Carter's Inc (CRI) 2004 Q2 法說會逐字稿

Ladies and gentlemen, please stand by. We are about to begin. Good day, everyone, and welcome to the Carter's second-quarter 2004 earnings conference call. On the call today are Fred Rowan, Chief Executive Officer, and Mike Casey, Chief Financial Officer. After today's prepared remarks, we will take questions as time allows. If you have any follow-up questions after today's call, please direct them to Eric Martin, Director of Investor Relations. Mr. Martin's direct telephone number is 404-745-2889. (Operator Instructions).

Carter's issued its second-quarter earnings release yesterday after the market close. The text of the release appears at Carter's website at www.Carter's -- under the Press Release section.

Before we begin, let me remind you that statements made on this conference call and in the Company's press release other than those concerning historical information could be considered forward-looking statements, and actual results may differ materially. For a detailed discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the cautionary language section of the Carter's second-quarter earnings release.

And now, I would like to turn the call over to Mr. Fred Rowan.

Good morning. We are pleased to have each one of you on our conference. Consistent with previous calls, I will begin with an overview of our second quarter and our feelings about the remainder of 2004. Mike Casey will follow with the financial results.

We had a terrific quarter, both top and bottom line, despite a bit tougher climate. We're also confident with our projections, which support a good second half. We remain steadfast in our beliefs that our intense focus on our five growth initiatives not only yielded excellent second-quarter results, but will provide continued momentum through '04 and beyond.

Our growth initiatives are as follows. Dominate the young children's, babies', sleepwear, playwear and licensed product categories by being the absolute product leader. Take the leadership position in the playwear category under the Carter's brand. Build power brands at Target and Wal-Mart. Increase our retail store productivity and expand the reach of the Carter's franchise. And make our supply chain a competitive weapon, the first initiative being product.

The way we measure results is as follows. Did the previous season, spring '04, sell well at the retailer shelves, and better than spring '03? The answer is yes. Is the current season, fall '04, off to a good start at the shelf and at higher rates than fall '03? That's also yes. Is the upcoming season, spring '05, being perceived by the customer to be better than spring '04, and do the forward bookings support that notion? The answer to that is also yes. Mike will cover the numbers to support that, but it's very encouraging.

We've also in turned the corner in sleepwear, which was a bit sluggish in 2003. The turnaround is attributed to better product and better costs. That is a result of an elevation of our merchandising skills and moving offshore. We have better fabrics, art and color and improved silhouettes. We're also improving our margins. In fact, previously stated, the addition of Robin Rice as our Chief Merchant about a year ago has materially improved our product performance and the product development process.

The second initiative is playwear. We have made significant progress and have become very competitive. That's because we're marketing high-value everyday essential core products versus high-fashion collections. This provides the consumer with the same formula they enjoy from Carter's baby and sleepwear categories -- great product and great quality.

It's also much easier for us to forecast accurately and deliver at very high percentages of one-time merchandise. It does not require as much inventory and there is considerably less distressed goods with this formula. There is less reason for markdowns and allowances. It is a more profitable business for our customers and is more profitable for us. We are witnessing significant market share gains.

Thirdly is the building of these discount brands. We do not report some things about these retailers for competitive reasons. However, both are performing at very high levels. Our strategy is to build each brand to a lifestyle agenda; that means expanding into baby, sleepwear, playwear and licensed products and presenting the brands aspirationally at the floor. We then service at extraordinary levels. We have exceeded both these retailers' expectations. We have a major presence in baby, we're building a major presence in sleepwear and in the process of launching newborn and infant playwear. And we have excellent representation of licensed products.

Baby and sleepwear still have significant opportunity with productivity gains on the brand walls and additional core products. I did mention at our last call we will introduce the Just One Year brand name to replace Tykes' name at Target. The reasons for that are twofold -- Newell Rubbermaid owns some rights to some Tykes categories whereby we pay a royalty rate, and Just One Year is a much better consumer brand name. Target loves it and our consumer research support that. We launched the name and the product in December for an all-store rollout during January. Inventory risks are small and Target is funding the marketing story.

Fourthly, our retail stores. We are pleased with much of our progress, but we expected to do a bit better in June. Traffic did decline some. In retrospect, it appears cooler weather in two regions plus the shift to the July 4 vacation period from the last week of June to the week of July 5 was significant. July business is strong, well ahead of plan. I hear most retailers are enjoying increased traffic as well most recently.

Despite June, we see good things developing. Our products are clearly better, the fall products are off to an excellent beginning and our product service levels to our stores are very high.

We reported at our last call we had successfully tested new concepts applicable to all of our stores. One, we upgraded window formats with high emotional content; we moved the baby category from the back of the store to the front; we made it easier to shop; and we've introduced stronger, better brand signage. The results are very, very encouraging. It's a clear winner. We have converted 40 stores. We will have 100 converted by the end of November, and probably we will complete another 50 in the first quarter.

Lastly, our supply chain. The thinking here is to make our supply chain a competitive weapon and to improve profitability. The architecture is intended to come to accomplish several things -- one, vastly improved product benefits; also, to get innovations to the market faster and more accurately forecast the plans as to elevate service levels. While doing those things, we lowered product costs, maintaining gross margin quality. We increased our inventory turns and we reduced the cost of capital.

The methodology for this is to remove product complexity, improve the product development calendar, increase the percentage of full package sourcing, increase our forecasting and planning skills, lower the cost of distribution and transportation, and leverage our unit growth with our sourcing partners. We then increase our competitiveness by taking a high percentage of these savings and reinvesting in our brand and product to drive revenue and market share gains.

We have done remarkable things moving offshore with little disruptions. There is a great deal of opportunity, however, to substantially reduce costs and improve product value. We can do that by reducing more complexity from our lines, particularly in playwear. We can by shrinking the product development cycle, increasing the percentage of full package sourcing, taking advantage of some developing countries for sourcing, reduce sleepwear costs via the full package sourcing, improve our forecasting skills that are just beginning to contribute, and that will be material to our future.

We can also materially lower distribution transformation costs with some new concepts that we're testing. We can leverage our growth more with the sourcing partner -- we are a sourcing partner's dream, with continuity and high unit volume growth.

We're adding a sixth initiative, and that is to elevate the power of Carter's brand. We're in the process of studying ways of elevating brand imagery, and customer and Company profitability. I cannot speak to the guts of this study for competitive reasons. I can say, however, we have learned enough to know we have the potential to have a much better formula.

We have been working with a branding research firm for months. This plan will have both short-term and longer-term objectives. We can offer brand and product and store enhancements beginning in '05.

Concluding my remarks, I would like to comment on why we feel we can continue to deliver high returns to our shareholders. We have the best brand in the business. To the consumer, we are the real deal, and we are a must-have brand to our customer base. We have multiple organic growth platforms driving revenue and profits. We have a six-cylinder engine, but we don't have to have an A rating on all these cylinders. Our internal plans are not build that way.

We have large and growing markets. We are supported by strong demographics. We dominate our categories, and they are essential to the consumer, which means we fare well in economic downturns. We only focus on shorts. This is also not a back-to-school-dependent brand. We are everyday needs. We are a lifestyle brand at very popular pricing, and this Company is supertalented.

With that, I will turn the call over to Mike Casey.

Good morning, everyone. I would like to comment on our second-quarter results and then I will also update you on our outlook for the third quarter and the year. We're reporting solid growth in the quarter, with revenues up 12%, and net income more than doubled in the second quarter. We're reporting revenue growth in each of our business segments -- that's wholesale, retail and the mass channel. We also achieved growth in all our major product categories -- baby, sleepwear and playwear. We've increased our gross and net operating margins and we've improved our cash flow from operations.

Second-quarter revenue growth was driven by our Carter's brand wholesale business. It was up 17%, excluding off-price sales. Our sleepwear business was the largest contributor to this growth, with revenues up over 30% in the quarter. I think as you know, we've been improving our sleepwear performance. It's been a major focus of ours, and we have significantly improved our merchandising and sourcing capabilities. And we feel as though we've regained our product leadership position in this category.

Our fall sleepwear shipments are expected to be up approximately 15%. Our spring 2005 sleepwear shipments, which begin in November, are projected to be up over 10%. Our Carter's playwear revenues were up approximately 6% in the quarter. Fall playwear shipments are projected to be up approximately 10%. We've had a very positive reaction to our spring 2005 playwear line. We project spring 2005 playwear shipments to be up approximately 15%.

Our baby product category under the Carter's brand was up approximately 14% in the second quarter, driven by strong demand for our new Carter's Classics programs, and replenishment trends have been in line with our expectations.

With respect to our retail stores, revenues in the quarter grew 6%, driven by new door growth. Since the second quarter of 2003, we have opened 15 stores, nine in strip centers and six in outlet centers. We currently have 174 stores.

Comps were flat in the quarter. That was a bit lower than what we had expected. Comps are currently up approximately 2.6% year-to-date and we're projecting comps up 2% for the year. We've significantly improved the product offering in our stores. Our service level to the stores in terms of on-time deliveries and replenishment has been excellent. I would say we have a stronger product offering as we head into the second half of the year.

In the second quarter, our transaction counts in our stores were up over 4%. Units per transaction were up about 2% and our average prices were down about 5%. I would say lower average prices are a reflection of our focus on driving core products, like bodysuits, bibs, and washcloths, which generally have lower price points.

Our focus on core is also relevant to our playwear line, where we have reduced the higher-priced, and I would say higher-risked, fashion playwear sets, and we're driving more core basics in playwear. Average prices also reflect higher markdowns to stimulate sales and clear prior-season goods sooner.

We're segmenting our stores into five categories. Three of the five segments reported positive comps in the quarter. The strip stores performed the best, with comps up over 10%. Comps for our mill stores -- these are outlet stores in indoor malls -- were up 6% in the quarter. Comps for our trade area outlet stores -- these are stores that are in densely populated areas, like Princeton, New Jersey -- those stores comped up 2%. And then, comps for our drive-to outlet stores -- those are the traditional outlet stores that are 20 to 30 minutes outside of densely populated areas -- and stores in tourist locations were each down about 2.5%.

Fred commented on the stores we've converted to a new store format with our baby product category in the front of the store. We've also significantly upgraded our window displays and in-store marketing. We began the store conversion in April, have about 41 stores converted to date. 100 stores in total will be converted by the end of November, and we're very encouraged by the results.

Where we've had traffic, the results have been meaningfully better. For example, in our strip stores, for those stores converted to the new format, we're reporting comps up 17%. And mill stores are comping up about 15%. Trade area outlets are comping up about 2%. And then the tourist and drive-to outlet stores converted to the new format are each down -- comping down less than 1%.

We'll open eight to 10 stores this year. Five or more of those will be in strip center locations. And we plan to close four stores when the leases expire at the end of the year.

With respect to our mass channel business, revenues grew 28% in the second quarter. We achieved double-digit revenue growth from the Tykes brand with an expanded program in infant playwear. We're on track to launch the new Joy line with Target in December. That line will include an expanded offering of baby sleepwear and hanging layette.

The second quarter includes a full three months of shipping of our Child of Mine brand at Wal-Mart. We launched that brand in June of last year. We're currently updating the brand wall with new products at Wal-Mart, and we've also expanded the baby apparel offering on the brand wall based on higher productivity of those products relative to licensed products.

We've also expanded our product offering at Wal-Mart with more space devoted to baby sleepwear and hanging layette, and we're launching newborn playwear in spring 2005. So, I would say we're on track to achieve our growth plans this year with the mass channel.

With respect to our profit margins, our gross margins improved 250 basis points in the second quarter to 38.1%. There are two major components of the 250-point margin gain. 150 points came from more favorable experience on cost reduction. The other 100 points came from correcting certain inventory adjustments, which contributed $0.03 per share to earnings in the second quarter.

Our internal audit group has been analyzing and documenting controls in all key financial areas in the Company. As part of their review, they noted certain adjustments made in 2003 which understated inventory and overstated cost of sales. After a thorough review, we determined those adjustments to be incorrect. The adjustments were not material to our 2003 results. The adjustments reduced earnings per share in 2003 by $0.04. We reported pro forma earnings of $1.22 per share in 2003. Excluding these adjustments, we would have reported $1.26 per share. That's a difference of 3%. Though not material, we thought the correction was noteworthy and wanted you to know the impact of the adjustments on our second-quarter results.

We expect gross margins for the year will be approximately 36% -- that's a bit lower than last year -- due to channel mix. We believe there continues to be significant opportunity for cost reduction, most of which we'll reinvest in the product to continue to drive double-digit revenue growth.

Operating margins in the second quarter increased 190 basis points to 9%. We expect operating margins for the year will be approximately 12%. That's up about 70% on a pro forma basis.

SG&A was up 80 basis points to 30.7% of sales. The increase relates primarily to co-op advertising. We project SG&A for the year to be approximately 25.5% of sales. That's an improvement of about 100 basis points.

Royalties from our licensing business grew 32% in the second quarter. The growth was driven by a full quarter of Child of Mine royalties. We expect royalty income for the year to grow approximately 10%.

In terms of liquidity, our cash used for operating activities in the first half was $5.4 million. That's an improvement of 17 million compared to 2003. The improvement is driven by an increase in earnings and favorable changes in working capital.

Inventories at the end of the second quarter were 148 million. That's up 12% compared to June 2003. We have built safety stock levels to ensure a very high service level to our customers. I'd say the growth is in line with our revenue opportunities in the third quarter.

Our forward lease of supply and our inventory turns have both improved since last year. With respect to debt reduction, we reduced debt approximately $8 million or 4% year-to-date. We've reduced debt 30% since June of '03, with the proceeds from the IPO and other accelerated payments.

CapEx for the first half was approximately 11 million. That includes investments to complete the leasehold improvements at our new distribution center in Stockbridge, Georgia. We expect CapEx for the year to be approximately $25 million, including 9 million for the new distribution center.

In terms of guidance, third-quarter revenues are projected to be up approximately 10%. Our current view is 234 million in consolidated revenues for the third quarter. Third-quarter diluted earnings per share is projected to the $0.57 on 29.9 million shares. That's growth of approximately 19% compared to pro forma earnings of $0.48 a share in the third quarter of 2003.

The third quarter is our largest quarter of the year, given the seasonality of our business. It contributes approximately 30% of our annual revenue and approximately 36% of our annual earnings.

For the year, our current plans continue to support 10% topline growth, and diluted earnings per share is projected to be $1.56 to $1.58. That would be up 28 to 30% over last year. The increase in earnings guidance is based on our year-to-date results.

That concludes the business overview. We'll open the call to your questions.

(Operator Instructions). Dennis Rosenberg, Credit Suisse First Boston.

Congratulations. Could you talk a little bit about your sales for the off-price channel? What has it been historically and how much is it down now? And what is your strategy relating to selling to that channel?

Sure. Generally speaking, this year will be lower -- at least that's our current projection. Last year, if you recall, the first half of last year I think a number of our key accounts got backed up with inventory. The market was certainly not as robust as people had planned it in the first half of 2003. So, our customers got backed up with inventory. That impacted what we had otherwise projected we would sell to them at full prices.

As a result, we had a higher level of off-price sales. And we defined off-price as anything we sell at 25% or more off the normal selling prices. And our strategy is to move that excess as quickly as we can. The first thing we do with excess is offer it to our key accounts. If they pass on it, we turn to our retail stores. If that's more than we want to flow through our retail stores, we move it to the off-price channel, like T.J. Maxx, Marshall's and Ross stores.

So, generally speaking, we are having much more favorable experience this year, relative to last year, in terms of excess. I'd say it's largely driven by a better market. It's also driven by our focus on core product. That was the primary reason why we shifted to core product -- to increase forecast accuracy and improve our service level. So, generally, our experience has been better.

Specifically in the second quarter, our off-price sales are down about 30%. So, our -- that's part of what we call our total Carter's brand wholesale business, which in total, including off-price sales, is up 12%. Excluding off-price sales, our Carter's brand wholesale business is up about 17%, and for the year, right now, we're projecting our off-price sales will likely be down about 26% over last year. And that's a good thing. That's just a fundamental sign that the market is better for us and that we're managing our exposure to excess better than we did last year.

Margaret Whitfield, Ryan Beck.

A couple of questions. It sounds like there are still a lot of opportunities regarding the supply chain. And I wondered if you talk longer-term about whether or not those opportunities might offset the mix impact upon your gross margins and where ultimately you think you could get to. Also wondered if you could give us your assessment of the competitive environment within your three distinct channels, and if you had any backlog figures or numbers to support your notion, which I would agree with, that the spring '05 playwear offerings look significantly improved?

Sure. Well, I'll tell you what, let me just address your question in terms of the supply chain opportunities. There's no question that as we complete the transition to what we refer to as full package sourcing, there's opportunities for, one, significantly better product, and two, a better experience on the cost side.

We're building capabilities in Asia, particularly for our sleepwear business. We're focused on having fewer and better suppliers. I think you know that we are relatively new to full package. We started that transition at the tail end of 1999, and we have become a major player in Asia, working with Li & Fung and other agents.

We expect that we'll complete that transition in sleepwear over the next year or so, because we're still producing some of our sleepwear in the Western Hemisphere. And the other key thing is we're leveraging our buying power. Fred mentioned it. We are a manufacturer's dream in terms of having that predictable flow of product. We're now sourcing bodysuits for three different brands. Our unit volume in our core product has gone up significantly, and that's given us significant buying power with our suppliers.

Yes, I will answer the second question about the competitive environment. But first, let me answer the playwear. Our spring playwear '05 orders are all in. And we're up, as Mike mentioned, 17%. And that's to start ship in the fourth quarter. So, in our history, we have a long history of low cancellation rates. Even more importantly is our fall '04 playwear selling well. So, that's an indicator that we're on the right track.

As far as the competitive environment goes, I think it's important to remember first that all retailers want fewer brands and they want to give those brands a bigger share of the market, because they can't afford to be unfocused and there are a lot of brands that are unimportant. And they need brand -- branded companies also have resources, can do the kinds of things that are required for consumer -- fixturing, great presentation and very powerful supply chains.

All brands -- all these retailers have private-label business. So, every channel and every retailer within a channel has private labeling. It varies some within a given channel. Most department stores -- Kohl's, for example -- about 25% of their mix is private-label. Penney's is 45. Department stores are probably in the 35, 40%. But they will all tell you they need the national brands, because the great national brands bring heavy consumer traffic.

Now, the competitive nature varies considerably within a -- from channel to channel, and it varies considerably -- our competitors vary considerably by category. If you take department stores in the baby and sleepwear business and our baby business, we are very dominant. Little Me would be a typical competitor in the baby business. Disney competes in all channels and across all stores within a channel. In the playwear business in the department stores, OshKosh would be a big competitor, whereas if you went to Wal-Mart, Garan would be a playwear competitor there.

If you took Target, it's -- they've been more private-label-driven, but they've seen the need for having a strong national young children's brand. That's why we got their -- they have private-label Circa and Cherokee. Gerber competes in the discount channel in the baby business.

But generally speaking, that's the mix. Now, I don't know if that's your question of understanding the competition within the channel or how the competition is doing within the channel.

How is the competition doing was more what I had in mind in terms of if you see any competitors fading or strengthening?

What we see across all channels is a fading of small companies. And that -- that's one of the ways we increase market share. We're definitely seeing a continuation of that. It's very pronounced in some retailers versus others, where they are cluttered and still are trying to get out a lot of those small names. One of the advantages we have going into Wal-Mart, for example, is they had so many small names and they knew it, and they had no really great branded formula in that channel.

Private-label will be private-label. I mean, there are a number of good private-label businesses within the -- in all channels. But even at that, they've had too many private-label brands, so they are cutting those out as well. We don't see anybody putting great pressure on us. We don't feel -- I don't want that to sound cocky by any means, but we don't feel -- see threatened by any brand coming on putting great pressure on us. We do clearly recognize that private-label is a competitor of ours, and we watch that carefully. We don't want to be out of line with the competitive formula that they have. Some people are very good at that private-label business. The stores in general have gotten better at it, but we get better at our business as well.

You mentioned Disney competes in your channels. If I understand correctly, there are negotiations going on there. What do you see with the Disney brand currently?

Well, Disney competes everywhere. They have a presence in every channel because it's a character business. And they've been up and down. Disney pretty much gets driven by their releases and how good their latest movie is, and they've had a vacillation in their performance. We do not compete directly with Disney. There's plenty of room in these channels. They are large and growing markets. There's plenty of room for Disney. We have a very different proposition from them.

You know, it's the same way with OshKosh. We have a -- you know, they have a great brand name. We don't practice criticizing competition. But they have a terrific brand name. They've struggled, but there's room for both of us. I think the message is here that even with OshKosh as a competitor in playwear, they are older, they have a more rugged product presentation, they are more woven product, higher content of wovens. We can coexist there. We don't feel like if they do well we are in trouble. We don't feel that way at all. We dominate the younger sector, but we also are doing well in the older playwear. Our fall '04 currently selling is doing very well in the older segments as well. So, I think our share gains speak for themselves in playwear.

Robbie Ohmes, Banc of America Securities.

I was hoping you could talk a little bit more about the slowdown in retail comps you saw, and then the confidence -- you know, real pickup for the back half. And then, also, could you just talk about your retail strategy in general? The strength in the strip center comps, you mentioned I think it was plus 10 for the quarter, makes me wonder if you would think about accelerating the rollout of those stores over the next couple of years? Thanks.

Good question. These strips are doing very well. And we have enough of them up now to know that it's a real deal. We always philosophically want to make sure that our core business performs before we go to any dramatically new specialty stores format. Part of the brand study is to look at what our store of the future should look like.

But we do -- our current thinking is we will over the next couple of years edit out some of the low-performing drive-to outlets and replace them with strips. And so, it's very likely we would accelerate that over the next couple of years. But we also have this terrific formula now that we've discussed briefly this morning of moving the baby up front and the windows, etc., etc., that's adding punch to our formula. We didn't know -- we really didn't expect that some months ago to do so well because it was embryonic. But now we know we've got something. We know that that helps every channel within the total retail channel. We know even in the drive-to outlets, we've got some good drive-to outlets. It just depends on how far you have to drive to.

I guess the strategy would be to trade off some of the low-performing outlets for strips, get this rollout almost 100% of the new conversions. The ones we wouldn't convert would be the stores that we just feel like eventually are going to come out of the stream. And the strengthening product and just retail skills themselves.

We had to get a lot better in our stores of presenting core. There's still a bit more fashion in there than we like. The store people are learning how to accelerate that core business and present it more to the consumer. They are learning how to better manage their inventories.

When you shift to a core business versus a fair amount of complexity in the store and too much fashion, you have to learn how to manage that inventory and make sure it's well backed up. So, we've been doing that, and I think that's going to be a benefit -- I definitely know it's going to be a benefit to us.

So we see these things emerging. That's why we feel good about the second half. You know, June was June. We don't get too excited about one month. We don't think everything is good if a month is great, then everything is bad if a month is weak. We'd feel like we're very encouraged by what's happening in the month of July. We can see the performance of products that are selling better than they did. We can see that we've got good inventory backed up now and we're getting better results as a result of that.

So, I think there are a lot of good things happening here and we're learning that core business. We have learned it at our department stores when we implemented that a number of years ago. We're learning how the benefits of that in playwear, and our stores are following suit.

And can you just speak to the -- you know, the average ticket was down I guess you said 4% in the quarter. Is that something that will still be a drag on comps for the balance of the year, or--?

No, we are seeing that improved now right now in fall. We also had taken out some categories about a year ago, and in retrospect, we sell a lot -- like outerwear. We had some higher-ticket items that we took out of our stores. We felt we got too aggressive there, and we have reinstated those for fall of this year. So, that will help us as well.

But we're having the shift -- a positive shift now in the average ticket. So that's really good news. And, once again, they are getting backed up in their core business inventory. You know, when you go to core and don't back it up, that's not good news. But when you go in there and really back it up and market it heavily, that's great news.

(Operator Instructions). Margaret Mager, Goldman Sachs.

Let me just ask, I guess on what's going on at Wal-Mart in the playwear area. You said you are on track to launch newborn playwear in 2005.

Yes.

Can you just walk us through the Wal-Mart situation in terms of product categories at the moment? I guess the way -- tell us how we should think about it. Is it newborn, infant and toddler? Is that the general three categories in playwear? So if you roll out newborn, you still have infant sizes and then you can go onto toddlers -- can you just walk us through that?

Yes. You pretty much got it. It's newborn, then infant, then toddler, then 4 to 7 -- 4 to 6X. That's the way we compete in Carter's. And (multiple speakers)

So, newborn is only up to 12 months?

Yes.

And how would newborn playwear be merchandised versus what you are -- how you're currently merchandising your Wal-Mart offering? Is it on fixtures versus on a peg wall?

Yes. It's a fixture business. So you get racks. So you get additional space and it's right near the brand wall, which carries the baby business -- the baby basic business. So, you go from that, and then when you get into the infant, you get additional racks for that. And then as you go to toddler, the same thing happens. And if you go into the older playwear -- we don't know that we have to get in the older playwear with Wal-Mart, and that decision we don't even have to make now. You know, we are we going to roll out the newborn in the first quarter of '05. And Wal-Mart is very anxious to do that. As a matter of fact, they've put pressure on us to do that. They wanted to move a little faster than we did. So that was good news.

So, you will roll out newborn playwear to all doors in the first quarter of '05? Is that fair?

Correct. That's correct.

And will you have your own fixture or will you have to share this fixture with other brands, and do you have a signage program?

We never share -- we never intend to share with anybody. It's important to have the brand stand by itself. We have our own signage. Both Target and Wal-Mart really work with us and respect our ability to build brand presentation at the floor. We are the ones that designed the wall and did all that for them. And we would design the language on the signage.

There will be new products hitting the brand wall. We're updating the brand wall within the next few weeks. So it's worth scheduling a trip to Wal-Mart, I'd say in the next couple of weeks or so. What you should also see, Margaret, just to distinguish what's on the brand wall versus what's on the floor, there's a program that we launched this past year called hanging layette. It's on a fixture, and it's extraordinary -- the performance has been extraordinary. So, if you want to get a better sense for how does the product look on the floor, we had had the newborn sleepwear, but what you also should see is that hanging layette program on the floor. It's beautiful -- beautiful product, performing extremely well.

So that's in the stores right now?

Yes.

Okay I'll have to go and look.

Yes, it's worth the trip.

Okay. I was shopping in your factory outlets recently and I bought all the things you mentioned -- bibs, sleepers and -- another thing, that you all have the low-ticket items you were talking about, so I testified here to your average price mix shift. But my other question is, within that Wal-Mart mix, will the playwear have a higher margin than the baby and sleepwear that is in the stores already? So, will you be getting a slightly positive mix shift within the Wal-Mart business?

Generally speaking, the margins in the mass channel are improving. I wouldn't say that -- I would say that the margins on playwear would be comparable. So I wouldn't say that -- generally, the mix, regardless of what brand it is, baby is always our highest margin, then playwear and then recently sleepwear, as we're finishing that transition to full package. So I wouldn't expect that that's a major contributor to the margin lift. I would say generally speaking, margins are improving in all categories. But it's not necessarily driven by introducing playwear.

And then regarding the Target transition to the Joy brand, is there going to be any lull in your target business as you execute that transition, either in the third quarter or the first part of the fourth quarter?

None. That's all good news. It's just like when we started up Target. We rolled everything out in December, started up in January. There's no lull. It should be a very smooth transition.

They are excellent on transitioning new product.

Okay. Will there be any markdown liabilities as they blow out the Little Tykes?

No.

Okay. With regard to the royalty income, Mike, I think you said it was up 32% and you see 10% for the year?

Correct.

Can you just -- why is that? Why would it slow down so much?

Well, one thing to keep in mind in the second quarter you've got a full three months of the Wal-Mart royalties. So, you have a nice lift from that. I think the other thing, what we're experiencing, is in the mass channel, we look at the productivity of the two brand walls, one at Target, one at Wal-Mart, weekly. What we're experiencing is that we're seeing higher productivity from products we shipped to those two customers and lower productivity on certain licensed products. So we're shifting more of the mix on that brand wall to apparel we ship versus product that our licensees ship. So, that has one impact on the second half.

And there's one licensee that is underperforming our expectations. It's in the bedding category, and we're on that. So, that will impact some of the growth that we will have in the second half. Our expectation was never that we would be growing our licensing business 32% a year. Our expectation was that we would grow royalty income at a rate faster than topline growth. This year, it will probably be comparable to topline growth. But I would say there's opportunities to continue to have our royalties grow at a rate faster than topline growth. But it won't necessarily be this year.

Will it be lumpy 3Q to 4Q?

Right now, for third quarter, I would say our royalties will be down in the mid-single digits, and then in the fourth quarter, you should expect that royalties will be -- right now, we are projecting royalties will be up a bit in the fourth quarter.

Okay. If I could jump back to the sales line for one second in your Carter's branded wholesale business? You said it was up 17%, excluding off-price. Can you just give us an update on how off-price went in the quarter and what's going on with the off-price business?

Sure. The off-price business in the second quarter was down 32%. 31%. And that's just -- I think as you remember, Margaret, in the first half of last year, a lot of retailers got backed up with inventory. They were expecting a very strong first half. And because of -- you know, a prolonged winter, the duct tape scare, the focus on the Iraq war, just things were not as robust as many had expected. That obviously impacted the level of shipments we had expected to them. So, we had a greater mix of off-price last year than we expect this year. So, I think it's -- one, this year's performance is a function I think generally speaking a better market; two, I think it's a reflection of the benefit we're getting from focusing on core product.

There is something else going on I think in the market, too, Margaret, is -- and I see it particularly at Penney's. I think that's a great turnaround story, and one of the major reasons for them doing well is they are taking a real key item approach to their categories. And I'm going to speak only to apparel. But they are doing that across all their markets.

But what they're doing is they don't want collections either. They want items. They want great core items. And we're lining up that way. So, as that lines up more, it definitely pulls the off-price business down. It's just like converting playwear to a core business -- essential core products versus high-fashion content. I actually think Penney's has a model that a lot of stores are going to try to model after. They are cleaning up. It does a lot of things. It makes it easier for a consumer to shop. It's a much more profitable business. So I think we're going to continue benefit by having less distressed merchandise over time.

Okay, that's interesting. And I'm just curious, the upstairs market versus the mass market, anyone curtailing their kids' business either broadly or with you, of note in the upstairs market as the mass market just continues to be the -- to dominate children's apparel?

No, we don't see any signs of that at all. As a matter of fact, our customer base -- when we say upstairs, we're not talking about Nieman's or Saks, but as you get, say, from Federated down, we see they in fact consider the children's market critical because they want to draw the new mother into that store. And we don't hear any of that. We hear the -- we are more important and they really like our core strategy and they like the fact that we're -- we continue to upgrade our products every season. But we don't hear any negatives like that.

Okay, so just looking across the non-mass wholesale customers, any one declining? And maybe you want to speak to Kids"R"Us in particular, since they had that big store closing strategy? And I know you said babies was not part of that. So, maybe you could just --

When we -- when they had all the Kids"R"Us stores, that was about 10 or 12 million for us. And what has -- the net of that closure is we are about even making up that revenue loss through Babies"R"Us. Business is very good there. That's a very good chain.

Babies"R"Us was always the strength for us. Their focus was on the baby category. So, that's where our strength was. That's obviously where Toys"R"Us saw the strength as well. So, that's why they hung onto it.

Okay, good. Thanks. And then last question, on SG&A. The run rate through the first half was above the rate of sales growth. But yet, to get to your 25.5 target in the second half, it has to be pretty meaningfully below.

Yes, keep in mind that most of the business is done in the second half of the year, just given the seasonality of the business.

Right, but I'm just talking about the run rate of the increases in absolute dollars, not just the expense ratio.

Sure. But even -- keep in mind, we were investing in that brand study in the first half of the year, we were converting it to the new distribution center -- for a number of reasons, SG&A was higher. But we feel good about our projections for the year. You get the benefit from leverage, and we don't have the level of investments that we had in the first half -- pardon me, in the second half that we did in the first half.

I guess actually it really only is the second quarter that was ahead of (multiple speakers)

Right, and, you know, the second quarter is our lightest quarter. And that's when we were doing a good portion of the work on the brand study.

So, SG&A you think will run in the low-single-digit percentage increases in the second half?

That's correct.

Okay, question on co-op. You mentioned co-op as one of the line items in SG&A that you funded in 2Q. Is that a generally planned expense or is that a response to a market condition, be it broadly or at a specific customer? Like, how does co-op -- (multiple speakers)

Well, it's planned for the year; the thing that you try to predict is when is the retailer going to need support. So, that's the only thing -- it's generally some portion of 2 to $3 million a year. This year it might be in the range of 3 to $4 million a year. But it's generally planned for the year, and then it's just a question of when does the retailer request some support for things like baby sales and so forth and based on their own business needs in terms of what they're trying to accomplish. So it's planned for the year; it's just we do our best to sort out when those charges are going to fall.

So, you're comfortable with that line item looking forward, that it's not going to (multiple speakers)

Yes, we are. Yes, we are.

Okay. Thanks a lot and, you know, good work.

Marie Driscoll, Standard & Poor's.

I was wondering if you could elaborate a little on what you are doing with your brand study?

Well, I would have to say I cannot say too much, because it's a big competitive move for us to do this. We feel adamant that this brand we have we can increase the power of. We feel like that we do a really good job in product. And every season, we improve product. And what we feel we have a big opportunity to elevate the branding part of brand market; what we are studying is how to do that.

We feel by doing that, we also can elevate the pull of the consumer. The consumer would want to shop this brand a lot more. We can increase the emotional content. It's hard to explain this over the phone, but this brand has great -- it has very strong emotional connection with the mother and grandmother and the gift-giver. And we think we can elevate that considerably.

We also think that eventually we can have a much better store format that will pull consumers in, elevate the brand image and elevate the image for our department store customers. One of our major objectives, unquestionably, is to increase the power for our current department store base, where they will want to come in and shop us even more.

We think there are expansion ideas of opportunities and categories for the brand. We think there are some things we're not into in certain product categories that we can get in. So, it's a very comprehensive study. We think that as well will increase the profitability for both our customers and for ourselves.

It's going to take some time. I've said we're going to start introducing some things in our fall '05 product line. We're already testing some things in our stores and we're doing a number of things. But this is a long-term objectives. It's not something we're going to have a dramatic improvement in next year. We're being very careful about it and we're making sure we do what is brand-correct. We will see some benefits in '05. We will see I think a significant change starting in '06 -- '06, '07, '08. We're looking both short and long term. I don't want to be too vague, but I just can't divulge more than that.

Okay. I had two other questions. In going through the retail comp, you mentioned that the average price was down 5%. And I'm wondering if that's across the board, you know, in your wholesale business as well?

No, I wouldn't say so. One of the things in our retail stores -- largely it's a focus of the focus on core products. I don't know if you've been into the stores, but what we're doing is we're allocating more floorspace to what we refer to as our core products, like bodysuits, bibs, washcloths -- that's in the baby category. But even in our playwear category, a year ago, we were selling what we called fashion playwear sets that were retailing for about $13.50, and we have significantly reduced the amount of the playwear sets and focused more on core basics -- just basic tops and bottoms, and those retail for about $7.50 to $8.00. So I think it's more a reflection of the mix of what we're selling -- getting products on the floor that have much more predictable demand as opposed to higher-risk fashion playwear sets. So I think it's more of a mix of what we're selling as opposed to just lowering our prices 5%.

I should have said part of this branding study is to come up with a formula where price is less important than the structure of product -- value of our brand. So we really feel like our opportunity is to enhance other things in this brand so that price becomes less important.

And my last question is just about quota and how you think you stack up for this year going into next year, as well as your competition.

In terms of quota, I think the important thing for you to understand, only about 15% of our products come under quota right now. It's a combination of the baby category isn't subject to quota, and those things that are subject to quota we do our best to avoid it by placing production in parts of the world that aren't subject to quota. Our annual quota costs are about 3 to $5 million. So it's an insignificant component of our total cost structure.

The issue that we're managing very closely is the elimination of quotas next year and the inability to carry -- borrow from next year, if you will, and that's something we're staying very close to Li & Fung, our primary sourcing agent, and we're just monitoring the availability of quota and we have the flexibility to move if it becomes an issue. So, we're staying very close to it. That's about all you can do at this point, is just monitor it very closely, and we are.

Do you think -- what do you think the implications are for 2005, 2006 with the elimination in quota and pricing? Do you have any feel for that?

We don't expect it's going to meaningfully impact our business. I think it depends on the type of apparel category you are in. If you are in the adult business, it may be more impactful. But because the quota has not been a significant component of the cost of the baby business, we don't expect it's going to meaningfully impact our business.

And ladies and gentlemen, we have no further questions on our roster at this time. Therefore, Mr. Rowan, I will turn the conference back over to you for any closing remarks.

Well, that concludes our remarks. We certainly thank each of you for joining the call and we will look forward to our next call. Thank you very much.

And ladies and gentlemen, this does conclude today's Carter's call. If you would like to listen to a replay of this call, it will be available beginning at 11:30 AM Eastern Time today through midnight, Saturday, August 7. The dial-in number for the replay is 888-203-1112 in the United States and Canada, and 719-457-0820 for international locations. The confirmation code to access the replay is 511730. (Operator Instructions). We do appreciate your participation and you may disconnect at this time.