represented over two thirds of our international sales in the quarter.

We saw a high single digit growth in our retail sales driven by a nearly 70% increase in E Commerce sales in Canada and Mexico.

Many of our international wholesale relationships are with several smaller retailers representing or brands throughout the world.

As retailers have historically been a good source of sales and profitability they've been particularly hard hit by the pandemic stronger dollar and other local market challenges.

We currently expect that sales to these wholesale customers will be the slowest to recover from the global pandemic just for context. These customers contributed less than 2% of our company's annual sales in 2019.

We expect a better recovery with our multinational retailers, including Walmart Cosco and Amazon Amazon is seeing good performance from its expansion of our simple joys brand in Europe. This past year that should be a good source of growth for us in the years ahead.

With respect to our supply chain our team did an excellent job working with our suppliers to reduce our exposure to excess inventories inventories at the end of September were down over 10% compared to last year.

As we shared with you in July we're seeing delays in the receipt of products from Asia.

Leave those delays were caused by reduced capacity by carriers earlier this year when demand slowed due to store closures. The delays also reflect in adequate capacity to support the surge in demand when stores reopened this summer and the precautions being taken to keep manufacturing and transportation workers protected from that.

Currently virus.

Thankfully our wholesale customers are lean on inventories and in need of fresh product they've been very supportive and recognize that the delays are a function of the market disruption.

As we head into the holidays the flow of products has improved and we do not expect shipping delays to have a material impact on fourth quarter sales.

We're also managing the exposure to freight surcharges imposed by inbound and outbound carriers due to the surge in E commerce sales in constrained capacity.

Best analysis suggests the surcharges may impact fourth quarter earnings by about $2 million.

With lower input costs in excess manufacturing capacity in Asia, our supply chain team has negotiated negotiated lower product costs for spring Twentytwenty, one demand for that product offerings planned comparable to last year and the related shipments begin later this quarter.

In summary, we're making good progress recovering from the disruption caused by the pandemic we've been.

Weve endured a historically challenging market this past year with the unprecedented scope and duration of store closures record unemployment and a highly contagious and deadly virus.

Thankfully, we have 20000 Carter's employees, who have demonstrated an extraordinary resilience in commitment to helping their families in their company through this crisis. Their good work is reflected in the strong performance we reported this morning.

We expect the road ahead will be bumpy that said, we believe we have a strong product offering and good marketing plans as we head into the final weeks of the year.

No one knows how long the market disruption will last but we do know is that the fundamental strength of our brands and business model should help us continue to weather the storms.

We own the largest share of the young children's apparel market in the United States in Canada with twice this year of our nearest competitors children's apparel is it less discretionary purchase we focus on essential core products bought in multiple quantities on a frequent basis in those early years of a child's life are.

Average price points are less than $10, providing a great value to consumers in a weaker economic environment.

We are the largest largest supplier of children's apparel to the largest retailers in the United States we are.

We're also the largest young children's apparel specialty retailer with one of the strongest and most profitable ecommerce platforms in children's apparel wherever.

Wherever you are shopping for young children's apparel, you'll likely see a strong presentation of our brands.

I want to thank all of our employees were focused on delivering a strong finish to this year I'm grateful for their commitment to strengthen our brands and to serve the needs of families with young children.

Over the next few months, we will refresh our growth plans based on our experiences. This year based on our current estimates we are planning good growth in sales and earnings next year.

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

Thank you Mike Good morning, everyone I'll begin on page two with our GAAP income statement for the third quarter.

As Mike noted our third quarter results were meaningfully better than we had planned.

Net sales in the quarter were $865 million down 8% from last year.

Reported operating income was $114 million, an increase of 35% and reported EPS was $1.85 compared to $1.34 a year ago representing growth of 38%.

Our third quarter and year to date results for both 2020 and 2019 contained unusual items, which were detailed on page three.

Weve treated these items these non-GAAP adjustments to our reported results to enable greater comparability.

My remarks today will speak to our results on an adjusted basis, which excludes these unusual items.

Moving to page four and our adjusted piano for the third quarter.

Net sales declined 8% to $865 million, which is a meaningful improvement over the 30% decline we saw in the second quarter. We continued to see strong demand online with our U.S. ecommerce business, achieving a 17% comp and ecommerce comps in Canada up nearly 60%.

While gross profit dollars declined 5% due to lower sales gross margin rate improved by 180 basis points versus last year to 44.4%.

This represented record quarterly gross margin and was driven by improved price realization and continued progress in reducing excess inventory.

Royalty income was roughly comparable to last year at $9 million spending was very well managed during the quarter adjusted EPS DNA declined to $24 million or 8% across a broad range of expense categories.

Adjusted operating income grew 4% to $120 million and.

And adjusted operating margin expanded 160 basis points to 13.8% driven by our strong gross margin performance and management of spending.

Below the line, we had higher net interest expense than last year due to the $500 million in new senior notes, which we issued earlier this year.

We had other income of approximately $3 million in the quarter largely foreign currency gains.

And our effective tax rate was about 19% in the quarter up from about 18% last year.

Average share count declined 2% driven by share repurchases in 2019 recall that we suspended share repurchases earlier this year as part of our liquidity improvement initiatives.

So on the bottom line adjusted EPS grew 5% to $1.96 up from $1.87 last year.

Turning to page five with some balance sheet and cash flow highlights our balance sheet and liquidity remained very strong.

Total liquidity at the end of the third quarter was nearly $1.6 billion with over $800 million of cash on hand, and virtually all of the borrowing capacity under our $750 million credit facility available to us.

With all the uncertainty of the current environment, we believe that having substantial liquidity as we clearly do is a strategic advantage for carters.

As Mike said, we ended the quarter with inventories, 11% lower than a year ago, we believe.

We believe the quality of our inventory is high overall, we've made good progress in reducing excess inventory, although we're still working through some excess spring product, particularly in our stores.

We're currently planning that inventories at the end of the year to be roughly comparable with a year ago.

Our Q3 accounts receivable balance declined 10% compared to last year, which reflects lower wholesale sales.

Accounts payable.

Comps payable were $473 million at quarter end compared to $206 million a year ago. This increase reflects the successful extension of payment terms and rent deferrals, we can.

We continue to receive strong support from our from our vendors and landlords as we collectively manage through the disruptions caused by the pandemic.

Long term debt was $1 billion up from $770 million in the third quarter of last year, which reflects our successful senior notes financing transaction in may and lower revolver borrowings.

In the third quarter, we repaid $244 billion, which represented all of the outstanding borrowings under our credit facility.

When considering our meaningful cash position net debt at the end of the third quarter was $158 million compared to over $600 million at the end of Q3 last year.

Based on our current outlook, we believe we will have ample liquidity for the foreseeable future as our business continues to recover from the pandemic.

Despite year to date net income, which is lower than last year. Our operating cash flow was very strong at $320 million compared to $73 million last year. This increase reflects improved working capital, including lower inventory and the successful extension of vendor payment terms, which I've described.

Turning to page seven with a summary of our business segment results for the third quarter, while sales were down profitability in each of our business segments improved in the third quarter and our consolidated adjusted operating margin expanded by 160 basis points over last year.

Turning to page eight with third quarter results for our U.S. retail segment.

Total segment sales declined 3% compared to last year as Mike mentioned, we saw good demand over the fourth of July and Labor day holiday selling periods.

For the quarter total retail comparable sales declined to 3.5%, reflecting strong ecommerce growth of 17% and lower store sales.

Timber, which is the largest month of the year in our business had particularly strong performance with comparable store sales down only slightly versus last year.

So our traffic continued to be a challenge for us and the broader industry consumers are understandably cautious, especially as we see virus counts rising again in many areas of the country.

Store traffic in the third quarter exceeded the industry benchmark, which we follow.

While traffic was down we saw improved conversion and higher transaction values in our stores in the third quarter.

The adjusted operating margin of our retail segment improved by 50 basis points to 11.4% driven by improved price realization, especially online and our improved inventory position and good control of spending.

Turning to page nine consumers continue to take advantage of our omni channel capabilities and the third quarter.

We've worked to optimize our stores to make it convenient for customers to arrive and quickly pick up their online orders.

Many customers are also taking advantage of curbside pickup, which is a new capability for us.

Overall, the synergy and integration between our E Commerce business and our nation wide network of convenient and easy to shop stores continue to grow.

On page 10, all of our.

All of our recent marketing efforts continue to be highly integrated with our presence on social media and the third.

In the third quarter, we built on our leadership position.

By adding more followers on Instagram and Facebook than our largest peers in children's apparel combined.

On page 11, we had particularly high engagement in September with two specific promotional events.

With the pandemic many families weren't able to take their usual end of summer vacation around labor day.

Recognizing that we held the promotion to give away staycation packages to families. This promotion generated the highest ever social engagement for the Carter's brand.

We also held a special celebration of 125th birthday of the Oshkosh B'gosh brand, which included the release of special limited edition vintage overalls and sizes for the entire family.

This promotion proved very productive as we sold out of the kids sizes of these special overall within a few weeks.

Turning to page 12, another family tradition, which has gone virtual is the announcement that a new baby is on the way there.

During our baby Love event in September we gave away 10000 Carter's bodies its with the message 2021 looking right to celebrate the happy news and the new baby set to arrive in 2021.

Moving to page 13, since the pandemic began we've been providing families with ideas for activities, while they spend more time at home.

We recently initiated a twice a week email series for parents with toddlers and babies Lipton with new ideas and tips for fall.

These communications have continued to deepen our relationships with our customers and reinforced that no grant understands parent had better than Carter's.

On the next page it seems clear that we will all be living with the reality of social distancing for a while longer like so many other things the tradition of kids visiting Santa will be different this year.

Realizing this we've collaborated with the innovative and popular county, a platform in order to deliver personalized virtual messages from Santa to thousands of children for Christmas.

And the next several pages Weve included examples of some of our marketing for the holidays, maybe this year more than most families are looking forward to being together and celebrating the holidays.

On page 15, we've seen strong demand for our holiday products Halloween Thanksgiving and Christmas products are all exceeding expectations and last year's performance metrics.

On page 16, Carter's is known for our pajamas, especially Christmas Pj's with sizes for everyone in the family.

On page 17, we also have extensive offerings for special outfitting for dress applications for the holidays.

And this year on page 18, we have toys from skip hop and Carters and the majority of our stores, we will introduce special santas Tory shops for the holiday season.

Moving to page 19, with a recap of the U.S. wholesale results for the third quarter.

While net sales were lower than last year, our sales were meaningfully better than we had expected.

Upside to our forecast was due to several factors we saw some earlier demand for fall product from several retailers replenishment demand for little baby basics with strong and the impact of the delay in the arrival of product, which we mentioned on our last call was less severe than we had forecasted.

All of our wholesale customers are investing in and growing their online businesses, which has translated into strong demand for our brands.

Demand for our exclusive brands at target Wal Mart, and Amazon was strong in the third quarter with combined sales growing 10% over last year.

Our skip Hot brand grew nicely in the wholesale channel this quarter with consumer spending more time at homes get Pops home gear play time, and Bath time products have proven very popular.

As Mike said sales of the Carter's brand were down in the quarter in part due to the fact that in the early days of the pandemic, we proactively canceled a good amount of fall and winter inventory commitments and given that many customers have understandably chosen to run leaner on inventory in the current environment.

Shipments to the off price channel declined meaningfully in the third quarter as we're more effectively using our own retail channels to clear excess inventory.

Yes wholesale adjusted segment income was $67 million in the third quarter compared to $73 million a year ago adjusted.

Adjusted segment margin improved by 140 basis points to 22.3%, reflecting lower inventory related charges, which were partially offset by higher bad debt expense.

On page 20, we launch our core little Baby basics collection annually. This year. We did so in late June which is somewhat later than normal. These products are the everyday essentials that every parent of a newborn needs.

We're seeing very strong performance of little baby basics. This year, we sell the signature products and multiple channels, including at some of our largest wholesale accounts such as Kohl's and Macy's.

Performance in our own stores on Carter's Dot com and in our in our international business has also been strong.

Beginning on page 21, we have included a few slides that highlight our exclusive brands, which are available at target Wal Mart and Amazon.

Just one new brand continues to enjoy good momentum target has invested in several digital campaigns highlighting just when you. These campaigns have increased awareness of the brand among new and existing guests at target.

Sleepwear for infant and toddler as has been a particularly productive category with plans for continued momentum in the fourth quarter with Christmas for Janice and a broad assortment of settling dressing products.

On page 22, and a child of mine brand at Walmart in the third quarter E Commerce sales a child of mine more than doubled over last year.

Sure two investments in brand marketing has driven good productivity and momentum in child of mine, which we expect will continue into the holiday selling period.

Finally on page 23, our simple choice brand continues to resonate with consumers.

A strong partnership with Amazon and simple choice and simple choice has grown to be one of our largest brands. We participated in another successful Prime day recently, where we posted a significant increase in sales.

I apologize assortment has expanded over the past few years and now includes baby toddler and pajamas up to size AIDS as well as shoes and accessories.

Moving to page 24, and third quarter results for our International segment International net sales declined 10% to $114 million. This decrease was principally driven by lower wholesale shipments to markets outside of North America due in part to the stronger us dollar as well as the disruptions club caused by.

By a global pandemic.

Canada delivered a very good quarter overall with retail comparable sales growing 7% online.

Online demand continued to be strong with E commerce comps up 58%.

For comps in Canada were down a bit but the arrival of colder weather and good back to school demand helped boost to sales.

Net sales in our Mexico business were down year over year, reflecting a weaker peso and lower wholesale sales for me.

We're making good progress in the retail portion of the business in Mexico, our new larger co branded stores are performing well and ecommerce, which we launched late last year continues to post strong gross.

International adjusted operating margin expanded 270 basis points to 15.8% driven by strong performance in Canada that was partially offset by a.

And lower contribution from our partners business.

On page 25, we have included a photo of one of our newest stores in Mexico. The stores are six larger format co branded store initial consumer reaction has been very positive.

In Q3. This store has quickly become one of our best performing locations in Mexico.

On page 26, we have included pictures from the first three Standalone Carter's stores in Brazil, two in Sao Paulo, and one in Rio de Janeiro.

These stores are operated by Ria swallow our exclusive partner in Brazil has been.

As many of you know we've had a strong following by Brazilian consumers shopping with us in the United States over the years, so establishing a direct presence in this important market is a good step forward.

Early reaction from consumers to these new stores has been very positive.

Turning to page 27, with our outlook for the balance of the year.

As with last quarter and given the ongoing market disruption caused by the pandemic, we're not providing sales and earnings guidance today.

We expect the covenant team will continue to have a significant impact on our operations in the fourth quarter.

We are assuming a store traffic will continue to be lower than last year, and we're mindful of the risk of the resurgence of COVID-19 in key markets in North America.

We expect that online demand will continue to be strong in the fourth quarter and we're planning for continued gross margin expansion.

We're tracking several other risks over the balance of the fourth quarter, including the broader macroeconomic environment, including unemployment and consumer confidence has.

As well as developments related to possible additional economic stimulus.

And the upcoming elections.

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

Thank you.

I'd like to ask a question. Please signal I pressing star one on your telephone keypad.

If you are using a speakerphone. Please make sure your mute function is turned off to allow your signal to reach our equipment.

Can press star one to ask a question we will pause for just a moment to allow everyone an opportunity to signal.

Our first question is coming from Paul would you guys with Citigroup. Please go ahead.

Hey, Thanks, guys can you talk about what's happening at point of sale at the Big three retail as you are partnered with them on the wholesale business I'm just.

Just in terms of what's happening at Pos versus the rest of the business. The rest of the wholesale business and trying to get a sense of sell through versus sell in and what that might imply for wedding business might like stabilize and just if you could comment on that term lets say sales are the top three.

The ones that you're referencing has been brisk I think by and large.

By and large and many of our wholesale customers are lean on inventories in part because we earlier this year when the pandemic kit curtailed our.

Our inventory commitments for fall and holiday, we did not do that for the exclusive brands. We did do that in the core Carter's wholesale business, but with respect to target Walmart Amazon So sell throughs point of sale over the counter sales have been brisk.

And and we expect it will continue to be through the through the balance of the year.

And Mike did I hear you say that you're you're planning your spring demand to be flat versus last year is that [laughter] set at a company wide level, maybe if you could talk about how you're thinking about demand in retail versus wholesale wholesale for spring sure that's relative to spring 20, and that's the.

The cart Carter's brand were plant planting the Carter's brand.

Spring 21 comparable to spring 20 so.

So so it's there is some indication based on that demand that things may may stabilize time will tell I think a lot.

Depends on how we get through the holidays. We have two important months ahead of us and I think of some retailers I remember that our top to top meetings earlier. This year in January it was clear some retailers did not have the holiday performance that they had expected.

So they they they entered a they plan to holidays 20, more conservatively and that's that's a better place to be to be leaner on inventories at least what we're getting a signal for spring 21 that there might some be some stabilization.

And that perhaps they may have recognized they went a little too lean on spring 20. So we'll say the next two months are important for for many retailers just to see if they can get to continue to see good momentum in their online businesses I'm sure you follow shopper track, but shopper track trends for soft goods for apparel.

Down over 30% and sometimes closer to 40% store traffic has been tough ecommerce business has been very very good for us and for us and for our wholesale customers.

Like archery, lapping really big declines and spring of 20 to plan the business down just just wondering you know de risk not having enough inventory if things do bounce back yes, yeah that as a risk yep sure is in <unk>.

We decided early this year to run leaner on inventories I think its a much healthier model when your lean on inventories are seeing better sell throughs, you're seeing better price realization, you're seeing less product on the clearance rack at the back of the store at the end of the season. So at least near term with the uncertainty in the market, we're going to continue to run lean on him in.

Story.

Got it. Thank you good luck thanks Paul.

Thank you. Our next question comes from David Buckley with Bank of America. Please go ahead.

Hi, guys. Good morning, I wanted to ask about the better profitability across all channels and the improvements in gross margin and expense management looking to fourth quarter and into next year. How much of this do you view as sustainable, particularly as sales trends continue to recover.

I'd say, we're focused on improving the profitability of the business that we have David there's there's uncertainty around the level of consumer demand I think that uncertainty and the volatility on the topline make may continue to Mike's point into next year. So our focus has been improving profitability really throughout the piano also works extremely encouraged by the improvement in gross margin.

And I'd say the single biggest contributor to that improved gross margin is the fact that we are improving our price realization in our own retail operation most of Thats coming from E Commerce, which had become extremely promotional as a channel for us over the last few years. So we reverse that and it goes hand in hand with that leaner inventory position I think we've got the confidence of the.

Beauty of our products the quality of our brands to get paid a bit more for that and that's what we're seeing in the pan out. So we're certainly planning for continued progress on gross margin. We've also had a strong focus on on spending management and that did that discipline will continue as well.

That's great. Thanks, Richard just given the higher profitability can you guys also discuss how E. Commerce E. Com performed as Threeq you progress how it started fourth quarter and then what type of channel mix shifts are you anticipating for the fourth quarter there.

You come has done very well and its strong sales and profitability of higher price realization through two fewer promotions. So we feel really good about that business comps remained strong in Q2 and what stores started open up early in Q3, we continued to do well August was a little softer because really didn't have that back to school event.

But it rebounded strongly in September so.

Got to we've got good ecommerce business continues to be strong in the fourth quarter, and we're optimistic but optimistic going forward.

Thank you very much.

We will go next to Susan Anderson with B. Riley. Please go ahead.

Good morning, Thanks for taking my question and nice job managing the corner.

[laughter].

On the U.S. wholesale segment, it looks like and sales, but we're still fairly significantly down the department store channel I guess I'm curious how much of that is still due to weak demand there versus inventory constraints and are you expecting it to continue to improve sequentially and then just really quick on E commerce.

Think you said, 24% was shipped from stores, maybe if you could talk about that EBIT margin difference between shipping online ordering from the DC versus the stores. Thanks to the wholesale performances reflects more curtailment of inventories I'd rank that higher than conservative planning by the <unk>.

Our wholesale customers. They wish we had more inventory, but we we can fall and holiday inventories for our wholesale customers back some portion of 30% or more earlier. This year. We did what we did and then and then there was the margin differential on shipping from the stores versus the DCC it's better.

I don't think are going to parse it out in detail, but it's better all the way around its better from a customer experience point of view, we're seeing some capacity constraints in the small parcel channel. So consumers are able to get that product.

Our stores more rapidly it makes more effective use of the store based inventory. So we're pleased to see the adoption from from consumers and I think from an operational and execution front of you're getting better at it every day, it's a meaningful new capability. So the most expensive way to support the ecommerce customers shipping it from our distribution center to there.

To their home, we've got 850 beautiful stores from from Maine to Hawaii, and and were leveraging those stores to improve.

Improve the speed of delivery and the profitability of fulfilling those E commerce orders and it also makes us a better use of the inventory in those stores. So you can we have technology that can identify where there might be some extra inventory and that inventory is best used to support that ecommerce orders. So this a fairly new capability.

And are these what we refer to these omni channel capabilities leveraging the stores to provide a better experience for the E commerce customers those are margin accretive activities.

Great. That's very helpful. Thanks, So much good luck next quarter. Thank you Susan.

Thank you next we'll move to Ike Boruchow with Wells Fargo. Please go ahead.

Hey, good morning, everyone I want to focus on Ah Hey, Mike.

Just on the wholesale channel I think Mike you talked about like leading sales on the table.

Q4 weeks I totally understand with the inventory, but I think you talked about 60 million can you maybe give a little complex on the 50 million is that all off price is that all low margin revenue just would like to understand what that what that what that revenue actually looks like.

Hey, I guess, Brian just to add to this.

This has been a question we've heard a good amount of us I just want to clarify that to the Q3 shipments of our brands in the Carter's brand were meaningfully lower as the exclusive brands were higher.

The reason for that if you look back in March we had relationships with all of these retailers outside of the three exclusive brands most folks called US and said, we don't need to summer product, we're going to cancel orders we had a decision to make at that time. So we then proactively canceled about 30% of the fall orders that they had given us and so that is across the board.

Ah yes. So the relationships are very good our wholesale partners are very pleased with our product performance product selling really well the challenges. They don't have enough of it and that is a proactive step that we took that caused that because we had a lot of uncertainty going forward. So we did have lower off price sales because we've been managing the inventory better and we're moving that product through our own retail stores.

But as far as the rest of the wholesale customers. The main issue really is they don't have as much of our inventory as they would like because we proactively took steps to reduce it given the unknowns for fall winter that part of the business I think that's a that's a high margin.

Component of our business the core Carter's wholesale business is a very good margin business for us and we intentionally decided to reduce the risk of having too much inventory in the second half of the year. We're encouraged by that's an opportunity for next year. So it's a much better place to be when you're seeing very good sell throughs everybody's lean on inventory they wish.

He had ordered more and we'll have an opportunity to order more for the second half of next year now.

Well I guess, just the just to wrap that up I mean, I guess my my question is I know, you're not giving guidance on wholesale but $50 million is about 15% of revenue should your wholesale business in Q4 look kind of similar to what it did in Q3 are down 15%, but with better margins. The country just trying to understand how your bookings.

And how we should be expecting your wholesale business too so look in Q4.

Yeah, I don't think we want to be precise around segment guidance for it for the quarter I I think the complexity of what's driving the businesses is what Mike and Brian have described we have great momentum and exclusive brands. We expect that that will continue we'll see good demand from those retailers.

I think the carters.

Carter's brand will be down for the reasons that have been described that we cut back on inventory, which from a risk mitigation point of view.

In the early days of the pandemic was absolutely the right strategy and I'd say those retailers are also hungry for inventory as well they are they're coming to us and asking for additional product in some cases, we're able to support it and as I said in my remarks, the replenishment demand for little Baby basics. Currently is really strong in the wholesale channel and those are some of the folks who buy the core mothership Carter's brand.

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Thank you Sir.

Sure.

Thank you. Our next question is coming from Jim Chartier with Monness Crespi Hardt. Please go ahead.

Hi, Thanks for taking my questions like I, just want to kind of follow up on the comment about flat spring 2021 or is that just for the Carter's brand at wholesale or is that for overall carter's, including retail prescribing car Carter's the flagship Carter's brand wholesale.

Okay, and so is it reasonable to assume that the.

Exclusive brands are planned up given the momentum that you've seen in that business.

Their their order cycles, a bit different what we will share more of that with you in February Okay. And then we're expecting continued growth good growth with the exclusive brands.

It does.

I guess.

How does bring flow or ship between first and second quarter and is sub.

Suburb 2021, looking flattish as well or is that.

I expect it to be better than that yeah, we'll share more of that with you in February but some of the summer spring does start to go in December this year, that's just the normal cycle, they like to get some fresh product on the floor going.

Going.

During the holidays and that going into January so some of that some of the spring does go in the fourth quarter.

Okay and.

And then the $50 billion wholesale impact is more pronounced in third quarter than fourth quarter or is it more pronounced in fourth quarter.

Well I think football is the bigger season than a holiday. So I would say more pronounced in the in the third quarter. Okay. And then lastly on your plate Ware.

Seems like back to school, you know a big impact on on Playwear and third quarter should that business improving in fourth quarter. Just because you don't have I'm sure you're less dependent on back to school to drive that business. So it's back to school is behind us.

So we.

We saw that dip in August that was the worst of it and then in September.

People realize kids weren't going back to school, they shift into other product categories and.

And ER and we have the benefit for the first time in three years, we got the benefit of a cooler weather rolling through and that is always a stimulus in our business anytime wet weather turns from warm to cool and then in the spring tool to warm and said that's a reason to get out and shop. So we saw that in a meaningful way in September.

Great and then on the store closures.

Are those store closures EBITDA accretive the business overall.

Are there I'd say there are low margin stores I'd say low single digit operating margin, we're opening up stores with operating margins closer to 20 and closing a low single digit operating margin. It's just that because there are you know in years past, we say you know as long as it's a cash flow breakeven or better.

Breakeven or better why close them, but you got to look at where the arrows pointing and the consumer loves these co branded stores.

Formats of the Standalone Carter's and Oshkosh stores, we made a decision a year or so ago too to exit those those stores why parents weren't were closing the stores because a better center has opened up in an adjacent market. So we're often asked why are we opening stores. When people are closing stores, we open up stores, because we make a lot of money in those new stores and.

Consumers Love Love Love scene in our stores, it's a beautiful brand experience. So we'll open stores closer to the consumer co branded stores and better centers with better margins and we're going to close when leases either come up for renewal or there was a kick out a provision that gives us an opportunity to make a decision as to where.

We're not we're going to reinvest in that in that center or exit it and we're more inclined in light of everything we're going through we're more inclined to exit some portion of two or more stores.

What percent of those will happen over the next couple of years. So our focus is.

Our focus is fewer better more profitable stores located closer to the consumer that have a higher likelihood of.

Serving that was omni channel consumers, those who love to shop online and swing by the store and pick up the product.

Great. Thanks Best of luck in holiday. Thanks.

Thanks, very much Jim.

Thank you next we'll news kitschy. So yes. Please go ahead.

Great. Thanks, so much Mike would it be possible to elaborate on why you're saying October was up over 90% of prior year sales. When September was it 95, and maybe that is there something going on there that can explain the trend chart. It's a it's a it's an experience we've had over the years anytime you see a surge in demand like we did.

In September with the cool weather Theres, a wall and so you know when when weather like here in Atlanta returned to like 80, 85 degrees, you're not you're not thinking so much about long sleeve long bottom outfitting. So it's a it's a it's a normal type of experience that when you see a surge like we did in September.

Well all immediately after that but we feel good about the fourth quarter I think we have a handle on the floor for fourth quarter.

Yeah, maybe can you just describe first what's the normal contribution of October to Fourq, two like on a percentage basis and how much. How important is November December I I'd say September September is the largest in terms of sales and earnings contribution October would be smaller than that I think November and December combined are more important than October 1st for sure.

Given the holidays.

Got it and then maybe is it possible just with sell through at wholesale being good inventories being lead you know is it is can you put some scenarios if possible maybe there could be a pull forward of inventory in the channel in November and December would retailers want you to do that could you do that so maybe just to frame some of the range of scenarios for that possibility I would actually say we have seen.

Our customer, saying, Hey, if we got it bring it and bring it and we're happy to take and that's that's true. This year, it's been true for years and depending on the sell through if we have the product we're happy to ship it to them earlier and well My guess is we'll see some of that this year.

Great and then just one last one for me if I give you talked about less sales to off price. This year is that like a strategy that you continue to want to de emphasize that channel or is that something where next year, you could see wanting to retail and replenish that channel as well as the rest of the retail partners.

It's one of the it's one of the.

Learnings we've had this year that we can better leverage our stores are beautiful stores throughout the country, including Canada, Canada was a huge help to us even through some of the excess.

It was created when stores closed for several weeks. So no. There's no. There's no plan Hey, let's go back and so a lot of little marks and stuff to the off price retailers mixture that is now we like the strategy that we put in place and in 20, and we hope that continues in the years ahead.

Understood. Thanks, so much thank you.

Thank you Jay.

[noise]. Our next question comes from Steve Marotta with CL King and Associates. Please go ahead.

Good morning, Mike and Richard adjusted third quarter as gene a as a percent to sales was roughly even with last year, which is pretty remarkable given the sales decline as well as a massive shift in distribution channel mix towards E Commerce and digital is there anything in the quarter from a discretion.

Entering standpoint that was withheld and I guess the underlying question is given seasonality. Aside can we think about this is a bit of a run rate from and this unique standpoint, and then I have one quick follow up.

Sure Steve I would say there are a lot of things at work in SDN and the third quarter, we had favorability across virtually every line item within within the spending accounts we were.

We were favorable on the selling expenses that you might expect to be favorable just given where the top line wise. So stores expenses were lower we pulled back on marketing I think our marketing team has done a great job kind of more real time reading the mood in the sentiment of the consumer if they're not out listening and not in a mood to shop weve been able to kind of pull back on marketing and we did that in the <unk>.

Corridor distribution expenses were lower where we saw some higher expenses would make sense to I think relative to ecommerce fulfillment costs were up that tracks to the 17 comp that we did and then I'd say across most of the DNA accounts most of that the administrative areas. We saw favorability as well we had asked the organization to curtail spending just given that business.

Got a little choppy in the middle of the quarter. So the teams that have done a fine job pulling back on spending where they cut we also have favorability at the moment as it relates to our various performance based compensation provisions just given how the years unfold at those are much lower than they were a year ago I wouldn't expect that run rate to be the same in the fourth quarter mainly.

Because we've chosen to lean into some investment spending first and foremost because we have the ability to do so we're not concerned about liquidity.

I think we've been effective over the years, where we could lean forward and make some investments, which we think will yield long term benefit that's what we're spending on if you. If you strip that out I'd say the run rate on spending is probably in the neighborhood of what we were down in Q3, but if you layer in these additional investments.

The comparability year over year, I won't be quite as favorable and they are across a few different areas. We've chosen to continue to invest in the website we're gonna.

We're going to relaunch, our mobile app, which I've given the rise of prominence and usage of mobile devices for E. Commerce shopping we've been kind of overdue to do that so I think that's a great long term investment we've chosen to make some investments in our primary distribution center in terms of the speed and efficiency of our E commerce deliveries.

We are going to invest more in marketing and in the fourth quarter. So as we've been able to pull back on some of the brand at rest of promotions were putting that back into brand marketing, which has proven very effective for us.

I'd say importantly, we've chosen to restore some of the compensation provisions that work at a curtailed earlier in the year in response. The initial response to the pandemic. We have we have restored wages and such across the organization, which we think is appropriate given given the business that we're driving and given given the outstanding performance of our employees.

That's very helpful. So what I heard was it's not wouldn't be a big surprise to have best Genie de leverage in the fourth quarter.

Correct.

Okay and Oh My one quick follow up is as it relates to royalty income it was down significantly in the second quarter on a year over year basis relatively flattish in the third quarter can you talk about that differential and how would you think about the line item going forward.

Yeah, I think we are here to your point year to date, it's down much more considerably than it was in ER in third quarter. I think we started to anniversary now some of the structural changes our strategic changes that we've made and some of those relationships. So that genuine kids agreement that we had with the target for a number of years that was a significant source of the of the decline.

In the earlier quarters that that starts to normalize a bit and then some of the categories that we had in source. So that's now sales and margin for us relative to royalty income I think we're starting to overlap some some of that as well I think there have been some market disruptions for a number of our license partners, where they've had difficulty getting their product out of out of China.

And Asia. They are subject to some of the same kind of transportation and delivery issues that we've seen with our apparel products and then just the disruption in the wholesale channel when they sell those products to their wholesale customers. We are in a royalty hopefully as the market starts to recover.

Roughly stream to us will continue to improve.

That's very helpful. I appreciate it thank you sure.

Our next question is coming from a worn Chen with Evercore ISI. Please go ahead.

Hey, good morning.

I just wanted to ask a question on the strong digital growth, you're seeing both owned and partner.

The customer data to see how much of that is channel shift because sales that used to play through your own stores your partner stores.

Sure that is new customers coming out of the brand.

Are you referencing online growth weren't.

Yes, I'm referencing the online growth both your own E Commerce, and you mentioned some.

Some some really good numbers out of your partner, who your partner E. Commerce stores are you're probably E commerce business.

Absolutely exclusives, yes, yes, so I think it's just I think its a.

A shift of the consumer from from stores to online, particularly during the pandemic I think people are more comfortable shopping at home or they're going to ever. If you follow shopper track, we do and its traffic to the stores has been down and thankfully the people who are coming into our stores are coming to buy.

Hi, not coming to shop, the units per transaction or the average transaction value is higher and so but more and more people are shopping online bill.

Online because of the convenience.

And because of the speak for our own.

Kind of ecommerce capability capabilities, the beauty of the product presentation, the ease of navigation and search capabilities. These of checkout Richard.

I've commented on the re launch of our App, which will happen in the in the fourth quarter. So I just think that is a it's going to be with us for a while that's where that's where consumers are shopping and they enjoy the convenience of shopping that it is interesting to me in the kids apparel market.

Still about some portion of 70% of children's apparel is bought in stores.

I think it's just the nature of young children's apparel, you want to go in and you find out you're expecting a child you want to go in with your family and enjoy that experience of shopping for that first world crude beautiful new baby in the store.

My guess is our ecommerce penetration I think it was close to 40% in the third quarter. My guess is it'll be probably close to 40% for the fourth quarter.

That's about 10 points higher than it was a year ago.

We moved through 21, so hopefully there's a vaccine the fears related to the virus.

Subsides, and Ah well start to see a store traffic and prove prove again, but we're very fortunate that we have I would say one of the most successful and certainly one of the most profitable E commerce platforms in kids apparel and that that will help us among other things to weather the storm until it settles down.

Got it thanks, and then my follow up is just on.

Just on the exclusive programs what is the price and volume trends, what does the price and volume trends stand for that side of the business and is there an opportunity to add mode. Brett This off range yes.

Cost categories or ER scripts.

Well I think in terms of breadth, we have added to the <unk>.

To the exclusive brands, we've got more I line product for those accounts and we've expanded I think we said earlier, we've expanded in the toddler for target Wal Mart and Amazon are those businesses are doing really well and then we're looking at bigger sizes, starting with sleep or so.

There has been a.

The increase in the skew base for what we saw those accounts as that business has grown and deserves a broader array of our products.

Thank you.

Welcome.

Thank you.

That will conclude today's question and answer session Mr. Keith at this time I will turn the conference back to you for any final remarks. Thanks very much. Thank you all for joining us on the call. This morning.

I appreciate your support this past year from all of US here at Carter's we wish you and your families.

A happy and healthy holiday season, together, we look forward updating you again on our progress in February Goodbye everybody.

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

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