Carter's Inc (CRI) 2006 Q3 法說會逐字稿

Ladies and gentlemen, please stand by. We are about to begin. Welcome to Carter's third quarter 2006 earnings conference call. On the call today are Fred Rowan, Chief Executive Officer; Joseph Pacifico, President; and Mike Casey, Chief Financial Officer. After today's prepared remarks, we will take questions as time allows. (OPERATOR INSTRUCTIONS). If you have any follow-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. (OPERATOR INSTRUCTIONS).

Carter's issued its second quarter earnings press release yesterday after the market close. The text of the release appears at the Company's web site at Carter's.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 Company's most recent annual report filed with the Securities and Exchange Commission.

Also on this call, the Company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial information is provided in the Company's earnings release.

Now I would like to turn the call over to Mr. Rowan. Please go ahead, sir.

Good morning. Before Joe and Mike speak in detail to our third quarter results, I would like to give you an assessment of our business and some insight into our primary areas of focus.

We had a good quarter, exceeding top and bottom line guidance. We are committed to continuing delivering high returns for our investors. As I have stated in recent calls, we are a company in transition, focusing and investing in the significant elevation of product design, retail productivity and brand equity. We certainly would admit that it has taken longer than anticipated to fix the OshKosh product agenda in our retail stores.

We believe we can make a bigger impact in the second half of this year; however, it will occur during the first of 2007.

Fortunately, we have multiple growth platforms, which are Carter's wholesale channel and our mass channel brands. They're connected to a very efficient and cost reducing supply chain. These channels and supply source have exceeded expectations in the third quarter and all year. We're confident we have a strong OshKosh product offering for spring 2007 and summer 2007. Customer reception has been strong, and forward-lookings validate our progress.

Carter's bookings for spring 2007, baby sleepwear and play clothes are at record levels. Therefore, we expect good momentum from both brands as we enter 2007. We studied both our brands, beginning with Carter's, nearly two years ago and, most recently, OshKosh. We learned a great deal and concluded the following.

Our brands have great imagery and powerful potential, unlike most. OshKosh still resonates high with the consumer.

First and foremost, we should significantly elevate product design, incorporating distinct brand point of use plus we should more frequently innovate. We did that and started after Carter's Baby during 2006 with resounding success. We have done that for baby sleepwear and play clothes in Carter's as we entered 2007. We have done that for OshKosh spring and summer 2007.

Secondly, it was recommended we should elevate the emotional connection of our branding and product to the consumer at the point of purchase. We launched a new marketing packaging for Carter's Baby this year, also with great success. We will launch a new marketing package for OshKosh for fall 2007, which should be material.

Thirdly, we needed a far better shopping experience in both brands' retail stores and a powerful customer relationship plan. We are at various stages but have a point of view we're launching with Carter's and spring 2007. OshKosh will begin with the spring 2008 line, which launches late next year.

It was also recommended we upgrade Carter's design skills and both brands' retail skills. We hired a chief designer for Carter's who has heavily influenced our spring 2007 lines, and we're well into the fall development. We're witnessing, I think, remarkable changes. At retail we now have two GMMs, ahead of visual marketing, a VP of planning and allocation and a new senior executive store operations plus the significant upgrade of regional VPs, district managers and store managers.

Finally, we needed to build in-house marketing skills for our brands and stores. We recently hired a chief marketing officer and support staff and connected our wholesale to our retail strategy.

All investments are baked into our numbers yet we still perform at very high levels. We have never been reluctant to be bold for future growth.

Lastly but material to our future is our most recent decision to place [Patty DeRosa] as President of Marketing, responsible for Carter's and OshKosh's brand marketing and their product offerings. Joe Pacifico will assume leadership of our stores while we search for a president. Patty has helped transition OshKosh products for spring and summer to a highly competitive level and had our new chief designer for Carter's and has been advising us on Carter's as well.

With this change, she can get her arms around the entire marketing agenda, which will accelerate our results. Joe can concentrate on retail execution. We have big opportunities, particularly since Patty has recruited such a capable staff.

With that, I will turn that over to Joe.

Good morning. On a consolidated basis we had another positive quarter. Our performance is a result of our balanced portfolio, made up of strong consumer brands, central core products and a diversified distribution strategy that reaches consumers where they shop.

I will now walk you through each of our business segments, starting with Carter's wholesale. Excellent quarter at Carter's wholesale. Start with the product -- over-the-counter sales in Baby have been excellent, as they have been all year. Fall sleepwear and play clothes over-the-counter were also strong. We believe our customers' inventories are much clearer at the end of quarter than they were last year, and we're in good position as we enter the fourth quarter.

We also continue to realize strong results with the best retailers in the segment. By driving topline revenue growth, increasing turn and lowering inventories, we're really helping our customers run more profitable businesses.

Our supply chain continues to get stronger every year and has become a competitive advantage for us. We're well positioned to take on the increased demand being placed on suppliers as a result of the ongoing consolidation at retail. 2006 will be another strong year for Carter's brand wholesale.

As we look forward into spring 2007, we have had excellent reaction to our spring line. All of our final bookings are in, and we are up double digits across all three of our product markets. We attribute this success to our investments and focus on design and product elevation.

Talk about the mass channel -- we had another excellent quarter in mass. Productivity gains in the existing space at both Target and Wal-Mart was the driving force behind our third quarter growth. Both Target and Wal-Mart each grew by 15% versus the prior year.

We had excellent over-the-counter selling, which resulted in solid growth in all product markets. I'm particularly pleased with the fact that over half of our growth in each account was fueled by productivity gains.

For the quarter, our growth at Target was accomplished through 8% productivity, 5% two new doors and 2% incremental space. At Wal-Mart the growth was a result of 9% productivity, 3% new doors and 3% timing of shipments. We expect the mass channel to grow plus 20% for the year. Together, Target and Wal-Mart control almost 30% or $5.2 billion of the U.S. apparel market for young children. Even though we continue to gain share based on our performance, we still only have slightly more than a 5% share in this market. I think this underscores the opportunity we have for continued growth.

I'm confident in our ability to achieve our 2007 plan, based on the spring 2007 orders which we already have in hand and the positive momentum we have experienced in 2006.

Talk about Carter's retail -- at our retail stores quarter three was not as strong as we had expected, but we did have positive comps in September that resulted in positive comps for the quarter. Definitely think that the July and August performance was negatively affected by the spring carryover inventories that we discussed on our last call. September provided good performance across all product markets, and we ended the quarter in a good inventory position. We have less inventory than a year ago, and the quality of this inventory is much better.

My immediate focus in retail is strengthening our execution. We have been in a transition period this year and have had an entirely new retail leadership team. At the same time, we tried to change many parts of our retail model very quickly, and we didn't execute as well as we should have. Our strategies for retail include product elevation, better inventory management, more compelling store layouts and super pricing. Fortunately, we have a good team in place and we will be focused on executing the strategies.

With our stronger product agenda for 2007 and the execution of our initiatives, I believe we will have a strong 2007.

Now I will talk about OshKosh. Overall, we're making good progress at OshKosh. I believe we have improved the quality and the profitability of the business. We're consistently improving the product and the price-value equation in addition to reducing the complexity associated with the old business model.

Specifically talking about OshKosh wholesale, as we discussed on previous calls, wholesales will be down for the year. This decrease is a result of our decision to close unprofitable accounts from last year and the fact that we positioned the price model too high for [fall].

The fall product also was better but really not up to our expectations and not strong enough to offset the unprofitable businesses we exited the year before. We made a lot of changes based on fall and have significantly improved the product by also changing the positioning and pricing for spring 2007.

Our spring bookings are up 10% a dozen and 3% in dollars. Our summer bookings show further improvement, and we're projecting they will be up double digits. Our customers have provided a lot of positive feedback for our creative expansion of the core items at key price points, so we're executing the right strategies at OshKosh.

In addition to these improvements in product, we have also established a dedicated sales team which will focus entirely on the OshKosh brand.

Talking about OshKosh retail at our retail stores, performance was negatively impacted by the fact that fall product was again positioned too high and did not offset the businesses we exited, including adult apparel. Again, product not up to our expectations.

Our single most important priority for OshKosh was to improve the product, and we expect to see the results in both our wholesale bookings and retail over-the-counter sales going forward. This is where we will have the biggest impact for the brand.

In addition to product, there are definitely other opportunities at the store level. Our focus will be on superior execution and on establishing stronger key item presentations on the floor.

In closing, I would like to reiterate our reason for the strength of our business. It's derived from our focus on the core. As we move forward, we will continue this focus, and focus on product elevation, investments in branding, strong partnerships with the best retailers and superior execution. We have made great strides with establishing these disciplines in OshKosh, and we believe the benefits of integration will continue.

The strength of our product and the talent of our people give me great confidence as we move forward into the final quarter of 2006 and into 2007.

Now I will turn it over to Mike Casey, our CFO.

Good morning, everybody. I would like to walk you through our third quarter results. Then I will update you on our outlook for the balance of the year.

For the quarter, we reported GAAP earnings of $0.57 per diluted share, which includes acquisition-related charges of $0.01 per share for the amortization of OshKosh intangibles and $0.01 per share in compensation expense related to the new standard for stock option accounting.

Our third quarter results in 2005 include charges of $0.34 per share related to the refinancing of Carter's [deck], and charges associated with the acquisition and plain closure costs. Because these charges impact comparability, I will comment on our results and our guidance excluding these charges, which is outlined in our press release.

Excluding these charges, adjusted earnings for the third quarter are $0.59 per diluted share, up 16% in the quarter, and $0.03 better than the guidance we shared with you on our last call. Our results reflect the strength of our Carter's wholesale and mass channel businesses, which helped to offset lower-than-expected performance from our retail segment.

In the third quarter our consolidated sales were $392 million, up 5%. Excluding OshKosh sales, Carter's sales increased 10% to $303 million. OshKosh sales of $89 million were down 8% in the third quarter, largely due to our decision to edit out unprofitable sales from certain wholesale customers and the impact of closing 32 OshKosh stores or about 18% of the stores we acquired.

Our consolidated wholesale sales increased 4% in the third quarter. Excluding OshKosh and off-price sales, Carter's wholesale sales increased 9% in the third quarter. That's better than our guidance of 4% growth, due to the strong performance of our baby and sleepwear products. OshKosh's wholesale sales, excluding off-price sales, were down $3.9 million or 14% in the third quarter, largely due to editing out about $5 million of unprofitable sales reported in 2005.

As Joe mentioned, our mass channel brands -- Child of Mine and Just One Year -- continue to experience very strong demand with sales up 15% in the third quarter compared to our guidance of 12% growth, with stronger than expected performance in our baby and sleepwear product categories. On a consolidated basis our retail sales were up 3% in the third quarter, our growth weighed down by a decline in OshKosh's retail sales. Carter's retail sales increased about 7% in the third quarter. That's total growth, in line with our previous guidance.

Comp store sales in our Carter's retail stores were about $1 million lower than planned. Our comps were up 1.7% in the quarter versus our guidance of 2% to 4% comp growth. Offsetting the lower comps were sales from our new stores, which were about $1.4 million better than we expected.

For Carter's stores on a comp basis, our transactions increased 4% in the third quarter. Our units per transaction were flat, and our average transactions -- pardon me, our average prices decreased 2.5%. The lower average prices were driven primarily by a more aggressive promotion of our fall playwear products, which represented 38% of our third quarter sales at average prices 8% lower than last year.

Fall got off to a slow start because of our promotions on spring, which consumers responded to more favorably than our fall play clothes, particularly in July and August. Comps for spring playwear grew 8% in the third quarter, whereas fall playwear comps were flat. The only decrease in comps in the third quarter was in our accessories, which includes bedding, hosiery, shoes, and toys. Accessories represented 15% of our third quarter sales with comps down 6%.

In the third quarter, we aggressively promoted certain components of our accessories to reduce the scope and improve the productivity of space devoted to accessories. Our strongest comps continue to be in our baby category with comps up 9% in the third quarter, up 9% year to date. Baby comps were positive across all three regions and across all store segments. Average prices in our baby category were up 4% over last year.

The performance of our new stores is consistent with what we shared with you on our last call. We have opened 23 Carter brand stores and three Carter outlet stores over the past 12 months. As it relates to our new brand stores, many of these stores are in new centers but not yet getting the traffic we expected. On average, these new stores are expected to generate about $900,000 in sales in their first year.

As traffic builds in these new centers, we believe the stores will achieve our financial objectives of $1.3 million, per door in the [infill segments].

The new outlet stores are off to a stronger start. On average the outlet stores we have opened in 2006 are on track to generate about $1.5 million in sales in their first-year, which is consistent with our model.

OshKosh's retail stores contributed $63 million in sales during the quarter, about $4 million or 6% lower than the previous guidance. As we discussed on our last call, our fall 2006 product was not as strong as we had hoped, and our sales were negatively impacted.

With respect to profitability, on an adjusted basis our consolidated gross margin in the third quarter was 37.6%, a bit better than the 37.5% reported last year.

Gross margin for our Carter's brand products including mass channel was down 90 basis points from last year, driven primarily by a decline in gross margin from our retail stores due to higher promotions of fall playwear accessories.

With respect to OshKosh profitability in the third quarter, gross margin as adjusted for last year's acquisition charges improved over 300 basis points. We have improved OshKosh's gross margin by editing out low-margin customers, low-margin products, closing unproductive stores and improving the sourcing formula.

For the year, we expect our consolidated gross margin will be comparable to the 36.7% we earned in 2005.

With respect to spending in the third quarter, on an adjusted basis our consolidated SG&A was 23.3% of sales; that's 80 basis points better than our guidance and 40 basis points better than last year. We have made significant investments in our retail segment, which we've funded by controlling the growth of spending and reducing costs as we integrate OshKosh.

On a consolidated basis, our royalty income for the quarter was $7.8 million, including $3.6 million from OshKosh. Excluding OshKosh, our royalty income was flat in the quarter, due primarily to the reduction of our accessories in our retail stores.

On a consolidated and adjusted basis, our operating margin was 16.2% in the third quarter, up 50 basis points compared to last year. We have made significant progress improving OshKosh's profitability this year, and we are on track to achieve our cost reduction objectives.

Keep in mind OshKosh had an operating margin of about 5% in 2004 and it was trending to be less than 5% at 2005 prior to the acquisition.

For 2006, we expect our consolidated operating margin will be 13%, equal to 2005. We view this as very good performance, given the fact we have absorbed a full year of OshKosh's results this year; whereas last year we had the benefit of including only its most profitable part of its year, in its second half.

Interest expense for the third quarter was $6.6 million; it was down 12% compared to last year. The decline in interest is due to the progress we have made in reducing debt since the acquisition. A year ago we borrowed $500 million to finance the acquisition and to refinance Carter's debt. Since the acquisition we have reduced debt by $107 million or 21%. We plan to pay down an additional $30 to $35 million on the term loan in the fourth quarter, which would bring debt reduction for the year to approximately $70 million or 17% reduction this year.

Given the interest rate protection in place and the benefit of the refinancing last year, we expect our average borrowing rate for the year will be about 6.5%, which is comparable to last year.

Just a few comments on the balance sheet. Inventories at the end of the quarter were $200 million, down 5% compared to last year. This decrease reflects lower levels of excess inventory, the closure of 13 OshKosh retail stores since the end of the third quarter of 2005, lower levels of average inventory in our retail stores, and the closure of OshKosh's offshore facilities.

CapEx for the first nine months was $16 million, primarily for 22 retail store openings and the system's integration. We expect CapEx for the year will be about $35 million, over half of which will be invested in our retail stores.

With respect to guidance, we expect to achieve the high end of our previous guidance for both the sales and earnings this year. We're projecting our consolidated sales will be $1.340 billion, up 20%, and earnings are projected to be $1.50 per share, up 23% for the year. Inherent in this guidance are consolidated fourth quarter sales of $374 million, up about 70%.

Carter's sales on a stand-alone basis are expected to be up 14% in the fourth quarter. Carter's wholesale sales excluding off-price sales are planned up over 20% in the fourth quarter, up 10% for the year.

Mass channel sales are planned up 10% in the fourth quarter -- up over 20% for the year. Carter's retail store sales are planned up 6% in the fourth quarter with comps flat to down 2%. For the year, Carter's retail sales are expected to be up 5% with comps flat to last year.

That brings total sales for Carter's on a stand-alone basis to over $1 billion, up 10% for the year.

For OshKosh, we expect fourth quarter sales will be $93 million, down 11% from the fourth quarter last year, due to editing out about $11 million of unprofitable sales reported in the fourth quarter of 2005. OshKosh's wholesale sales are planned down 11% in the fourth quarter. OshKosh's retail sales are planned down 5% in the fourth quarter with comps down 4% to 6%, due to fall and holiday product performance.

This brings total expected sales for the year for OshKosh to $323 million.

On an adjusted basis, we expect our consolidated gross margin in the fourth quarter will be 36.9%, comparable to the fourth quarter of 2005. On an adjusted basis, we plan to improve our consolidated operating margin in the fourth quarter from 11.8% to 13.9%, driven by a lower SG&A, which is projected to be about 25% of sales, down 210 basis points from last year.

The improvement in SG&A reflects a lower-level of spending on recruiting and consulting, relative to the fourth quarter of 2005.

With respect to earnings, earnings per share for the fourth quarter are planned at $0.46 per diluted share, up 35% compared to last year, excluding non-cash charges of $0.01 per share related to the amortization of OshKosh intangibles and $0.01 per share in compensation expense, related to the new standard for stock option accounting.

For comparability purposes, our projected earnings growth of 35% also excludes $5.5 million in charges in the fourth quarter of 2005 related to the acquisition of OshKosh. Again, these charges are outlined in the press release. With respect to cash flow, we expect cash flow from operations will be $70 million this year, and that's consistent with our previous guidance.

We will give more specific guidance on 2007 on our next call in February. We continue to believe our business supports 8% to 10% growth in sales, and 15% to 20% growth in earnings on an annual basis.

As you have heard, we've made significant investments in our spring and summer product lines, elevating design through color and art. As Joe said, our customers are responding very positively to our spring and summer product lines. Our investments' upgrading product are expected to initially lower our gross margin by about 50 basis points for fiscal 2007. First-half margins may be more meaningfully impacted.

We're committed to funding this near-term gross margin reduction and improving our 2007 operating margin by at least 25 basis points by managing the growth in SG&A. We will provide more information in February after completing our 2007 plan.

That concludes our business update, and we will open up the call to your questions.

(OPERATOR INSTRUCTIONS). Omar Saad. Credit Suisse.

If I could, if you take on -- because it sounds like some expanded responsibilities related to the retail business. I was hoping you could elaborate on some of the execution issues you've mentioned earlier in the Carter's business. What are some of the -- maybe if you could give an example of a few of the key points you think where you guys missed and the opportunity to improve the performance there?

I think our initiative to reduce our inventories, introduce product more frequently was a good strategy. I just think we didn't executed it well, and that we probably tried to execute it midstream. You really have to do that from the start of the season. So I think we tried to catch up, and we probably made some inventory mistakes -- not as lowering the inventory but the way that inventory was delegated. It should have been, probably, in a few different products. I think that cost us a little bit in revenue there.

If you look at the inventory levels, it looks like the inventories are down year over year. Do you feel like you have enough inventory in the stores going forward? I know that an issue and an area of focus has been to clean up the stores a little bit. Where do you stand on that? Do you feel like you need to get some inventory back in the stores?

I think inventory total levels are fine; it's how we executed and keeping in stock and the right items and the key items and getting them out to the floor. The stores can only hold so many units, so I think our objective is right.

Plus what we want to do is bring product in more frequently, newer product, but also getting rid of it quicker. We have a tendency to hang onto it too long, and I think that's what cost us. It's not -- we've got to get it in and out and get it turning much faster, which I think we will do.

When you look at the business, the baby business has obviously been performing quite well both in your stores and in the wholesale channel. How do you explain the divergent performance on the playwear size in the stores versus in the wholesale channel?

Again, I think it's when we reduced the playwear inventory at retail. We didn't take a big enough stand on the key items that our wholesale customers would. That's a little bit of the problem. Then the product was not as good as we expected in total. But wholesale has a little bit different mix, and they really jumped [at] some key categories and play were. Those were the categories that performed the best, so that's why you see the difference.

On the OshKosh business, it seems like it's happening a little bit slower than perhaps you had hoped. Taking the longer-term view, if I look at that business, it looks like the wholesale side of it is going to be about $100 million this year, based on some of the comments.

When you compare that to the size of Carter's wholesale business, obviously there's a huge disparity. How should we think about the progression as you work to ramp up that wholesale business? Are you still comfortable that it can get to that Carter-size wholesale type level?

I definitely think opportunity is there because they actually -- they should be stronger in the big market, which is playwear. But again, we have to prove ourselves to the customer. We said we positioned fall too high. Spring we got right, summer we got better, and really getting positive feedbacks on each line as we go out.

So our style is to learn and make it a lot better the next time out. I think you will see that. We see fall 2007 already; we're working on that. So we're confident in a lot of potential in wholesale.

Can it be $500 million? I'm not sure about that, how quick we hit that member. But definitely very positive growth for the near-term.

If the customers are ordering as much OshKosh as you had hoped, what are they putting in the stores? Is it mostly private-label, or are there other brands that are gaining share?

Carter's, we hope. You can see the Carter's bookings for spring are definitely very positive. I don't think there's any one person I would say that's -- retailers will always be driving private-label, but that's nothing different than we have dealt with every year. I wouldn't have anybody specific that we would single out as affecting our business.

Robbie Ohmes with Bank of America Securities.

I just want to follow up on that last comment. Are you surprised Carter's playwear is ending up to be more competitive with OshKosh playwear than you maybe thought?

That would be my first question and the second question, I think, maybe for you is, What are you guys looking for in a new president of retail? I think this would be your third president of retail in two years or so. If you could tell us that.

Can you give us the segment profitability for Carter's and OshKosh wholesale and retail, if you could?

I think that what we look for in a retail president is, first and foremost, leadership skills, good operating skills so we can execute our strategy. We look for a leader who can -- has a sense of product and store ambience because he or she in fact is in charge of both the GMMs, the buying, and floor sets and the visual.

You say we have -- it's factual; we have had three presidents. I think our moves have been made for different reasons, primarily made so we could be a better retailer, not just an outlet retailer. Even the outlet retailers have far greater retail skills today, the requirements are.

This most recent move was made not so much for not having this skill as it was an impossible task to manage, we think, both retail, the brands and the product agenda. Patty's dominant skills and passion are in the printing and product. So it makes for a good chess move here that will strengthen our business.

We have great confidence the execution will improve under Joe because he actually has the qualities that we would look for in a retail president. We don't want to stress Joe, either, so I hope that answers that question.

I don't think we said at all the Carter's and OshKosh are competing. That's not at all correct. If we led you to believe that, we didn't mean that. Our points of views are different in these brands. If you look at that playwear market, it's a huge market, $12 to $13 billion. Nobody has any commanding share; there's a big opportunity. 40% of the players and that business are no-names.

So there are plenty of strong players that we can gain share from. Joe is correct in saying there is no one player you would single out. Children's Place is doing well now, but they are not the reason why we're not doing well. There is plenty of room for several dominant competitors.

Thanks and then just on the segment profitability, Mike, if you could. Thanks.

I would say the trends were consistent with what we discussed earlier within the year, good growth and profitability from our wholesale mass channel segments, driven primarily by strong product performance. Product performance has been very good in both of those channels. Good progress on cost reduction from our sourcing and operations crew.

The retail margin is still strong but lower than what we have seen historically, due to some things we talked about on the call this morning. So just to give you where we came out in the third quarter, third quarter operating margin for Carter's wholesale sales, 22.9%. (technical difficulty) that compared to be 21.5% last year. OshKosh wholesale, 18.7% compared to 16.2% last year. Carter's mass channel, 16.3%, up from 12.7% last year. Carter's retail, 18.8% compared to 23.9% last year. OshKosh retail, 11.9% compared to 12.8% last year.

Keep in mind, you always have some corporate expenses we don't allocate to the segments. That was 2. -- 2.7% sales in the third quarter this year compared to 3. (technical difficulty) % last year. That supports the adjusted operating margin we were reporting for the third quarter, 16.2% compared to 15.7% last year.

Melissa Otto. WR Hambrecht.

On your tax rate, it looks like there was a lower tax rate. Would you comment on the tax rate going forward and how that splits out for both Carter's and OshKosh?

(indiscernible) tax rate is going to be around 38%. We have had a benefit in the third quarter of approximately $800,000 resulting from favorable results of the tax audit which was completed in the third quarter. So, on a normalized basis, you should expect to tax rate to be close to 38%.

That will stay consistent for next year as well?

Fourth quarter and next year; correct.

Is there a difference between what the tax will be for OshKosh, or is that completely integrated?

It's on a combined basis.

Would you comment on the Federated wholesale business and how we should think about that going forward for both Carter's and OshKosh?

The total -- again, Federated is about 4% of our business -- will be down slightly on Carter's this year, but remember they closed about 17% of the children's revenue we lost due to door closings. So we will definitely be down a little bit; but we look at it from the Carter's standpoint positive going forward.

From OshKosh, we continue to show down the line each season. We just showed them summer to a couple of the groups. We are showing it to corporate, and we have not got placement yet but we're confident we will keep trying going forward. We think we can get the product placed there, based on the performance of the OshKosh product in the market.

Would you comment, just in general, what you are seeing in the overall environment? Just in general what are your reads going into the holiday season? Just your $0.02 on the overall retail environment right now.

I think we sense business is good. I think you get -- over the last couple of years, there can be one great month and one average month. I don't want to get too over torqued on a given month in the quarter. Fortunately, we present our results quarterly.

There's no question the really good competitors have elevated design and spent more money on branding and frequent flow of innovation. So I think we're right on with their strategic thought. So I would say we're encouraged about the market itself.

Brad Stephens. Morgan Keegan.

You mentioned for OshKosh, summer bookings were up double-digit. Was that in dollars or units?

Both.

Both?

Yes.

So you are seeing average price go back or -- ? I'm just trying to clarify because if OshKosh's up double-digit for units in Q1 and dollars is only up 3%, it sounds like a pretty big discrepancy there, and it looks like it's reversing in Q2.

Just to be clear, we do not have multiple bookings in for summer; that's an expected growth based on the initial response we're getting for the product. But we do expect it to be double-digit growth for summer.

The org chart now -- if I look at the organizational chart with the movement of Patty, can you remind us who is going to be the head of OshKosh at OshKosh stores, et cetera?

Joe will be head of retail for both brands. Patty was in charge of OshKosh merchandising and design in addition to retail. She now takes on the responsibility up to Carter's merchants and designers and our -- the net of that is Joe really gives up three or four direct reports, so it gives Joe more time to concentrate on retail.

Patty doesn't take on any more, either. So it's a good move in terms of ability to focus for both of these executives.

Could you talk a little bit about the mass channel? What is the long-term potential of that? I know you got it 10% type growth in the third quarter or 12%, came in a little above that. You're guiding to 10 for the fourth quarter. What is the long-term potential of that? Is it the 10% growers? Is it still 15% grower a year?

We expect it to be in the range of 10% to 12% going forward. I think we had some questions after the last call with people that expected it would be a 15% to 20% growth business. And that was true;, prior to OshKosh. Now that we have an opportunity to turn the OshKosh business around, that will be a growth vehicle for the Company. We will continue to have good growth in the mass channel, but the game plan was never to have the mass channel to be much more than 20% of our mix.

Now with OshKosh in the overall mix, the mass channel will probably be in the range of 15% to 20% of our sales.

So you are starting to slow that a little bit going into next year, it looks like?

Correct.

Margin-wise, if I plug in flat operating margins for the fourth quarter I get to see about a 14.5, 14.6% operating margin. What is the potential here? Can it be in the 16 range?

Well, here is our focus. With this year we're going to come out around 13% because, which, again, is terrific performance, giving the issues for retail and the acceleration we saw on the mass channel this year.

Going forward, Brad, we expect to keep on improving that operating margin around 25 to 50 basis points. That's very [helpful]. Talked about it in the last call our gross margins around 37%. They will be around 36.7% this year. They are balanced. That may come down a bit next year, funding the investments we have made in the product. But there are plenty of opportunity in SG&A.

Two big components of SG&A are in, certainly, retail productivity, which has not been good this year, and in our distribution costs. So we're confident we can continue to improve that operating margin. We've known it for a long time. We see plenty of opportunity to continue to do it.

I guess Children's Place and Gymboree are starting to get a little more aggressive on the outlet front. In outlet malls where they have entered, have you seen a deceleration in your comps?

I (technical difficulty) are coming in. We're actually happy for the competition -- it becomes a [drop four] consumer shopping for a young child. The issues we had this past year, I would not say are attributed to the competition; I would say they are more self-inflicted.

I would say the beauty of this is that most of our problems are self-inflicted; and, we see that the product wasn't up to our expectations or -- and we didn't execute in some critical periods. So I look at it as a very positive thing. I don't look at it as it's a competitor really hurting us. They are doing a good job. That's not to say that we admire a number of things they do, but we have our destiny in our own hands here.

(OPERATOR INSTRUCTIONS). Margaret Whitfield. Ryan Beck.

I was just curious when this change occurred and when you began recruiting for a new president for retail stores.

We just made the change this past week. We've just started the process for recruiting.

You mentioned a lot of new hires. I know you have already been on the call for a while, but if you could just in brief, give us some of the backgrounds of some of the new hires, chief marketing officer, head of planning and allocation, et cetera?

Chief Marketing Officer is [Kathryn Sadler], who has had varied experience with some top retailers in the country. We have hired [Tom Hearne] as her head of Store Operations. Tom spent a number of years with The Gap when they were good, and most recently we recruited him from Home Depot. [Rick Welsh], the GMM over OshKosh, started his career with Neiman's, spent a number of years at The Gap. [Kim Ferguson], our GMM over Carter's, is most recently from 19. We have a head of Visual Marketing, [Glen Chandler can], who came out of Victoria's Secret. Supertalented group.

Of course, we went pretty deep in the organization about a year ago, so we beefed up our real estate team. We have Mark Hoffman there. Actually, (indiscernible). We should add that we have really gotten a much better at our real estate in picking better site. So we're more optimistic about our new store performance. Much better profile there.

Then we have made a significant upgrade, as I mentioned earlier, [without] the names. We have really beefed up our district managers, which are really a key to success at retailing, and also store managers. We have seen some stores really turn up significant numbers because of better leadership in the stores.

With respect to the playwear, fall being lagging but orders looking better for spring, could you just provide more color on what is different about the spring playwear products for both Carter's and OshKosh, other than what you mentioned about the price reduction, that will allow you to perform better next year?

Got a lead on improving color and application on garments, meaning the prints, embroideries, et cetera; a significant upgrade in fabrication and a greater focus on core silhouettes that will drive significant volume, most of which, you know, is without any increase in price. So really driving up the value proposition for both brands.

As Joe mentioned earlier, a significant reduction in complexity at OshKosh, which was really preventing them from concentrating on core. OshKosh had just took some time. I think I mentioned last call that we had a lot going on when we made that acquisition and we just didn't get our hands around fast enough for the fall product agenda. It was better, but not good enough.

But I think I would encourage you as we enter into 2007 to take a look at these products and take a look at our stores. I think you will be pleasantly surprised.

Are there any changes to your brand stores that we should be aware of now or in the near future that might improve the business levels there?

I think you'll see at the first of the year across all of the chains, brand stores and outlet stores, a much better way out of merchandise, easier shopping experience. I think you'll see, simplified -- as Joe mentioned -- simplified pricing. We're not going to make a huge change in brand stores versus outlets, now. We went to make sure we moved through careful methodical phases with great execution, a lot better products in the stores.

Let's face the facts. Product prevails. Everywhere we have really had any kind of slump, it has been, first and foremost, we weren't happy with the product. We are thrilled with the product going forward. You can do all the great branding work and all the store work in the world, but the product agenda is powerful. It's sort of all for naught.

So we will get to that. We're playing around with some new store looks, we've several different ideas here. We're going to be working through that as we get through this quarter. So that when we hit the first quarter, we expect to have Carter's looking significantly better.

OshKosh, the main thing is to get the product proposition right and then start working on our store looks as we move later into 2007. As I mentioned earlier, we do have a whole new packaging program that launches with OshKosh fall 2007, which I think is extraordinary.

Does that include an increasing emphasis at OshKosh on denim, which has lagged in recent years?

Absolutely.

Okay. Sounds good.

We just had a major summit with our Asian supplier, Major Asian [Leon Funk], and it was extraordinary into what we think we can do in areas like denim and certain other categories, core categories that we should dominate both brands. We're optimistic as we get into the second half of next year we can really offer some significant cost reductions to both fuel innovation and elevate our margins.

But we should still think of OshKosh as more of a second-half business? The seasonality always has skewed to the second half. That will continue next year?

I think so, but I think you should expect they will have far greater sell-throughs since we launched the spring and summer products, at first.

R.J. Huttovy. Next Generation Equity Research.

Two quick questions, one of the retail side and one on the mass channel side. First of all, with retail, I wanted to know again, with Children's Place and Gymboree seeing the success that they have had at the outlet sites, if that has changed your perspective in terms of next year's store openings in terms of what kind of alternatives you are looking at in real estate.

Maybe if you could give us a little bit update what you're looking at in terms of strip center locations and as well as outlook locations.

Then on the mass channel, down the road, I was trying to get better sense if there has been any progress or any more discussions as to a possible sub brand for OshKosh at Wal-Mart locations?

In terms of door growth, what you should expect, the short answer to your question with respect for the competitive landscape -- and it has not changed our views on our door growth plan. Our plan has been to open up 25 to 30 Carter's stores and about 15 to 20 OshKosh stores. You should expect that at Carter's, most of those store openings will be at brand store locations, better centers.

In OshKosh, there are probably more (indiscernible) to open up in the outlets. In our experience with these outlets is very, very strong. But OshKosh has fewer outlet stores than Carter's. So I think you'll see the mix more heavily weighted toward outlets in OshKosh and more heavily weighted toward brand stores for Carter's.

As far as Wal-Mart goes, and the sub brand there, we really are not discussing that yet, because we really want to restore the product brand agenda for OshKosh in our stores and then in the wholesale channel first.

Brad Stephens. Morgan Keegan.

Joe, I know I asked this before but it took a while to sink in, apparently. For summer, you said you expect both units and dollars to be in the double-digit. Can you just give me some more color on the change between that in the first quarter, where dollars were up 3 and units were double-digit?

We will still see dozens being up higher than the dollars, but both of them will be up double-digit. So there will still be a discrepancy -- we will still be selling more units, but the discrepancy won't be as big as spring.

If I look at this past year, in Q2 would it be fair to assume that Q2 of this year, the average price was down from Q1 so it's an easier comparison? Is that part of it as well?

(indiscernible), there's a difference between units and actual dollar shipment sales in spring. The average prices for spring will be down about 8%. Our whole focus -- let's get the product right, let's get the price right. You should not [extend] the prior-year results with that basis of comparison. Okay?

So, going forward, what we're encouraged by -- this is probably the first growth that the wholesale business has had in years. So the fact that we would like to have shown better growth in fall 2006, we didn't, the fact that we're starting to show that the descent in sales (indiscernible) actually have started to show some growth (indiscernible) of seven.

From our perspective, 3% for spring is good. (indiscernible) summer I think you're going to start to see better performance. And you're going to start to see the turn (indiscernible) . We feel as though we are probably a season later than we would like to have been in terms of growing the business.

But the important thing is we want to see over 10% growth in OshKosh sales, sales dollars. You will start to see that, we believe, starting in December.

Joe, another question for you. Now that you have increased responsibility, can you tell us what were the big mistakes you think were made in the last year? Was it this downtrend of accessories a large mistake, or do you want to keep going forward with that?

I think it dedicated a lot of individual (indiscernible) but macro. We tried to reduce inventory. It was the right objective; we just didn't execute it well. So we got hurt in some product categories worse than others. We had new people learning, very experienced and quality people, but you have to learn a little bit about the -- our brands. I think we tried to do too much, too quick.

I don't want to make it any more complicated than that. We did too much, too quick, and we paid for it. The good thing is those are easy things to fix going forward. We've learned our lesson, and we will fix them going forward.

On the operational side, what needs to be added to these stores, whether it be markdown optimization, CRM systems, et cetera? For those, what should be the timetable of the roll out?

You have two significant investments being made, one a new point-of-sales system, and that starts the fourth quarter of this year; and the CRM system will be in place in the fourth quarter of this year. I would say overall, keep in mind we're supporting the largest retailers in the world. Systems has not been an inhibitor toward our growth. Systems are always being upgraded. We have put in a significant amount of our CapEx dollars into upgrading the systems, but we have a new team now that has a clear view of how these systems can be upgraded, and we certainly have the means to support what they need to upgrade the systems.

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

Thank you. Just in closing, a few comments. We feel we have a lot of reasons to be optimistic as we move through the fourth quarter and we face 2007. We are far more talented, particularly in the retail area. As Joe mentioned, the people have had a quick learning curve with our business and our brands. There's no question we have elevated product design; it's our best foot forward that I can remember in our 14-year history here. There's good organic growth in each of our platforms. We have far from maxed out on those. We have great sourcing opportunities that keep funding and fueling innovation and improving our margins. We understand how to fix these problems, these problems.

Also, as Joe has mentioned, are not rocket science; they are things that we know how to do and we can get to them pretty quickly.

We thank you for participating and look forward to our next call.

Ladies and gentlemen, this does conclude the Carter's third quarter 2006 earnings conference call. We do appreciate your participation, and you may disconnect at this time.