Carter's Inc (CRI) 2004 Q3 法說會逐字稿

Welcome to the Carter's third 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 404-575-2889. (Repeats numbers.) Carter's issued its third quarter earnings release yesterday after the market close. The text of the release appears at Carter's website at www.Carters.com 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, should 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 earnings release. And now, I would like to turn the call over to Mr. Fred Rowan. Mr. Rowan, please go ahead sir.

Good morning. Thank each of you for joining our call. I will begin the conference with an overview of our achievements during the third quarter. Afterwards, Mike Casey will prove present the financials. We had a terrific quarter, both top and bottom line.

The nucleus of our continued success is, one, our Company's broad and deep talent base. We are well-equipped for growth. Secondly, the importance of the Carter's brand in a young children's market that is large and growing. And thirdly, management's intense focus on a strong, strategic platform.

Our growth platform is diversified and has significant potential. The first of these potentials -- first of the growth platform is product dominance in the baby and sleepwear categories. Secondly, we come in the category leader in the large and growing play clothes market. Thirdly, building consumer brands at Target and Wal-Mart. Fourth, elevating our retail stores' productivity and extending the reach of the Carter's brand. Fifth, constructing a powerful global supply chain.

I will address each of these in detail, the first initiative being product. We've experienced good sell-throughs in both our baby, basic replenishment category and fall seasonal sleepwear. We're making good progress in improving our sleepwear products which were a bit sluggish in 2003. We're upgrading fabrics, color and application. Our forward bookings for spring '05 are good. Fall '05 product development looks very strong. This provides us with good visibility for the fourth quarter and well into the first quarter.

The second initiative is play clothes. We had excellent selling during the quarter and we also have strong spring '05 bookings. We're building a competitive advantage by replicating the Carter's core product formula.

Combined with the power of the Carter's brand, we're marketing essential core products. Those products have superior quality, great color and application, popular price points with outstanding service levels. This has been well-received by our consumers and our customers. This formula is far more profitable for our department store, our chains and for our Company. It's a very efficient formula.

We're also pleased because we are experiencing strong selling in the older age segments in this category. This clearly demonstrates we're not just a young brand.

Thirdly, we're building good branded formulas and successful business models with both Target and Wal-Mart. Product performance has led the way, combined with excellent brand presentation at the retail floor. We have also shifted and replenished stock at extraordinary levels. We have excellent relationships with both customers. We continue to grow by continuously improving product and expanding categories. We exceeded third quarter plans and we are well positioned for 2005.

As we have mentioned during previous conference calls, at Target we're transitioning in January to a new brand name. It is Just One Year versus the current Tykes name. It is a better name because the consumer testing was favorable. Target likes it more because it was the legitimate Carter sub-brand with department stores, and we like it more as well. And there is no transition cost or inventory risk above any transition we make, as we freshen product each January anyway.

Fourthly, our retail stores. We made significant progress since we last spoke. If you recall, our comps for the first quarter were positive 3.8 while the second quarter was flat, to bring us in positive 1.8 for the first half. And our third quarter was positive 6.1% versus positive 1.6 last year. Our year-to-date at the end of September was positive 3.5 versus negative 1.6 last year.

October business is robust. What has made the difference were two initiatives. One we started early in the year, which was to better present our core products, deliver far superior to our stores which were not that good during 2003 and to offer better core products.

The second move we made later in the second quarter was when we began implementing a better model. One, we vastly upgraded our window displays. We moved our baby category from the back of the store to the front of the store. We introduced more emotional signage and we made the stores easier to shop. Since April we have converted 86 stores to the new format. We'll have 100 done by the end of November and we will convert 50 more during the first quarter.

All metrics are improving. We're definitely attracting more consumers and converting more. We had 24 strip stores outside the traditional outlet (technical difficulty) arena at the end of the quarter and their comps are very good.

Since we spoke, we have a new President of Retail and a new GMM. They have been on board a few months. Marc Searstad (ph) is the President, with a solid background the likes of May Company, Motherhood Maternity, Gymboree and the Genghis (ph) Group. Glenn Selvert (ph) is our new GMM, with a background with The GAP, Federated and Footlocker and Footlocker Kids. Both of these leaders are off to a strong start.

Next is our supply chain. We had terrific results. We delivered product at extraordinary service levels to all our channels of distribution. Quality levels were superior. We significantly lowered costs in product, improved all product benefits while maintaining margin integrity.

We certainly are pleased with this report card, but we're also excited about possibilities to lower costs to fuel growth over the next few years. We will realize cost reductions from both sourcing and logistics. With respect to sourcing, we have the benefit of exercising volume leverage. With our growth we're offering nearly 200 million units for our sourcing partners to leverage costs down.

We're focusing on fewer countries and factories. We are placing product in developing countries such as Cambodia, Vietnam and Malaysia. And we're moving sleepwear offshore, as we sell only 50% in that arena.

And finally, logistically we have tested direct shipping to customers which does not require the use of distribution centers. We will be increasing that percentage next year and subsequent years, and this will be quite beneficial to us. I will turn the conversation back to Mike.

Good morning everyone. I would like to comment on our third quarter results and also update you on our outlook for the balance of the year and our growth objectives for 2005. We continue to report solid growth in our business, with third-quarter revenues up 18%. Our net income for the quarter increased 45%. We are reporting double-digit growth in each of our business segments, wholesale, retail and the mass channel, and we continue to expand our operating margins.

Our third quarter revenue reflects the growth in our Carter's brand wholesale business, which was up 14% excluding off-price sales. Our baby business was the largest contributor to this growth, with revenues up about 50%. And that growth was driven by strong demand for our Carter's Starters product which launched in September, and our new Carter's Classics programs which began launching in June.

Our seasonal business has been performing well. Our full sleeper shipments are projected up about 10% for the year and our fall playwear shipments are projected up over 8% for the year. Our spring 2005 products begin shipping next month, and based on the bookings our spring playwear shipments are planned up over 15%. Our spring sleepwear shipments are planned up over 10%.

With respect to our retail stores, revenues for the quarter grew 11%. That was driven by comp store growth of over 6% and sales from 13 stores opened since last year. We currently have 177 stores including 24 in strip center locations. Comp shared data, up about 3.5%. And we're projecting comps up 3.5% to 4% for the year. In the third quarter, the transaction accounts in our stores were up over 6% and units per transaction and average prices were comparable to last year.

As we mentioned on the last call, we're segmenting these stores into five categories. All five segments recorded positive comps in the quarter. The strip stores performed the best, with comps up over 10%. The comps for the Mills outlet stores, and these our outlets stores in indoor malls, were up 10% in the quarter. Comps for trade area outlets, and these our outlets stores in densely populated areas, accounts (ph) for the trade area outlet stores were up 8%. And then comps for our drive-to outlet stores, those are the traditional outlet stores that are 20 to 30 minutes outside densely populated areas, for the drive-tos they were up 5%. And then stores that are tourist locations were up 4%. So good growth in all segments.

As Fred mentioned, we continue to be encouraged by our new store format with the baby product category in the front of the store, upgraded window displays and better in-store marketing. The strip stores that have been converted to the new format are reporting comps up over 13%. That is five points better than the pre-conversion period.

The Mills outlet stores are comping up 11%, also five points better than the pre-conversion period. Trade area outlets are comping up 7% and the tourist and drive-to outlets are each comping up over 2%.

In terms of new stores, we'll open up 11 stores this year. More than half of those will be in strip center locations. We plan to close four stores when the leases expire at the end of this year.

With respect to our mass channel business, revenues were up 64% in the third quarter, primarily due to the growth in our Child of Mine brand. Also had very good growth in the Tykes brand with Target in the third quarter.

We recently updated the brand wall at Wal-Mart with new products. We expanded the baby apparel offering on the brand wall based on higher productivity of those products relative to licensed products. We 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 '05, and that begins shipping in January.

We're scheduled to launch the new Just One Year brand with Target in December. That will include an expanded offering of baby sleepwear and hanging layette. So suffice to say we are on track to exceed our growth plans this year in the mass channel.

With respect our profit margins, operating margins in the third quarter improved 110 basis points to 14% and we expect operating margins for the year will be approximately 12%.

Our gross margin for the third quarter declined 70 basis points to 35% due to a greater mix of mass channel revenues and additional provisions for excess inventories. We expect gross margin for the year will be approximately 36%, down 30 basis points compared to 2003 due primarily to channel mix.

In the third quarter, our SG&A improved 210 basis points to 22.5% of sales. This improvement is driven by leveraging our operating expenses against higher levels of revenue and controlling the growth in spending.

Our royalties from licensing business declined 3% in the third quarter. We are comping up against the royalties that we earned on licensed products for our Child of Mine brand, which launched with Wal-Mart in July of 2003. We expect growth in our royalty income for the year to be approximately 10%.

In terms of liquidity, cash used for operating activities in the first nine months was $14 million. The cash used reflects the growth in accounts receivable driven by the timing of wholesale and mass channel sales, and an increase inventory. The launch of our new Carter's Starters product in September and the growth in the mass channel drove quarter and receivables higher than last year. You should know that the aging of receivables, which are 93% current, and days sales outstanding, which are 41 days, are both comparable to the prior year.

Inventories at the end of the third quarter were $148 million. It is up 26% compared to September of '03. We have intentionally increased inventory levels to improve our shipping performance to our customers in our retail stores. As you may recall, we began this year with inventory levels lower than the previous year end. In retrospect, we were running too lean on inventories.

Last year and earlier this year, we were shipping less than 85% of demand for certain key items because we were out of stock. We also had under-supported our retail stores. There's no question carrying higher inventory levels has improved our shipping performance and our results. We are consistently shipping over 93% of orders placed, and our shipping performance to our retail stores is excellent and showing in their results.

Our inventory turns are on track to be 3.7 turns for the year, slightly better than last year.

We borrowed on our revolving credit facility to fund the growth in working capital. At the end of September, our revolver borrowings were $10 million compared to $2 million last year, and we cleaned up the revolver this month.

Cash flow from operations is currently projected to be about $40 million for the year. And with respect to our debt levels, we reduced our term loan debt about $8 million so far this year, about 8% year-to-date. And we plan to make additional prepayments on the term loan of $15 million or more in the fourth quarter.

CapEx for the first nine months was approximately $14 million. That includes $9 million to complete the leasehold improvements and our new distribution center here in Georgia, and we expect CapEx for the year to be approximately $23 to $24 million.

In terms of guidance, we're raising our fourth quarter revenue forecast to $210 million. That is $8 million higher than our previous estimate and that represents growth of 13% over last year. The new forecast reflects the strength in spring 2005 bookings for Carter's sleepwear and playwear, and the current forecast for our retail stores whose comps are now projected to be up 3% to 4% in the fourth quarter. We previously assumed comps of 2% to 3% in the fourth quarter.

We're also raising earnings guidance for the fourth to $0.45 per diluted share on 30 million shares. That's growth of 22% compared to pro forma earnings of $0.37 a share in the fourth quarter of last year.

So, for the year our current plan is to support 14% top line growth. And diluted earnings per share are now projected to be $1.63, up 34% over last year and $0.06 better than we had previously estimated. With respect to our current outlook for next year, our business model continues to support 8% to 10% top line growth and 15 to 20% earnings growth. And we will provide you more detail on our 2005 growth assumptions on our next call. That concludes our comments in terms of the business overview, and we will open up call to your questions.

(OPERATOR INSTRUCTIONS) Margaret Whitfield, Ryan Beck.

Good morning and congratulations. I would just like more color on the retail segment, if you could comment on what the new executives believe might be done in terms of improving the productivity and how this might change your strategy going forward. And secondly, could you give us an update on the brand study and where it stands and when you might be discussing some of the actions you might be taking going forward?

With reference to our retail division, we felt when we recruited these two gentlemen that they were far more experienced in retailing and they'd had significant experience with some (technical difficulty) important (ph) brands. And with our direction to strengthen our brand in conjunction with this brand study, we felt that would be a terrific mix. So we feel their core skills in branding and in operating --specialty retailing was far more advanced than what we had.

We also felt they understood the philosophy of essential core products, a philosophy that we feel is critical to marketing under the Carter's franchise. They had a lot of experience in children's, which definitely added fuel to our initiatives. They had seen a number of things, that we can get better at the things we philosophically believed all along we could. Therefore they have hit the ground running. I just think they have the accelerated pace of things.

As far as the brand study goes, it is an initiative and I am -- I do prefer to keep it a bit close to the vest because of the importance of competitive nature of it. But in summary, we have seen significant opportunity to elevate to the emotional content of this brand. And we are deep into the study.

We plan ultimately to significantly upgrade our stores and the formats with our department store customers. We definitely feel our department stores are going to benefit materially by this. So it will help the brand, it will help our stores, an it will help all of our customer base.

We will begin to launch some concepts in '05. You should expect that when we launch our baby business in September of '05 you'll see some material change there. As we move on into the fourth quarter of '05 and early '06, we will be seeing significant change all through 2006.

(OPERATOR INSTRUCTIONS) Sara Pinatore (ph), Banc of America Securities.

Good morning, I'm calling for Robbie Ohmes here at BofA. I just have a quick question about your gross margin. I think some of that you said was from inventory adjustments, and I understand that that may be because you were sending some product to the off-price channel. I have a couple of questions related to that. Can you tell me whether you have any constraints on whether you can sell off-price branded products into your retail or your outlet stores?

And also, did the fact that you did send some of that product to the off-price channel, does that reflect any issues with delivery to the mass channel? Or are you shipping okay in that channel?

Your second question, delivery in the mass channel has been exceptional. We monitor that performance weekly, and it is near 100% on time and complete when those orders are placed. And that is the benefit, quite frankly, of carrying more inventory. Our service level to our wholesale customers, and particularly our retail stores this year, has been exceptional because we have carried higher inventory levels. You should have no concerns in terms of our performance in terms of keeping our customers in stock.

I think your first question, are there any restrictions in terms of how much of these mass channel brands we can move into the retail stores, there's absolutely no restrictions whatsoever. What we are very thoughtful about is how much of that product we put in our retail stores. Most of our stores carry all three brands, but you want to make sure you keep that mix in the proper balance.

So fortunately, we have had extraordinary results in the third quarter. That gave us an opportunity to look at what we define as excess inventory, which is more inventory for certain components than what there's demand for.

And we always have a choice. We could work that excess through our retail stores and make a good margin on it, or we could write it down and move it out through the off price channels and liquidate it more quickly. And that is what we chose to do. So, the excess inventory provision in the third quarter, about 4 million. They were about $1 million last year and it did not meaningfully impact, obviously, our ability to achieve and exceed our growth objectives for the quarter or the year. So, I would say that we made a good move in the third quarter to mark that inventory down and we will move it out through the off-price channels.

Jeff Feinberg, JLF Asset Management.

Congratulations, guys. Nice job. Two quick questions. The first one is, I think you mentioned that the inventory turns for the year would actually be up a little bit year-over-year. Am I understanding correctly that that would imply that by the end of this quarter, the inventory growth year-over-year would be something on the order of low double digit to apply -- achieve that?

No, I think it's important than for you to know we began this year with inventories actually lower than the previous year end. So we were very light on inventory I would say, particularly in the first quarter and into the second quarter of this year. And that did impact some of our deliveries. It didn't impact our ability to grow the business, but it did impact some of our deliveries.

So, I would say starting in the second quarter we intentionally started to build inventories, and you could see the results at the end of the third quarter in terms of the balance sheet. I would say at the end of the year, inventories will probably be around $130 million. So that is up over 20% over last year, and then we will work those inventories down into next year.

And our objective is always to have inventory grow at a rate equal to or less than top line growth. I think we swung the pendulum a little bit too far to the left earlier -- starting in the fourth quarter of last year and into the first quarter of this year. We corrected that.

The nature of our business, this inventory is bodysuits and blankets and towels. So this is what I would define as low-risk inventory. So it doesn't hurt us to carry more, and I would say that's it has meaningfully improved our results in terms of keeping our customers in stock. So you should expect inventories at the end of the year to be up some portion of 20% or more, may still be up at the end of the first quarter. But then our current projections show it getting more in line with growth in revenue starting in the second quarter forward.

Terrific. It sounds like they're (ph) -- part of what is supporting that also is the strong bookings you alluded to for the spring.

Absolutely. Very encouraged by what were seeing in terms of forward demand.

Are you able to give any more flavor on that regard? Obviously it's double-digits (indiscernible) from the comments if I understood correctly.

Right, yes. We will start shipping it next month. And we will keep you posted in terms of -- we had very strong reaction when we showed it earlier this year. And then the bookings came in at a very high rate. And we're in a good inventory position to start executing the launch next month.

Wonderful. Final question, I think you mentioned in the prepared comments that your October retail business was robust. Could you please give some flavor just in terms of magnitude there?

Well, we don't comments by month. I think it's important just to comment that we don't see that in the third quarter we just had one good month. We had three good months in the third quarter and it continues to move in the fourth quarter. October, as you know, was not a good retailing month last year for most people, and so you would expect some improvement. What we like is we are improving more than what that drop was last October.

And we're very encouraged about traffic and the sell-through of our products. To Mike's point, some of our new products have hit, like the baby spring products which start to hit the floor and they are very successful. So we are encouraged about that.

Terrific. Sounds like it's a nice acceleration in the retail business.

We're happy with the progress.

Melissa Otto (ph), BE Research (ph).

Great quarter, congratulations. Just a quick question, really, on the wholesale business. Would you give your thoughts on the outlook for the wholesale business? It still makes up pretty significant chunk of sales, but it looks to be deteriorating a bit going forward.

Actually, we wouldn't say it's deteriorating. We're projecting good growth in the fourth quarter. Again, when we give guidance -- if we were to give guidance, say for next year, it would probably be in the mid to upper single digits. Our objective is to always outperform that.

I would say in a word that wholesale business has been good. And we would say we launched the Carter's Starters program, which was one of our largest launches and it was launched exceptionally well. And earlier this week, we started to get the sell-throughs and the sell-throughs are, I would say, robust.

The nice part of our business, it is kind of the must-have brand for young mothers and caregivers. So, whereas the wholesale if you looked at it in its entirety there might be some pockets of weakness, but it has not been a case in our business, obviously.

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.

Thank you. Just a couple of comments to reiterate our feelings about our business. Our current product performance is what really counts, and it is healthy. It is healthy across all of our channels. As Mike has mentioned, our baby is off to a good start. We anticipate to have broad success in products (ph) (technical difficulty). We are in a good position to respond to demand. We have the inventory that is required if we get an uptick in demand.

I think even more importantly we have visibility well into '05. We have gotten spring bookings from all of our channels of distribution. We got great visibility well into that first half, and we have meetings with the mass channels in December and we'll have great visibility that takes us on even into the second half. We're pleased about that. We are obviously particularly pleased about our store performance. It's important to the brand. It's important to our growth.

And finally, we see lots of cost reduction ahead. We feel, as I have mentioned in opening remarks, we're building significant leverage. We've got a very talented team there, so we know we are going to be able to fuel our growth in proven products through our cost reduction initiatives. We thank each of you for attending our call and we look forward to the next one.

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 1130 Eastern Time today through midnight Friday, November 5th. The dial-in number for the replay is 888-203-1112 in the U.S. and Canada, and 719-457-0820 from international locations. The confirmation code to access to replay is 826 187. (Repeats numbers.) We do appreciate your participation and you may disconnect at this time.