Carter's Inc (CRI) 2005 Q3 法說會逐字稿

Good day ladies and gentlemen. Welcome to Carter's third quarter 2005 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, Vice President of Investor Relations. Mr. Martin's direct telephone number is 404-745-2889.

Carter's issued its third quarter earnings press release yesterday after the market closed. 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 Carter's and OshKosh B'Gosh’s most recent annual report filed with the Securities and Exchange Commission. And now at this time Mr. Rowan, I would like to turn the conference over to you, sir.

Good morning. We certainly appreciate each of you joining our call. Mike Casey, and I will be presenting as Joe Pacifico, our President is on jury duty.

We delivered very strong results during the quarter and we expect to have a good fourth quarter. Despite macro economic conditions, we were able to strongly reward our shareholders. This is a testimony to our broad strategic platform providing substantial organic growth and brands delivering essential core products to the mainstream consumer. We’re also benefiting from a growing young children’s sector with favorable demographics. Thus revenue and earnings are more predictable. We do also have a deep, broad talent base, which enables us to execute at extraordinary levels.

I’ll first speak to Carter’s – Carter’s department stores and the retail stores, then the mass channel, our supply chain, and close with OshKosh. At Carter’s we had strong revenue gains from our department stores, which we call the wholesale channel, up double-digit. Our baby and play clothes led the way with sleepware slightly off plan. Baby was driven by the new branded formula with the launch of new stars, which is 65% of the baby business. We elevated the product benefits of packaging, the point-of-sale, and the emotional content. The net is we have very strong sell-throughs and a very pleased customer.

Sleepware was a bit sluggish, but not a concern. There were two reasons – very hot weather; and lots of hurricanes. However, selling has been robust of late. Secondly, we intentionally shifted our start ship dates to the right to match up with buy-now, wear-now.

Play clothes performance was robust. This has resulted from increased merchandising skills and living-the-life-of- fashion to essential core products. We feel good about both the fourth and first quarters because we will have strong replenishment orders in baby, plus sleepware and playware bookings are up double-digit. I have seen the development of our fall ’06 product lines and they are vastly improved. I am very optimistic regarding the second half product performance.

With respect to our retail stores, we have a total of 186 – 32 branded and 154 outlets. We missed our plan in comps for the quarter. We were at minus 0.9% versus plus 6% last year. There were three reasons – low inventories; weather; and cost of fuel. Low inventories were a result of our better-than-expected sales in the second quarter combined with a systems conversion causing some shortages during July and August. That was corrected by the end of August and we had a good September. I’d say weather was generally disgusting and occurred during key selling events. Fuel costs weakened our drive-to outlet channel.

Our brand stores continued to be the bright spot, although they were affected by the low inventory during July and August. Even with that, they were up 5.5% for the quarter. They were up 16% in September. And they are up 12.2% year-to-date. And they are also doing well as we speak. The brand stores enhanced the brand and are also growth cyclical. We opened five stores this year and we will accelerate the openings in the fourth quarter with fifteen more.

Despite weakness in comps, other key metrics were encouraging. Our average prices were up. Our units per transaction were up; and average transactions were up. This confirms product is good and the merchandising strategies make sense. We should have had positive comps had we avoided the inventory issue.

Business in our stores will be challenging during the fourth quarter as we were up 13% last year. However, we are close to even in October, which was up 18% last year. So that is encouraging. Some very good news is the addition of Patty DeRosa (ph) as our new President of Retail Stores. Mark Searstad (ph) has left us to pursue other interests. Patty is an extraordinary talent with past experience and huge successes at The Gap and Ann Taylor. Amongst her roles at Gap were President of Gap Kids. She was there when they were pregnant. It’s rare to recruit one with such breadth in branding, core products, business savvy, and motivational skills. With the addition of OshKosh and the intent to upgrade our brands, she is the right person at the right time. We had planned to open three brand prototypes late in the fourth quarter. We are delaying those briefly as I prefer to allow Patty to review our plan. She has ideas already, which would benefit [stores].

Speaking to the mass channel, Target and Wal-Mart, we had a record quarter of (indiscernible). Joy and Ran (ph) are just one year at Target’s and performing well. We were a bit sluggish early in the year, so we become more competitive on some pricing issues and reset the brand wall. Results are good. Expansion into fall sleepware is very strong led by the pj rack, Target’s most productive sleepware product. Child-of-Mine at Wal-Mart is also in good standing. Brand wall was reset September 1 and performing well. Fall sleepware and play clothes are performing to plan. Both retailers are pleased with us and we are expanding product categories and increasing productivity. Our supply chain is delivering on outstanding levels. We are confident in our 2006 plan with (indiscernible). We are booked 100% through spring up double-digits. In many cases they have seen our fall ’06 creative and really like it.

With regards to our supply chain, we delivered superb results. Inventory was lower, of better quality, turns at record levels. Distribution costs in actual dollars were lower than last year with revenue up 15%. Cost reductions from sourcing were well above plan and deliveries were excellent. We exited our two Mexican plants with no disruptions.

The OshKosh integration is going very well and is on schedule. We are keeping the brand distinct from Carter’s by separating marketing, merchandising, and product design. We are integrating all the support functions. We had an active operating committee at OshKosh led by Dave Brown, our senior executive of operations at Carter’s. We are executing well.

We’ve moved quickly to exit unprofitable and unnecessary businesses. We’re closing 15 lifestyle stores plus another 23 outlets that are under-performing. We exited the adult apparel and unprofitable wholesale businesses, specifically some discounters. We were able to liquidate old inventory allowing our OshKosh stores to have a cleaner mix. A big priority is to have strong core products for fall ’06 and knock out significant complexity in the neighborhood of 40%. We have had very successful sessions with OshKosh merchandising and design. We will move from four brands to two in fall ’06 and move from 12 collections a year to a tiered core products scenario while reducing lots and style colors. We have launched a brand study for OshKosh similar to Carter’s.

With that I’ll turn it over to Mike Casey.

Thanks Fred. Good morning everybody. I’d like to walk you through our third quarter results and our outlook for the balance of the year. We’ve had a terrific quarter. We’re reporting GAAP earnings of $0.035 a share, which includes charges of $0.67 related to the refinancing of Carter’s debt, the acquisition of OshKosh, and plant closures in Mexico. Excluding these charges, adjusted earnings are $1.02 a share. That is up 65% in the quarter. In our earnings release last night, we outlined the nature and dollar amount of the charges that impacted our results. The press release is available on our website.

Earnings are $0.21 better than the guidance we shared with you on our last call – good contribution from both Carter’s and OshKosh. Of the $0.21 – I’d say we picked up $0.09 in gross margin quality, $0.10 in lower spending relative to our plan, and interest costs about $0.02 better than expected. I’ll discuss this more in a moment. For clarity what I’d like to do is walk you through our results and guidance, excluding the charges we’ve outlined in the press release. In terms of other highlights for the quarter, our consolidated sales were a bit better than we expected and strong cash in the quarter enabled us to pay-down over $30 million on our new $500 million term loan.

With respect to third quarter sales, consolidated sales were $372 million. That is up 48%. Carter’s sales on a standalone basis were up nearly 10%, driven by a 13% increase in wholesale sales and a 12% increase in the mass channel. With respect to wholesale sales, as Fred said, good performance in baby and playware. Our baby business was up about 15%; playware up over 30%; sleepware down 2% in the quarter. As Fred said, a bit of this is timing of demand. Sleepware is planned up over 25% in the fourth quarter and planned up 6% for the year.

Spring 2006 sleepware and playware shipments, based on bookings, will each be up over 10%. In the mass channel we achieved growth in both the Just-One-Year and Child-of-Mine brands. Most of the growth was in our Just-One-Year brand in the quarter. As you recall, we reported a 70% increase in second quarter mass channel sales with the Child-of-Mine brand wall reset in June this year versus July last year. Year-to-date, mass channel sales are up 27% with 25% growth in each of these brands.

As Fred said, we had lower growth than expected in our retail stores. Two of the regions had positive comps. The Southwest was up 5%; the Southeast up 2%; the Northeast – which represents about 30% of the chain sales – down about 3.7%; the Midwest down about 5%. Just to complete the results by store segment, strong performance in the brand stores. Their comps were up 5.5%. But the mill stores – these are stores in indoor air-conditioned malls – up 3.2% and the tourist locations down 0.08%. Trade area outlets down 1.4. The drive-to’s at the bottom down 3.7%. The drive-to outlet stores represent about 38% of the chain’s sales.

With respect to OshKosh, OshKosh contributed $96 million to third quarter sales. I’d say that is in line with the plan we shared with you on the last call. In mid September, we transferred all fifteen OshKosh lifestyle stores over to a third party who will close these stores. This transfer eliminated the lifestyle store losses from our results beginning mid September. The lifestyle stores were trending to contribute less than $10 million in annual sales with an operating loss of over $4 million a year. As part of our integration plan, we have identified a total of 38 underperforming OshKosh stores, including the 15 lifestyle stores, which we plan to close by June 2006. That is 22% of the 171 stores we acquired. All but five of these stores will be closed by the end of this year. The closure costs are provided for in purchase accounting and will not impact earnings. In total these 38 stores contributed only $33 million in annual sales. That is about $870,000 in sales per door and less than 60% of the sales we expect from each store. Collectively this group of stores was unprofitable and we believe had no hope for recovery.

With respect to margins in the quarter, very good results. On an adjusted basis, consolidated gross margin improved 260 basis points from 35% to 37.6%. The improvement was driven primarily by the Carter’s brand. On a standalone basis, Carter’s gross margin improved 250 basis points.

We continue to have great performance from out sourcing group. They are leveraging our increases in unit volume to negotiate lower product costs from our suppliers. Carter’s product margins in each business segment are better than a year ago. We also had good experience with excess inventory provisions in the quarter. Excess inventory for Carter’s products is down over 20% from last year. And the quality of the excess is good. We’re seeing good demand from our own stores and the off-price channel. OshKosh’s gross margin was about 38% in the quarter. That is in line with our integration plan. OshKosh’s gross margin has historically been higher than Carter’s due to its retail store sales mix, which is over 65% of OshKosh’s total sales. Carter’s retail sales are only 35% of Carter’s total sales. For the year, consolidated adjusted gross margin is estimated to be 36.6%, up 40 basis points compared to last year.

With respect to spending in the quarter, SG&A on a consolidated and adjusted basis was 23.7% of sales. That is up 130 basis points compared to last year. The growth is entirely attributed to OshKosh’s higher cost structure, given its retail store sales mix.

At Carter’s we continue to manage the growth and spending to be lower than the growth in sales. In particular, we’re reducing our distribution costs as a percentage of sales. Our distribution costs are the second highest component of SG&A, second only to retail store expenses. We’re realizing higher efficiencies in Carter’s new distribution center in Georgia, which have resulted in no increase in distribution costs this year. OshKosh’s SG&A in the quarter was over $3.5 million better than our plan. Half of that lower spending relates to the timing of investments and integration consulting services including investments kicking off a new brand study for OshKosh. Some of these investments previously planned for the third quarter will now be made in the fourth quarter. The balance of the lower spending at OshKosh relates to eliminating the losses from the lifestyle stores and lower spending in other areas. The net effect of the improvement in consolidated gross margin, good growth in royalty income from licensing activities slightly offset by higher SG&A drove our operating margin on an adjusted basis to 15.8% of sales in the quarter from 14% last year.

In terms of liquidity, cash flow from operations in the first nine months was $34 million. This strong cash flow enabled us to pay down $31 million of debt in the third quarter, $30 million more than required. We’ve had no revolver borrowings this year. Cash flow was driven by the growth in earnings and favorable changes in inventory. Inventory levels in our Carter’s business are 6% lower than last year due to the timing of product launches and timing of inventory receipts. We expect consolidated turns for the year to be four times. That is a good turn for our business and our best performance ever. Inventories are estimated to be $215 million at yearend, up $94 million, including $78 million cash inventory.

CpEx for the first nine months, $11 million for investments primarily in retail stores, information technology, and distribution centers. Including OshKosh, we expect CpEx for the year to be approximately $20 to $25 million.

With respect to our outlook for the balance of the year, we’re elevating our earnings guidance for the year due to much stronger third quarter results. Given the timing of certain investments previously expected in the third quarter and now planned for the fourth quarter, we’re estimating consolidated adjusted fourth quarter earnings to be $0.63 a share. That is the midpoint of the previous earnings estimate of $0.60 to $0.66 per share. At $0.63 in EPS fourth quarter earnings will be up 26% on approximately $340 million in fourth quarter sales. Carter’s sales on a standalone basis are planned up about 7%. OshKosh sales are expected to be approximately $90 million. We expect cash flow from operations for the year to be approximately $60 million. We’re planning on paying down an additional $10 to $15 million in debt by yearend reducing debt by over $40 million in the first six months following the OshKosh acquisition.

We’re firming up our plans for 2006. We’ll give first quarter and full year guidance on our next call in February. At this point what we can share with you is that our long-term annual growth objective continues to be 8% to 10% top-line growth and 15% to 20% annual growth in earnings. With a full year of OshKosh sales, we currently expect 2006 sales to be approximately $1.3 billion. At 1.3 billion consolidated sales would be up 17% next year.

Our focus is on improving the quality of OshKosh’s business, which among other ways, we’ll measure the improvement in OshKosh margin (indiscernible) improvement at OshKosh by their operating margin. There are a number of opportunities to improve OshKosh’s profitability, some of which we’ve already realized. The annual costs related to the former OshKosh executive team were about $4 million. The lifestyle store losses were over $4 million a year. We plan to lower OshKosh product cost by $5 to $7 million a year beginning in the second half of 2006. We also plan to lower OshKosh’s distribution cost by $5 million or more by implementing the cost-savings initiatives we’ve had success with at Carter’s. Last week we announced the closure of OshKosh’s Liberty, Kentucky distribution center. The savings will be over $1 million a year.

We’re integrating our benefit plans with savings of over $2 million a year. Suffice to say, we’ll realize significant savings from integrating our two companies. Keep in mind, we’ll reinvest some of these savings to rebuild OshKosh to realize this great brand’s top-line growth and earnings potential. For 2006, relative to our long-term annual growth objective of 15% to 20% in earnings, we currently expect to be at the top end of that range. Again, we’ll firm up 2006 guidance on our next call.

That concludes our business overview. We’ll open up the call to your questions.

Thank you. (Operator Instructions) Brad Stevens of Morgan Keegan.

Good morning. A couple of questions for you. I think you don’t normally comment on customers, but if could you give us some color on a couple of issues we would greatly appreciate it. The other day, VF commented that Sears is exiting a lot of its apparel business. How should we think about the Sears business going forward?

Number two, as per Federated May, we’re starting to hear a lot of chatter that Federated is starting to actively address both the breadth and depth of its vendors. What have you seen there thus far?

Number three, given Wal-Mart’s public comments that they intend to be more promotional this quarter going into the holidays than last year – does that impact you at all? Or is it just business as usual? Thanks.

With regard to Sears, there is no question that they are struggling. We’ve taken their expectations down. We don’t really have any concern about that because we have a number of other customers. Business is quite robust. So we know we’ll more than offset that issue.

As far as Federated May goes, we’ve had great meetings with them. Yes, you are right. They are starting to take a hard look at who they want to do business with. We’ve met with their very top people. We have another meeting in Atlanta soon with them. We have a major commitment together to grow both of our brands. I think they like Carter’s. They like the potential of OshKosh. My opinion is this consolidation is a great move for us.

With respect to Wal-Mart, we haven’t seen any pressure on promotions. I would say if there are any – there are some significant trends in the marketplace. One of them is to increase the level of design. We’re seeing that across all channels of distribution. Fortunately that has been a focus of ours. So it is not so much about lower prices as it is to offer the consumer better benefits. I would say that is a trend everywhere. We don’t see any real pricing pressures. We see though, being able to offer the consumer product benefits.

Alright. Thank you very much. Congratulations on a fantastic quarter.

Robbie Ohmes of Banc of America Securities.

Quick questions. I got on a little. Have you mentioned – the retail comps were a little light. Can you comment on how they are performing quarter-to-date right now? Have you seen improvement and why you have?

The second question is looking at how strong the gross margin was in the third quarter. Looking at the fourth quarter, is there anything that would prevent – is there any reason why the gains you saw in the core Carter’s business year-over-year would not continue in the fourth quarter? Also, should OshKosh continue to help the gross margin through mix shift in the fourth quarter as well? Thanks.

I’ll address the comps quickly for you. We felt that the third quarter, some of the problem was self-inflicted in that our comps were down 0.9% was really due to – we sold more than we expected to in the second quarter. So, we weren’t well positioned in inventories we started in July. It was compounded by a major systems conversion, which is behind us now. It hurt us, though, on the supply side to the stores June, July, and August – again, corrected by the end of August. We had a really good September. Weather definitely hurt. It was pretty miserable. It hit certain key selling periods.

It also – the fuel costs, we think, definitely has affected our drive-to outlet stores where the consumer has to drive in excess of 25 miles. So we saw that trend. There is solution to that I hadn’t talked about until you asked the question. We’re aggressively opening more of our brand stores because they are doing really well. They did – they were up almost 60% in the quarter. Even with lower inventories in those stores July and August, they were up 16% in September and they are doing well in October. We can, over the next few years replace a lot of those drive-to outlets. We’ve already put that in our strategy. We’ll have a combination of (inaudible) with the brand openings and the breadth that has from (inaudible) upgrading our portfolio.

October, November, and December we were up 13% last year in that quarter, so that is a challenge. We were up 18% in October. I don’t like quoting monthly comps because it takes one hurricane to have a bad month. But then you have great months. We’ve seen that historically most quarters we will have one weak month. These were two really good ones. What is encouraging with October being up 18% last year, we’re starting to trend hopefully to a positive month. That is good news. I’ll let Mike come back to the gross margins.

Let me answer this core thing. I am sure some of this is on your minds. It is a bit of long answer. I think it is important to understand. We didn’t buy OshKosh because we felt we were getting weaker in Carter’s core businesses. We bought OshKosh because the debt was worth the earnings horizons. With respect to Carter’s, our baby business, we have a new (indiscernible) starters launch that is the result of this brand study we’ve done for a couple years. It’s increased demand on the reorder and replenishment business. The baby business is selling twice the sell-through rates as it did before we launched the new brand package. So our first six months of ’06 should be well above plan. We have four new classic launches at Carter’s starting 10/20 this year to 2/20 all have adjusted well. They should really help our core business. In sleepware will up 6% yearend. We’re expecting a very strong fourth quarter. Spring bookings are up double-digit. We’ll have more emphasis on improving the branding launch for fall ’06. Our play clothes is up double-digit for spring. We’re the best performing brand at our customers as we’ve transitioned that business to core. The Carter’s stores – the brand stores I’ve already spoken to. We’ve tested higher price points in those store in our core businesses. They performed at really good levels, even better than before we elevated some of those price points. They had good performance in the stores. The key accounts at Carter’s – I’ve mentioned Federated May – we’re very optimistic there. We’ve had good meetings with Penney’s . Kohls is going to open up 100 stores a year. We really do well there. We’re meeting with Babies R’Us next week. We certainly have had good results there. We expect them to accelerate their openings. We don’t have to really materially increase our market share a lot to gain more share in our core accounts there.

At the mass channel, Joy at Target, we’ve reset the wall. Additional selling is good. It’ll generate reorders. We’ve booked all of spring ’06. It’s in line with our plan. The hanging apparel baby – we’re extending. We will pick up a rack. In the sleepware we’ll get an extra rack. Target, the (indiscernible) of Dayton-Hudson is accelerating their store openings. There is significant opportunity there. At Wal-Mart we’ve reset the brand. Good reorders. Spring is booked. We’ve gotten big orders in play clothes for fall ’06 at Wal-Mart. We’re extending the hanging baby racks. We’re extending in sleepware. They increased their buy in sleepware by 25%. I think they will also be opening some stores. Basically in the mass channel, we will get more productive. We’ll have store growth. We’ll have comp store growth. We’ll have extensions that will give us space. We’re confident in these core businesses.

That’s a long story to your question. I am sure it’s----

That’s a terrific answer. And then just on the gross margins.

Just to frame it up, the consolidated margin was 37.6% in the third quarter. Our current plan for the fourth quarter is about, let’s say 80 basis points lower than that. That reflects our game plan for the Carter’s brand. It’s driven by product mix largely. We had a very successful launch of our new starters program in the third quarter. That is our highest margin business. We’re planning over 25% increase in our sleepware business in the fourth quarter, which relative to baby, is a lower margin business. It’s largely reflective of product mix. And for our business, 37 points in round percentage in the [third and] fourth quarter – that’s a good margin for our business.

Alright, terrific. Thank you very much.

Margaret Mager from Goldman Sachs.

Good morning. It’s actually [Randy Conneck] for Margaret Mager here. Going back to the retail comps, I want to get a sense of, in general, the ticket trend versus the traffic trend. In diving more deeply into traffic, give us the differential between the traffic you saw in the strong comps at the brand stores versus – assuming you had down traffic – at the drive-to outlets. Can you provide some color around that with that consumer?

And then in going over – thinking about years ahead or going forward to the OshKosh integration, what do you think about applying – in terms of carterizing the OshKosh business? What is a reasonable expectation that you think about getting the OshKosh margins more in line with the Carter’s business over a period time. How do you think about that timing horizon internally.?

Finally, with the closing of 22% of the OshKosh stores, would there be any plans whatsoever to ever put any of the OshKosh brand into your Carter’s-owned – the Carter’s stores?

Let me handle your question with respect to retail. Then we’ll take them one at a time. In terms of what you are seeing with the comps, you should view that largely as traffic-related. Comps were down nine-tenths in the quarter. Traffic was down 3.4%. The average dollar amount of each transaction was up nearly 3% – about 2.6%. The units per transaction were up 1.7%. That is in total. If you look at the brand stores, brand stores were up 5.5% in the quarter. Transactions – the number of transactions up about 4.5%. The average dollar value per transaction was about 1% and the units per transaction, up some portion of 1%. It’s largely traffic related.

Specifically to your question on the drive-to outlet stores, the traffic in the drive-to outlet stores – down 6.5%. Comps for the drive-to was down 3.7 and traffic down 6.5%. The dollar value of the transactions for drive-to stores was up 3% and UPT is up 2%. I think it’s Fred’s point. It was miserable weather and with gas prices going up, you think twice about driving out to a store that is 30 to 40 minutes outside of where you live. The beauty of our company is, we’ve got alternatives. You have the brand stores. You’ve Kohls. You’ve got Penney’s. In the mass channel you have Target and Wal-Mart. Wherever you are shopping for a young child, you’ve got a great Carter’s brand presented. So you should view what you are seeing in retail this quarter as largely traffic-driven.

With respect to your questions about OshKosh, we do and don’t want to carterize it. We do want to carterize it in terms of good marketing discipline, getting into essential core products, getting out of complexity and high fashion. We want to caterize it on the operating discipline side. We’re really good at that. I would say they have been very receptive to this [discipline] (ph). But it’s not the same animal on the front-end. These brands are distinct. We wouldn’t have purchased OshKosh had we not felt that they would not cannibalize one another. There are commonalties in that they could be in both (indiscernible) core products and broad categories premium quality, (indiscernible) pricing. But the difference in the brands distinctively – Carter’s is younger and leads with baby and sleepware. And OshKosh is older and should lead with toddler and 4-to-6X, 4-to-7. Carter’s is softer imagery, more an adorable brand with the adorable application on the garments, more knit. OshKosh would be more durable, rugged, more emphasis on [performance] (?) and particularly strong denim offerings. OshKosh would be more authentic. It may be that Carter’s should be more inside and they are more outdoor. Those should be [proper] (ph) priced for us. We suspect OshKosh has a better consumer. The target is to fix this thing (indiscernible) ’06. As I mentioned, get the complexity out, get the core strength, and get the proposition right, and start lowering costs. We are already doing that. We’ve actually made some progress with their summer line. We think their summer line is better and is definitely more focused. We just haven’t put that in our plan. Closing the stores to get out of some of these bad locations. We’re going to open stores. Eventually we think we could open brand stores as we move more through this brand study we’ve just started. As far as having one big store carrying both brands, it strikes me as not smart. We haven’t gotten there yet. That is not the first priority of business.

Okay. Thank you very much.

Melissa Otto, DE Investment Research.

Good morning. Congratulations on a great quarter. Just a couple of questions to follow-up. First of all, how does the tax break out for both the Carter’s business and the OshKosh business?

The effective tax rate?

Exactly.

Just assume it’s 39.5%. If you were to look at OshKosh’s historical results, they have historically had a lower effective tax rate than Carter’s. But then again in the third quarter, OshKosh earnings on a GAAP basis – there weren’t significant earnings. As OshKosh starts to produce, pre-tax income and you have something to take an effective tax rate against, we’ll start to see a better overall Company effective tax rate.

Okay, thank you. A follow-up on the margin question. In terms of the operating profit margin, you had mentioned that there was a 15.8% Carter’s margin for this quarter. How sustainable is that going forward?

Our plan is to continue to improve margins. Our focus is primarily on the operating margin because you are always going to have channel mix and product mix. We think Carter’s together with OshKosh, which historically has been a higher margin business in part because of the higher retail store mix – our plan is to continue to improve margins. It may not be improving every quarter, but on an annual basis, our plan is to improve margins. Our focus is improving the operating margin at least 25 to 50 basis points a year. So is it sustainable? I believe it is.

For that 25 to 50 basis points, is that applied to the OshKosh business as well?

I am talking overall yield. You will see acceleration in OshKosh’s operating margin. They are a fraction of where their operating margins were just three years ago. You’ll see acceleration in OshKosh’s operating margin. Of course, the operating margin is a fraction of what Carter’s is. It will be a nice contributor for a long time.

Great. And then could you give a little bit more color on the departure of Mark Searstad?

Well, as I stated, he left for personal reasons. We were fortunate to come upon Patty DeRosa. We think that – I think I stated that she has such skills that we were very fortunate to convince her to join us. It just matches up with the way we want to take this business. We’re all about brands. We’re all about increasing the power of the brands. We’re all about making our retail more important to brand. I’ve discussed this when we talk with our key customers about our brand stores. They took it very well. Because it’s a little bit like [a toast] (?) for them. The stronger this brand, the more the pull-through for the Carter’s brand in the wholesale channel. And the better the Carter’s brand performs also channel, the better the discount channel brands will perform as well. They are very receptive to that. She just has extraordinarily broad skills and she is a terrific leader.

Okay. Last question. What retailers performed particularly well for the OshKosh wholesale business?

You mean last year? Nobody performed particularly well. We had talked to a number of those retailers. They all had great respect for OshKosh. They view OshKosh as a firehouse in toddler and the older segments. They look forward to – I don’t want to say carterizing. It sounds like it’s a me too. They look forward to being a part of our Company and our accomplishments. They have great confidence that we are going to do a really good job together with OshKosh. I’d say the future is bright.

Thank you very much.

Dennis Rosenberg with DSR Consulting.

Good morning. I’d like a little more color on your ’06 guidance. You talk about 17% sales growth and 20% earnings growth. You are expecting margin improvement in the Carter’s business and you are expecting increased synergies in the OshKosh business. It seems to me that that 20% is a very, very, very conservative number.

It’s based on where we are right now. We’re meeting with our Board next week to walk them through our plans for the balance of the year and our growth initiatives for next year. I just think it’s more in line with what we’ve done historically at this point. Where we are relative to ’06, we want to get it buttoned up and see how our fall bookings come in, which are a major driver of the growth that we envision for next year. We’ll have those bookings by the end of January. It’s just trying to give you some thoughtful guidance based on where we are right now relative to Carter’s and where we are on the integration. We’ll update you more. It’s a fair observation. It’s the way we like to guide the market.

Okay, that was it. Thanks.

(Operator Instructions) Christina de Marval with Next Generation Research.

Good morning everybody. Nice job. On guidance, while we’re on the topic, I am wondering with respect to the ’05 guidance, I think you cut roughly 12 million off the top-line. Is that mainly attributable to the planned OshKosh store closures? If that is the case, why wouldn’t you actually elevate the earnings guidance to the extent that those stores were unprofitable?

Suffice it to say, it’s a major component of the revenue guidance. Keep in mind, when we gave guidance I think it was a week or so after we had closed the transaction. So we wanted to make sure that we were appropriately guiding the market. We assumed that the store closures would happen by the end of the year. We made good progress lining up someone to take over responsibility for closing those stores for us. We got that done a little bit sooner than expected. We got a bit more aggressive in cleaning up the portfolio. There were a number of outlet stores that we felt were marginally profitable and trending negative in centers that we felt really didn’t provide any hope for sustainable growth. So we got more aggressive. You should view that as largely taking more stores out than we planned and getting it done sooner than we planned.

Again, with respect to the earnings guidance, relative to where we thought we would be before, the difference between the guidance we had taking the [spit] (?) point, is largely based on the timing of investments. We are engaging the same firm that we used for the Carter’s brand study. We had very good results from that. We are going to kick off that same type of study for the OshKosh brand. We are also lining up a number of consultants who are helping us with things like integrating the technology systems and developing a distributional logistics strategy. One important thing you need to understand is there are investments that will need to be made in the OshKosh brand. It is not a company that has made significant investments in recent years. A lot of the savings we realized we will put back into the business to get it back on a growth curve.

Okay. That’s very helpful. On the topic of the stores that you’re closing at OshKosh, I presume there is a lot of overlap with the Carter’s outlet stores. You probably are quite familiar with the specific real estate. Is there any common denominator? Can you elaborate what the specific issues with the stores? Were they too big? Or locations? Is there anything that you can share with us?

We are in many of the same outlets. We don’t consider that to be a problem because the brand proposition is different. We don’t feel that it would be a canabalizing of those. We will be opening four OshKosh stores in the outlets. As far as the brand stores go, we’re not sure yet until we get well into this brand study, where they should be located. I don’t know that they shouldn’t be mall stores – whether they should or shouldn’t. I think their lifestyle stores – it’s probably a good idea, just poorly executed.

Taking out the 15 lifestyle stores, there are probably a good 15 to 20 outlets that you are also closing for OshKosh? Would you reopen in some of those same places with different circumstances in the future?

No. Those sites were undesirable sites. There are about 23 of those outlets in total that we’re closing. They are just bad locations. They are different from where Carter’s is. There are some really bad outlet locations, so it’s not a conflict.

I see. Also on the topic of OshKosh, can you share what the earnings contribution was in the third quarter and where you expect it in the fourth quarter?

Just so you know, they have contributed nicely to third quarter earnings, better than we expected. To give you their earnings accretion – their earnings accretion would be a non-GAAP measure. We are precluded from giving a non-GAAP measure. Just know that they contributed nicely to third quarter and they’ll contribute nicely to fourth quarter. I would say we are ahead of the guidance that we gave you on the last call.

Mike, with respect to inventory, why do you expect that to go up relative to the third quarter at yearend? Do you think (multiple speakers)?

Yes. We are comfortable with that yearend inventory. What you see in the third quarter is somewhat timing related. We had a major launch of baby in the third quarter for our new starters launch. Last year that was in the fourth quarter. You should view that as largely the timing of product launches and the timing of receipts. We’re very comfortable with both the level and the quality of the inventory at the end of the year.

Final question. You’ve tested some higher pricing in your brand stores. Can you share any feedback on the findings there?

We don’t like to discuss a lot of that for competitive reasons. We have taken some of our core baby products and elevated (inaudible). The strategy of the brand stores is to make sure that we don’t under-price our department stores. By doing what we did, we were bringing that more in line. The findings were really good. It just showed that as we have increased the level of design in our products we can get more for them in those stores. They would have a better pricing formula than our outlets.

Okay, thanks. That’s helpful.

Marie Driscoll with S&P.

Congratulations on the good earnings. Could you – one of my questions was answered. I was particularly concerned about outlet channels traffic. I guess you said it was down 6.5%?

That was in the drive-to outlet centers. That is the traditional outlet center that is a good 30 to 40 minutes outside of where most people live.

Right. Is that like an off-price channel?

It’s an outlet. It’s a traditional outlet center. It’s like the [tanger] (ph) outlets.

Okay. Yesterday on a Coach call, they differentiated between a more luxury outlet channel and a typical outlet channel. Are you in both types?

Sure, yes. Yes. I would say we are. Keep in mind what Coach does too, is they have invested so much in that brand in their stores, which we admire. We’ve spoken to them about how they do that. That is one way they drive up that outlet traffic. We have like five channels within a channel as Mike referred to earlier. Drive-to as being the weaker of the five because of having to drive so far, fuel prices and weather having an impact.

What we also measured in conversion. We did not do that until I would say six or eight months ago. We’re seeing real improvements in our conversion rate. Our brand store conversion rates are pretty (inaudible). And a couple of our other channels in the channel, we’re very impressed with the level of the conversions. We not only just measure traffic, we measure what happens once they get in the store. As I mentioned earlier, UPTs transactions. So the key metrics are good. It’s just that outlet drive-to is weaker. It’s not a disaster. But it is something that we can, over the next two-to-three years, correct and upgrade that portfolio.

Can you remind me of your traffic in the brand stores?

Yes. Traffic was up about 4.5%, total comp up 5.5. We had a nice lift from the average transaction value in units per transaction.

I have two other questions. One is, are you seeing an impact of higher energy costs on your distribution costs and your sourcing costs? I know you mentioned that sourcing improved your results about $0.10.

Correct. There is no question we’re seeing impact from the fuel prices. Fortunately we’ve got some initiatives, particularly leveraging the significant increase in unit volumes to negotiate better prices, which is more than offsetting anything we’re seeing on the fuel prices.

My final question. Can you remind what percent of your wholesale business is with Federated May? Why do you think – your comments earlier were that you thought it was positive there since the merger. I am wondering why.

In terms of percentage you can measure it in the mid single-digits.

For the combined?

Correct.

On the second part. Federated feels that it is a must to attract the young consumer and particularly the young mother. They’ve done considerable studies and have determined that if you get her in the store, she is going to shop more than just young children’s business. They definitely know that we own the two best brands in the business. What we are meeting on is not a question of whether we do more business. It’s how to be a better partner. So that consolidation is good news.

Were you stronger in Federated or in May?

Carter’s was doing a good job in both. OshKosh was just in (indiscernible). We hope to have their brand in all of Federated.

When you said the mid single-digits, did that include OshKosh?

No. I am just referring to Carter’s.

Can you give me what OshKosh’s was?

Also a very small percentage.

Great. Thank you very much.

That is all the time that we do have for questions for today. Mr. Rowan, I’ll turn the conference back over to you for any closing remarks.

Good. I will just say quickly in closing that we’re more confident than ever in our ability to perform for our shareholders. We like what we’re doing in our core businesses. They are continuously getting elevated. We are a far more talented Company than we were. We have some great additions to our talent base across all functions. We’ve got a great brand in OshKosh already showing some signs of improvement. We couldn’t feel better about the potential of it. We have the ability to invest where it’s needed. We’re quite capable of investing in key areas. We have not been sacrificing the short-term gains. We are really building this Company for the long haul. We’ll look forward to our next call. Thank you.

This does concluded today’s Carter’s call. If you would like to listen to a replay of the call, it will be available beginning at 11:30 eastern time today through midnight Friday, November 4. The dial-in number for the replay is 888/203-1112 in the US and Canada and 719/457-0820 for international locations. The confirmation to access the replay is 7496311. Again that is 888/203-1112 in the continental US and Canada and 719/457-0820 internationally with a confirmation code of 7496311. You may disconnect at this time. Please have a great day.