Carter's Inc (CRI) 2007 Q2 法說會逐字稿

Good day and welcome to Carter's second quarter earnings conference call. On the call today are Fred Rowan, Chief Executive Officer; Joe Pacifico, President; 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 second-quarter earnings press lease yesterday after the market closed. The text of the release appears at Carter's web site at www.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 measures. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the Company's earnings release. Now I would like to turn the call over to Mr. Rowan.

Thank you, good morning. Joe and Mike will follow me and address the business in more detail but first let me frame up our thoughts about the quarter and our key initiatives.

Our business for the most part is okay in a marketplace which is not robust. Gas prices and interest rates most assuredly are having some impact. Fortunately we have core essential brands that compete more favorably in softer economic cycles. We also have multiple channels of distributions.

Our issues are by and large our own, thus we believe fixable by us. Carter's wholesale and the mass channel brands are in good shape and our Carter stores, which were lagging, are turning the corner. OshKosh results have been bad and kept us from terrific results.

Despite the numbers we've remained convinced the acquisition was a good decision and important to long-term growth. It is a powerful American classic lifestyle brand. It still resonates well with consumers and our wholesale customers. It is more -- it has been more about our miscues which were both strategic and tactical. In retrospect the enemy was us not the brand.

Initially, we intentionally positioned the brand above the mainstream market. Thus we built costly product benefits into high price points. We launched our first offering in Fall '06, which was our first opportunity post-acquisition. Along with our positioning, we offered what I would call nonmainstream color palettes and [too] old art applications. This by and large flowed through Spring and Summer '07 and is in Fall and Holiday '07 before we clearly understood the brand and the consumer.

We initially put a senior executive leading both our retail stores and OshKosh merchandising -- far too much for any one person. And unfamiliar with our wholesale and outlook distribution needs. We also suffered from inventory issues in our stores. We did not have the depth of talent in many areas as we first thought, particularly retail.

We reached an agreement in time to reposition the brand and product agenda for spring '08. We have identified the essential core products, make corrections in color and art, and lowered our prices. Our model substantially increases our customer profitability and better needs the needs of the consumers' value expectations. The response from our wholesale to Spring '08 has been positive.

It is obvious we are changing for the better. This will take time. We will be better in Summer '08 and we will get better in Fall '08. Keep in mind the consumer hasn't voted as yet so we are being conservative.

For a brief period, this acquisition was a distraction to our Carter store performance. Fortunately, we have worked our way through that. Things are better. While all our brands and subbrands have organic growth opportunity, we feel we need to strengthen our strategic platform. To be confident we can say to our shareholders we could return to and maintain 8 to 10% revenue gains; 15 to 20% earnings; and continuous improvement in our operating margins.

So we are making material investments which should have both immediate and long-term impact. These costs are baked into our guidance. The first investment is in talent. We did not have the horses to lead to $1 billion or more business. While we are still assessing all bonus employees and key positions we have identified the following.

We hired Jim Petty as our new President of Retail. Jim is quickly evaluating all his people. We are recruiting for a Vice President of planning and allocations for our retail stores. We are recruiting for a Chief Merchant at OshKosh wholesale. And we are adding to our bench strength and design.

Secondly is research. We mentioned in the last call, we are using a consulting firm to determine our brands' threshold pricing and promotional strategy and also to strengthen our non outlet store format. We are also testing OshKosh pricing scenarios in our stores very soon. We have ongoing competitive analysis. We began a very disciplined approach to that since January. And we are launching online consumer behavior surveys.

The third area is branding. We are fixturing the OshKosh Spring '08 with our wholesale accounts. We are fixturing Carter 0 to 24 Spring '08; in the same accounts we are launching branding initiatives at wholesale and retail; and we are building a stronger branding platform in the 2008 budget.

Lastly, our stores. We are investing in site selection planning and allocations systems; CRM; and the consumer direct marketing.

So you know we are developing a plan for major cause realignment for the purpose of being price competitive, restoration of our margins, and having the funds to invest in our growth. We will keep you posted.

I will turn the conversation over to Joe.

Thanks, Fred. Good morning.

On a consolidated basis our sales of the Company were up 4% in the second quarter and 6% in the first half. We delivered growth this quarter across our Carter brand in all three businesses -- wholesale, retail and the mass channel. Combined sales in these three businesses were up 11% for the second quarter and also 11% for the first half.

In regards to OshKosh we continue to struggle. As a result we have made significant changes to product complexity, mix, design, the pricing strategy and leadership. I will talk more about these changes but believe we are on target to affect the OshKosh brand positively in 2008.

We remain committed to our strategy of having a balanced portfolio of strong consumer brands, multiple distribution channels, and a sense of core products. This has been a winning strategy for Carter's.

I will now walk you through the performance of each of the brands on a stand-alone basis, covering quarter two and first half and give you an outlook for the balance of the year.

Start with Carter's brand wholesale. Another excellent quarter. Excluding off price sales finished up 12% in overall. This brings us to plus 11 for the first half, truly an outstanding performance on top of strong double-digit increases last year. Very positive growth in baby, up 8% for the quarter and 13% for the half. Playwear was up 39 for the quarter and 17 for the half. Sleepwear was down 14 for the quarter. That was due to the timing of fall shipments this year versus last year and down 4% for the half.

In regards to sleepwear we have not been pleased with our inconsistent results in this business. We recently reorganized the business unit, added new talent and put it under the leadership of our baby table.

As we look forward to the second half the year we expect wholesale will continue to deliver solid performance. Baby has been selling very well over the counter. We expect our shipments to be up for the year 8 to 12%.

Since the last call, we have lowered our estimates for the year in sleepwear. We expect this business unit now to come in flat for the year versus our previous projection of +3. We have raised our estimates for playwear which we expect will offset declines in sleepwear and now expect this business to also be up 8 to 12% for the year. We are confident we will achieve our '07 guidance of plus sales 7% sales growth in Carter's branded wholesale.

As we look forward to spring '08 we are excited about a new strategy we are implementing. We are positioning the fixtures from our three product categories -- babies, sleepwear, playwear -- in the 0-24 size range, all together on the retail selling floor. This will provide a lifestyle strategy that leverages off of our strong baby foundation and should make it much easier for the consumer to shop.

We have received very good feedback in our initial account meeting and plan to execute this strategy at every one of our top accounts In spring '08.

We are still showing the Spring line to our accounts. They anticipate strong double-digit shipment growth in baby, playwear to be +6 to 8% and we are projecting sleepwear to be down 6 to 8%. The decline in sleepwear is due in large part to the elimination of unprofitable product categories. With the exception of weekly baby replenishment orders, we have excellent visibility in the first quarter of '08 and anticipate 6 to 8% sales growth in the Carter's brand wholesale.

Key to our success in wholesale is making sure we have dominant core product, positioned for the mainstream consumer market, better branding and we are partnering with the winning retailers in our sector, which we continue to see strong growth with our key accounts and we are investing with them to drive ongoing growth.

OshKosh wholesale, excluding off price, finished down 45 for the quarter lower than last year. Over half of this decrease can be attributed to later shipments of fall product this year versus last year. We expect the back half of the year to be up 4 to 6% which would bring us to -10 for the year, in line with the guidance we gave you on the last call.

For spring we are implementing the following initiatives. Focusing on OshKosh iconic core and key items. Younger art and color versus our previous line. Lower prices to both the retailer and the end consumer, which will increase velocity. Reduce complexity over 20%. Lower costs to need to improve internal margins and also improve customer margins; and we will invest on fixturing at the floor.

Orders are due in a few weeks but with the positive feedback we've received in our retailer meetings, we anticipate our final orders to show double-digit growth to last year and more importantly, we believe we have positioned the line for much stronger over the counter results.

We are disappointed that the OshKosh turnaround is taking longer than we anticipated. Our wholesale partners have been very supportive, due in large part to the relationships we built over the years with our Carter business. Our partners want to see OshKosh succeed and I think our Spring line, '08 line gives them a good chance to succeed.

Now that we have a retail President in place and Carter's brand retail is performing I am able to devote more of my time to leading the product -- OshKosh product team directly. We will build the OshKosh brand the same way we built Carter's.

Talk about our mass business. Continued to perform very well in the mass channel shipments +16% for the quarter and +15% for the half. We saw sales growth at target with just one year brand of +14 for the quarter, +12 for the half. Child of Mine brand at Wal-Mart we achieved sales growth of +17 for both second quarter and the first half.

Spring selling was very positive at both retailers. We are expecting this to continue with the setting of our new brand [Love] which is taking place at the end of July. We continue to feel confident with our guidance of +10% growth in the mass channel this year.

Carter's retail. As you know, we've had disappointments at retail. Key issues have been 1, inventory; 2, product performance at OshKosh; and 3, execution in leadership. We are encouraged by the improvement we saw in Carter's results in May and June. However we continue to underperform at OshKosh.

As you know we concluded our search for president with the hire of Jim Petty midway through the second quarter. Jim has an outstanding track record as a leader and an operator; and we feel very confident in his abilities to restore our retail business.

I will now talk about each brand separately.

At Carter's we believe we have turned the corner and are starting to see positive results of our efforts. We finished the quarter with a +8/10 comp and total revenue up 6.8%. This was driven in comps of May of +6.6, June of +6.8 following a weak April. This brings us to .7/10 comp and +7.6 total revenue for the first half.

For the quarter, Baby comp +19 after being +12 the prior year. Sleepwear was strong with a +6 4. Playwear comped down 8 after comping flat last year. We believe Playwear's decline was not a product performance issue but rather an inventory management issue as we have been pleased with both our spring selling and also our initial fall sell-throughs.

Number of factors that contribute to our revenue growth in the quarter -- customers continue to respond well to our competitive competitively priced core item price point changes that we have made. Our key items focus on floor sets, strong demand for our seasonally appropriate Fall Playwear transition line. More compelling and simple promotional messages. Better inventory levels and improved execution in the field.

I look forward to seeing continued progress in the third and fourth quarter.

OshKosh retail, unfortunately, did not see the same positive momentum with OshKosh this quarter. We came in well short of guidance comping down 9 7 on a 3.6% decline in total revenue. This brings us to a negative 4 9 comp in the first half with a revenue increase of 1.8. We believe as we said before that the reasons our product performance in pricing, low inventory in some product categories and the exiting of product categories.

For the second half we are increasing the volume of key items. We have implemented an everyday low pricing strategy [first] percentage off last year; it's about 70 to 80% of our mix will now be at everyday low pricing. We believe this provides significant improvement in price clarity for the consumer.

Improved floor sets with a focus on denim that is being executed this week. More impactful consumer promotions, restoring inventory to appropriate levels in all product categories. The Spring '08 retail should benefit from the same changes I outlined in the wholesale segment. We will also be reentering some of product categories we had exited earlier this year.

We remain confident the consumer supports this brand. The fixes I have outlined earlier will go a long way of driving a much stronger performance.

In closing, our business has been driven by powerful mainstream brands. Our focus is on core essential products, differentiated by color and art. With value pricing and distributed through a multichanneled strategy, we reach consumers where they want to shop. Carter's wholesale and mass business is our solid businesses that continue to drive good increases. This is based on the fact we are delivering products that consumers want. Our wholesale comps see Carter's as a very important brand that drives consumers to their stores.

Our missteps have been twofold. Retail execution and OshKosh products. At Carter's retail, I believe we have turned the corner and will continue to see positive results.

In regards to OshKosh the changes we have made will positively impact both our wholesale and retail businesses. We know the areas of our business that require attention and I like what we have already accomplished. Under Jim's new leadership and retail, I believe we will see that business come around. With the changes we have made at OshKosh we should begin to see this brand capitalize on strong brand awareness and heritage, as we push it to recognize its full potential. It's the same way we did with our Carter's brand over the years.

I will now turn it over to Mike to discuss our financial (technical difficulty) performance.

Thanks, Joe. Good morning, everybody.

Last night we reported a net loss for the second quarter of $2.48 per share which includes a non-cash charge of $2.60 per share related to the impairment of OshKosh's intangible assets and a charge of $0.01 per share related to the closure of our distribution center in Tennessee. The impairment charge reflects a partial write-down of the total value ascribed to the OshKosh trade name and the goodwill that we recorded at the time of the acquisition.

The earnings generated by OshKosh since the acquisition are significantly lower than we had projected. As a result, we concluded the book value of these intangible assets is impaired and should be written down. Excluding the impairment charge and closure costs, our adjusted earnings for the quarter are $0.13 per share.

For comparability purposes I will comment on our results, excluding these charges.

Our Carter's business segments continue to achieve strong growth; and we expect to achieve their growth plans for the year. As Joe discussed we didn't achieve our second-quarter plans for our OshKosh business segments. As a result, we have lowered the earnings projection for OshKosh for the balance of this year by about $20 million.

In terms of sales for the second quarter our consolidated sales were $288 million up 4% over last year, slightly lower than the guidance we shared with you on our last call, due to the performance of OshKosh. I think it is important to know that Carter's contributed 80% of our second-quarter sales. Carter's sales excluding OshKosh increased 11% to $229 million and were $6 million better than our guidance. OshKosh sales were 17% lower than last year and 12% lower than our guidance. Relative to the guidance the shortfall in OshKosh sales was about $1 million equally weighted between the wholesale and retail segments.

With respect to profitability, our consolidated gross margin in the second quarter was 33.2% compared to 35% last year, down 180 basis points. As I mentioned on our last call, we expected our gross margin would be down during the first half of this year to reflect the cost of product upgrades.

Carter's gross margin was down about 40 basis points to last year, due to more aggressive promotions in our retail stores. OshKosh's gross margin was down 650 basis points to last year, due to the cost of product upgrades, higher wholesale combinations and higher retail markdowns due to product performance.

With respect to spending in the second quarter, on an adjusted basis, SG&A was 50 basis points better than last year, 240 basis points better than our guidance. The improvement in SG&A reflects the control over discretionary spending and further reductions of cost at OshKosh.

On a consolidated basis our royalty income for the quarter was $6.7 million. It was flat to last year. The lack of growth in royalties reflects the timing of outerwear shipments, the impact of reducing the mix of licensed products in our stores, and a change in the product mix of our Genuine Kid's line at target. Royalties for the year are projected to be up about 9%.

With respect to our operating margins for the quarter on a consolidated and adjusted basis, our operating margin was 6.3%, down 140 basis points compared to last year, driven primarily by the decline in gross profit in our OshKosh business.

Our interest expense for the second quarter was down 18% compared to last year, driven primarily by a $62 million or 15% reduction in our average borrowings. In terms of liquidity, earlier this year our Board authorized $100 million share repurchase plan. In the first half of this year we used $40 million of excess cash to purchase 1.6 million shares of our stock, ordinarily 3% of our outstanding shares at an average price of about $24 a share. Subject to market conditions we plan to continue repurchasing shares this year.

Cash flows used in operations in the first half of 2007 was $8 million compared to cash flow used in operations of about $3 million in the first half of last year. This change in cash flow was due primarily to building inventories during the first half of 2007 and lower earnings.

Our consolidated inventories at the end of the second quarter were $232 million, up 22% to last year. That is in line with the guidance we shared with you on the last call. It is important to note that in 2006 we were under inventory in our retail stores. The average growth in consolidated inventories over the past two years is up about 10%. We expect consolidated inventories at the end of the September will be up about 23% compared to September '06. Year-end inventories are expected to be up about 20% as well and that is in line with our previous guidance.

Again, over the past two years the average growth in consolidated inventories is projected to be up about 10% as of the end of the third quarter, and the end of this year.

CapEx for the first half was about $8 million, primarily for resale retail store openings, remodels and system upgrades. We expect CapEx for the year will be between $30 million to $35 million. That is about 2.5% of our total sales and that is consistent with historical spending levels.

During the first half of 2007 we had no revolver borrowings due to the seasonality of our business and the build in inventory. We expect peak revolver borrowings of about $50 million this year and we expect to be out of the revolver during the fourth quarter.

With respect to guidance for the third quarter, our consolidated sales are projected to be $408 million to $413 million. That is up 4 to 5%. For our Carter's segments third-quarter sales are projected to be $321 million up 6% with 6 to 8% growth in wholesale sales excluding off-price sales and 2% growth in our mass channel sales. The projected growth in third-quarter mass channel sales is due to the timing of shipments and is expected to be up over 20% in the fourth quarter and up 12% for the year.

For Carter's retail stores we are planning 8 to 10% sales growth, with low single digit growth in comps in the third quarter. Today, July comps for Carter's stores are positive. OshKosh third-quarter sales are projected to be $90 million with wholesale sales again excluding off-price sales, up 12%, largely due to the shift in demands for the second quarter which was down about 45%.

For the year OshKosh wholesale sales are planned down 8%. OshKosh retail store sales are planned down 2% in the third quarter with comps expected to be down about 8%.

Gross margin for the third quarter is expected to be 35.6% down 200 basis points to 2006, due primarily to more aggressive promotions in OshKosh's retail stores. SG&A for the third quarter is planned at 23% of sales compared to 24% in the third quarter of last year, primarily due to the control of discretionary spending.

Royalties from our licensing business for the third quarter are planned [up] 16%, largely due to the timing of outerwear shipments which moved from the second quarter.

Interest expense for the third quarter is planned to be about $7 million, up 5% due to our planned borrowings on the revolver. Our consolidated operating margin is expected to be 14.7% in the third quarter, down 100 basis points from last year, again reflecting lower margins from the OshKosh business segments.

Earnings for the third quarter are expected to be $0.55 to $0.57 per share flat to down 4% to last year. For the year, we are expecting our consolidated sales to $1.415 billion to $1.425 billion, up 5 to 6%. Comps for our Carter's stores are planned up 2% for the year assuming low single digit comps in the fourth quarter. OshKosh comps are expected to be down 6% for the year assuming a negative 5% comp in the fourth quarter.

Gross margin for the year is expected to be 34.5%, down 190 basis points compared to last year, which represents a $21 million reduction from our previous guidance, due to the deterioration of the OshKosh business segments. SG&A for the year excluding facility closure costs is planned at about 25% of sales compared to 26% last year. Interest expense for the year we expect will be around $25 million, down 9%.

Our consolidated operating margin for the year is expected to be 11.5%, down 80 basis points to last year on an adjusted basis. Again, due to the deterioration of the profitability of our business segments at OshKosh.

With respect to earnings for the year we are projected $1.42 to $1.46 per share. This guidance excludes charges related to the impairment and to the closure of our distribution center in Tennessee. This guidance assumes a share count of approximately 60.6 million shares.

With respect to cash flow, cash flow from operations is now expected to be $50 million for the year, which is $10 million lower than our previous guidance, mainly due to the expected reduction in earnings. We are assuming a depreciation and amortization of $32 million for the year and an effective tax rate of 37.8% excluding the impact of the impairment charge.

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

(OPERATOR INSTRUCTIONS). Brad Stephens, Morgan Keegan.

First question. On the SG&A, you talked about you don't have the horses, and you need to reinvest. But when I look at your guidance for the back half of the year you are implying that SG&A is only up about 2%. So if you walk us through where you've cut SG&A? And then maybe next year as you cycle through it doesn't get some improvement in OshKosh where you are going to have to then ramp up SG&A again?

Yes. I would say one of the larger components of SG&A that we have stripped out is the first half and second half assumptions is incentive comp. Incentive compensation, that is about $12 million. I would also say that we had consulting costs last year that don't repeat and also say that across the board we have control and reined in spending where necessary. Brad, I will tell you what that said. I would also say there's not any type of proposal that we feel is (inaudible).

We need to fund to support our growth that we have not supported. So there's a number of things in terms of investments that we are funding that we will cover with you if you would like to know what we are investing in.

Second question. In the inventory where are you at per square foot in your retail stores into Q2?

At the end of the second quarter our inventories year over year are up about 2%.

Up about 2%. And so as you -- I guess my concern here is or my question if you are looking for both single digit comps in the back half of the year and we are seeing a substantial increase in inventory, how shall we expect to work through that from a margin standpoint? And then just what are your thoughts on inventory management at retail?

Part of it is just getting back to normal levels. You look at last year we ran the whole second half 25 to 30% low. So I think a big part of that if you talk Carter's goes into Baby which is a replenishment business where we share common inventory between wholesale and retail. So I don't see part of it is getting back to the inventory inventories we should be. I don't think it's excess inventory at all.

Each season our problems have been we have been too low. The only issue we've had so far this year is inventory. We've been too low in clearing out these seasons earlier each year. First quarter, we got hurt because we didn't carry in enough Fall and Carter's Playwear got hurt probably in the second quarter because our spring inventories were too low.

So I don't see any (multiple speakers)

Just to give you another -- at the end of the third quarter, right now, we are expecting inventory on a per order basis will only be up about 4% over a two-year period. Year over year, it will be up about 30%. So again we feel as though we are getting back where we need to be in the Carter's stores and we feel that is why we feel better about delivering positive comps in the second half of this year.

So you've got a base of comparison year over year that would give you a distorted result. So it's important to look over a two-year period.

So even with your Q3 and retail store inventories up 30%, (inaudible) off their [press] space from last year -- I think you were down like 20 -- you are still only looking for a low single digit comp in Q4. So how should we think about the margin performance of retail for the year?

We are expecting the profitability of the Carter's stores to improve. I think we were more promotional in the second quarter because the environment was more promotional. But we feel better about the inventory mix. You shouldn't equate a higher level of inventory in our Carter's stores that we have to be more promotional. We feel good about the product. Baby and Playwear and Sleepwear are performing and so you shouldn't have any concerns that higher inventory levels in those categories is going to result in higher markdowns.

My last question would be as I kind of run through what you said there I was say that Carter's retail for the year is probably going to run operating margins in the 16% range. You ran 20 and 21, you know, just not many years back.

How long -- let's say three or 4% comps -- does it take to get back to a 20% type operating margins at retail? Or is that even obtainable again?

I will tell you you are spot on in terms of what we are projecting for the operating margin for Carter's retail stores and that's 16% for the year, compared to about 17% last year. So you shouldn't expect that we're going to do any quantum leap in that operating margin in any one year. What we are committed to is improving it and what we usually say is, we would like to improve it 25 to 50 basis points.

Just taking a step back this year. And we are going to set the bar higher in terms of margin (inaudible) going forward. The overall objective of the Company is to improve the overall Company's operating margin every year; and over the past 18 months I would say we've had very disappointing performance from our Retail segment. And we are hopeful that the new leader helping us to develop a better plan for growth in retail, both growth and sales and more meaningful growth in profitability.

So we don't -- we are not anticipating further deterioration in that Carter's retail operating margin. We feel as though we can start to grow off of that number now.

Omar Saad, Credit Suisse.

Could you discuss your thought process around the leadership -- kind of long-term leadership for the OshKosh brand? And do you look at the Carter's brand versus the OshKosh brand as kind of independent, siloed businesses where you leverage the back end but keep the front end separate? Do you think you -- and I know Joe is going to step in, I don't know if that is a permanent or temporary. Do you think you need a leader to solidify the Division to that brand.

Joe is not the permanent guy there. He certainly has merchandising skills and [tried] in good direction currently to our SoHo Design Group. It does need -- we do need more talent in there. The first step is to get a Chief Merchant and we are actively searching but we are being very careful that we don't make mistakes there.

Fortunately as Joe has pointed out, he has some time on his hands and he has also a dedicated team, a small team to help fix that scenario. We do want to keep these brands separate. No question. The emergency back end and you keep the point in view different on the front end of the business so you have a competitive formula for each and they are distinct. We are looking into what higher levels of management skills we should have.

I don't want to elaborate on that because we are in heavy discussions but we are moving on with those discussions. So we do feel we need some powerhouse leadership.

Okay.

I might tell you, you know we have -- we are looking at talent across the company. I mentioned that in the opening. We are not -- everybody is getting a look including ourselves to see what we, how good we are in this new marketplace and what skills we should add to our business. So there are other things we are looking at. I am just not at liberty now to say that.

It's not critical to us fixing the business and having a stronger '08 though. I don't want to imply that we have to have lots of added management qualities to fix us. We did some rather stupid things with OshKosh and we can fix them.

If I could kind of follow-up on that. You talk a lot about the retailers and the retailer response and Spring '08 and each season what the retailer response. How do you think about the end consumer? Because in these branded businesses what the retailers really want is consumer demand and want traffic driving branded products that consumers are going to drive consumers to Kohls or Target or Penney's or Macy's or wherever.

How much research have you done, in terms of -- especially on the OshKosh side the end consumer where -- where the brand fits in for them? What has been missing from their perspective in terms of why they aren't buying more retail? Because consumers are coming into the store to buy the product, the retailers will make the orders.

You are absolutely right. You know it's all about consumer pull. Not pushing goods in and that's one of the structural changes we are making in our Company. There are a number of them. One is to invest in research. We are starting with this study to understand our pricing strategy. What should our pricing be, how should we communicate this strategy. We are also looking at our retail strategy. How we optimize store performance when we open new stores.

We also want to make sure we don't have any negative impact on our wholesale partner. We are starting other consumer studies as I mentioned in the opening. We want fact based validation. We believe as a company we have very high instincts and lots of experience but we really need to know.

We are implementing stronger pre lining with our customers of products, consumer surveys, and competitive analysis. And we've most recently added consumer panels to look at our products when they are appropriate. So you get their opinion on how they feel about it. So we are committed to that.

Kind of last follow on to this same line of thinking here. Marketing and advertising, you know you talk a lot about in-store presentation and the importance of that and I agree.

Can you talk about other channels for marketing and advertising. Where you have been historically? Do you have a marketing or much of a marketing organization in-house or people who are dedicated to that side of the brand building?

We do have a marketing organization. We are strengthening that as we speak. We don't feel that the first priority is to advertise. The cliche is always get to the media and all is well. Where we feel our deficiency to be particularly in OshKosh is this product agenda. It's not the store first. It's not dressing up the environment that drives the business.

It is dominant core product. So we have a very disciplined approach as Joe and I have stated earlier in the discussion today. Get those products acceptable to the mainstream consumer. We've done a lot of competitive analysis to our marketing organization. We know where we were out of line. We know where we need to move. We know from our consumers rejecting these certain color stories and certain levels of art -- we've got good feedback there.

So I don't want is a we are not going to invest in a stronger marketing organization, we will. But first things first.

That being said, we are testing a couple of new vehicles. When we were on a couple of national ads for Carter's in the fourth quarter and we also are continuing to test the (inaudible) logs and direct to consumer in our retail division, plus we have put a lot of investment into Carter's them stores for point-of-sale and product presentation, mannequins. We've really dressed that up that. You'll start seeing that in the second half of this year.

So we are trying a lot of vehicles. Also CRM at Carter retailing and the loyalty program. We are getting close to putting one together. We have gathered a lot of data. So you will -- but we are just starting a lot of this stuff and you'll continue to see us gain momentum as we go into Spring '08.

We are working hard with our wholesale accounts to help them understand the importance of fixturing. You know we fixtured our baby products and velocity has improved considerably over the years. We have branded more in there. We are encouraging them to go to the 0 to 24. They've been real responsive to that. We are going to fixturing the OshKosh product for Spring '08 and it is the first-time we've done that. These are positive moves and they are -- really are giant steps.

Brian McGough, Morgan Stanley.

Thanks a lot. I have a couple of questions. One is, that, I guess I'm wondering is that so earnings in '07 have been rebased because of the sales weakness and all the issues that you have been talking about. And I think you manage SG&A really well in order to offset the sales and margin weakness. And I think this actually dovetails off of Brad's question earlier. And in fact, Mike, I think you mentioned that SG&A was down at OshKosh in order to stabilize that business discuss quarter.

Yes.

But I'm wondering if the answer here is really to do the exact opposite and up the overall SG&A materially at least near-term in order to get to a point where, in '08, we can be back on a path where growth is a lot more stable and more profitable and more predictable?

I don't think upping the SG&A materially is the answer. I don't -- that's not to say we are not making the key investments. We are going to spend the money but in a very focused manner. We are going to invest in more talent.

I don't want to beat a dead horse here. We are investing in research. We are investing in branding. We are investing in our stores and we are spending an enormous amount of time on product dominance. And those things will earn us more money.

They will sell through. We are investing in a more profitable formula for our customers. That should have a significant return so we can then invest more. It doesn't take a giant increase in SG&A to have success this year and better success next year. It doesn't -- we don't think it takes giant investments to get back to this high-growth model.

And then when you talk about any new individuals that you'll bring into the Company from the talent standpoint, I'm wondering if we are talking a couple of people at the top? Or is this an instance where each of them will have the ability and the wherewithal and the capital to actually build out a team such that you have a much greater organization around product and merchandising?

Let me put it this way because I can't speak to too much because we are dealing with the people in our Company. We will have a new organizational structure. We will have more talent at the top and we will have upgrades in our existing talent base.

Okay. Fair. I just have a couple of more. One on OshKosh so I think how (inaudible) works is that you had actually wrote down about half of the book value. I think the book value per share went from 2.9 to -- 2.9 from about 4.1 over the past day. I am wondering when you guys did your diligence on this a couple years back, what are the one or two things that you think you got wrong?

We positioned the brand. I mean, we positioned above the mainstream market. We felt that we didn't have a good read on that market and it was changing rapidly. The market is basically polarized. You are either competing in the upscale market or you are in the mainstream. So we positioned it in the middle and it got noncompetitive. That's the first and biggest mistake we made.

Secondly as I mentioned, we put a senior executive over retail and OshKosh and it was just too much to ask of any one person and we didn't get the best out of any one of these businesses. Those are the two main things. The cost structure in the Company also is too high and it is coming down.

Then lastly on the incentive comp standpoint I understand how you noted earlier how incentive comp came down this year. But on the same token we want the team to be incentivized to actually do a great job and be paid.

When I look at what you reported this quarter, I think this is the first quarter in a while where your basic share count was actually right in line with your diluted count implying that a lot of options are out of the money?

Just so you know when you have a loss under the accounting rules your basic share count is equal to your diluted. So that is just an accounting matter. You shouldn't think of that as that there's different activity.

But just how do you -- in light of everything that's happened over the past year running, how are you addressing overall morale internally and how are you keeping people motivated and all charged up to show that there is still a big light at the end of the tunnel a year or two down the road?

It is a terrific question and it is one we have been most concerned about and we are spending a lot of time about that. I would have to say that we've reached out to our people. We've got them very engaged in what is important to turn this business around. We are communicating frequently our people do know we had a rich history of high performance. We are not a hot and cold company.

I would say, by and large, our people feel we can fix it. It is a good test, just so you know, to people who just enjoy the good times. So you have to go through these times as well. It's not the first time we have been through it as a management team. It's the first real time since '99 when we went through it and we repositioned this Company.

In '99 we paid no bonus and we came roaring back in 2000. We have been in a couple of other companies in turnarounds. We've employed this same thinking. We do take it seriously, though. We need people and -- but it does test your resolve. I have to say that there is some risk to it.

Thank you and the best of luck.

Robby Ohmes. Banc of America Securities.

A couple of quick questions. I think it first question is can't you give us a little more detail on Jim Petty? I know he's just got there pretty much but what do you think his approach is going to be to retail? Specifically Carter's versus the OshKosh stores where he will be focused and also if he came in and it was his plan for retail that for OshKosh retail that triggered the impairment charge? And if so why would a guy with fresh eyes have such a weak outlook for the retail business if he is coming in to fix it?

The second question would just be on the OshKosh wholesale. Could you be more specific about which customers do you think will lead the improvement there you know -- JCPenney, Kohls etc., sort of remind us who -- which stores we should be looking at to see growth of floor space for OshKosh? Finally if, Mike, you could give us the EBIT by division that you give in the Q, that would be fantastic.

Jim's charge is to first and foremost attack the fundamental. The operating issues and he will tell you the same as the story I will tell you is there is a lot of low hanging fruit. He is after better execution. He's looking at his talent. We will be making some changes. He is energizing the stores to be aggressive in selling.

He's wanting to fix the printing and allocation deficiencies we have. He's out in the stores on a regular basis to get a feel for the business. He spends time with us but we are not overburdening him. He's definitely a part of our strategic direction. He is a good voice, but we are not bogging him down at corporate so to speak. That's the first phase.

He then will propose other things to us but let's stick to the fundamental spurs.

In regard to OshKosh's wholesale, the same type of concept we call Kohls, JCPenney's, Babies R Us, (inaudible). Those continue to be the top accounts.

Rob, let me just walk you through the segment profitability excluding the impairment and the closure cost related to the distribution center. Last year the operating margin in the second quarter was 7.7%. Second quarter of this year, 6.3%. So down 140 basis points.

The Carter's wholesale business continues to show significant strength. The operating margin improved from 14.7% to 17.3%. Carter's mass channel also continued to show improvement 12.8% last year, 12.9% this year. Carter's retail last year 12.4% down to 7.6%. That would say a couple of things just -- we were certainly more promotional. The average prices were down a little over 3% and we were spending more money to get the stores back in stock with inventories.

So we [sent] an entire distribution and freight cost and we do expect the margin to improve the second half. And OshKosh's wholesale segment last year at an operating margin of 5.9%. This year negative margin about 30%. A loss of $3 million.

OshKosh's retail segment last year 5.1% operating margin. This year a negative margin 4% with a loss of $1.9 million. Then you always have this other reconciling item which is basically nonapplicable cost, corporate overhead and other type of cost. Last year that was 3.0% of sales. This year, 2.7% of sales.

Just a very quick follow-up to that, Mike. When you normalize the mass channel operating margin for the timing shift in shipments second quarter versus third quarter, is the operating margin if you combine 2Q and 3Q year-over-year going up or down in mass?

Yes. It's going to -- I believe it is going to go up and I'm looking at the year. It's expected to be 14% last year to 16% this year.

Melissa Otto. WR Hambrecht.

I think a lot of my questions have been answered, but just wanted to try to get a little bit more color around the OshKosh write-down in terms of the brand. Can you just elaborate a bit more on that?

Be happy to clear this up and put it in perspective. We paid $320 million for OshKosh a couple of years ago and as part of the accounting requirements is that you have to allocate that purchase price to the assets that you acquired in the liabilities that you assumed. So the net assets, the net tangible assets that were required were $75 million.

So the difference between $75 million and $320 million is $245 million. We described $102 million to the OshKosh [freight pay], which continues to have significant value. The balance or $143 million falls out as what is to be called goodwill. Years ago goodwill would be amortized over a period not to exceed 40 years. Because the OshKosh business has been around for 100 years and we expect it will be around for at least another 100 years. The rules change.

So you never -- the days of amortizing that over some period of time ended but there are requirements are to periodically assess the appropriateness of the values ascribed to those in tangible assets and determine whether or not those assets are properly valued.

And if there is an event that causes you to believe that that asset is overstated you are required to write it down. So I would say over the task of past couple of quarters we've had a close eye on whether or not there was a need to write that down and we -- until probably the last week or so we didn't believe it needed to be. Until we received a new projection from our retail business which suggested that there would be a significant reduction in the gross margin that would be earned by the OshKosh retail segment.

And that's what caused a -- what we refer to as a trigger that caused us to conclude that that both the trade name and goodwill needed to be written down. So I would view what we did as we needed to do. Just the cash generated by OshKosh since the acquisition is inconsistent with what we expected at the time of the acquisition and those values were overstated and needed to be written down.

RJ Hottovy. Next Generation Equity Research.

Just had a couple of quick follow-up questions. First is on I guess the gross margin. Back in the fourth quarter conference call you guys said that at the back half that you expected about 40 basis points improvement and obviously with the revisions on OshKosh, that's probably not looking quite as possible; but I think a portion of that came from some direct sourcing initiatives that you had in place. Just wanted to know how much that direct sourcing is still in effect with your guidance for the backpack of the year?

It really wasn't over direct sourcing. We felt confident our sourcing formula is a good one. It was more about lowering the cost significantly and restoring our margins. We still intend to No. 1 be price competitive as I mentioned by dramatically lowering our cost structure we intend to restore our margins. So you should see as we enter 2008 to improve these gross margins.

The second question I had, just a little more clarity on the Carter's wholesale side of the business. Obviously, you continue to see excellent growth in that side of business and just wanted to see if you could give us a little bit more clarity and if that is coming from existing accounts or there's been any more sign up of new accounts out there? Just a little bit more granularity if it's possible on that side of the business?

Yes. That's only from existing accounts and great deal of it driven by product especially in the baby part of the business. There's no significant new (inaudible) accounts. You know our penetration we only on more than 20% of our key accounts '07 business so lot of opportunity on the organic side for the Carter brand. Some of those accounts are growing. Penneys, Kohls, Babies R Us, they are all new door openings. So we use a formula of increasing productivity, new store growth and comp improvements. And to Joe's point, a significant opportunity for share growth. It doesn't take much of an improvement in market share to have a significant increase in revenue.

I think that's all I have for you this morning. Good luck with the upcoming quarters here.

Marie Driscoll. Standard & Poor's.

Good morning. Most of my questions have been asked so I was hoping you could give us an update on what you are seeing at retail. We've heard from a number of other vendors that some of the -- in the department store channels they are postponing deliveries. So I'm wondering if you could talk to that? And competitively, what do you see happening versus in the competitive set for the OshKosh brand?

Well, from a competitive point of view, we were targeting initially the wrong set of competitors. When I said we took it higher we went after a set of competitors that was mispositioned for OshKosh. We are in the mainstream business. We've got to compete. We've got to have a good relationship competitively priced with private labeling. We have to be in line with Children's Place. We have to be in line with Old Navy. It's that simple.

From an on-order file, I mean, we just rolled out our New Baby program in the month of June and early July. And initial results compared to last year have been very favorable. So we see that business continuing very strong. That is a replenishment business.

As far as fall, we ship a lot of our goods at the end of June, end of July and we are holding our order file incredibly well. So, we are not seeing any push back on the Carter side whatsoever or the OshKosh side.

I think once again you know, to reiterate, we are in this central core businesses. Some brands that have more fashion content definitely take a bigger hit in these slower markets.

Then given the new retail hire, what should we be looking for as we go to the stores so that we can gauge the improvements?

Good inventory management, we are in stock, size, and color. Easier to shop.

Price clarity, much stronger promotions, much stronger product displays in the windows and then throughout the store. OshKosh last year, we really did have a strong denim presentation. Whether you walked in for back to school we think if you walked in this weekend you'll see a change in that. So we will get better at that each season but I do think you'll see some definite improvements for this fall.

So in the fall we should be seeing that. And do you still think -- do you still have a lot of confidence in the brand as you reposition it to a more value positioning versus Old Navy?

Tremendous confidence in the brand. As I said in the opening it wasn't the brand. It was us.

Thanks.

Margaret Mager, Goldman Sachs.

I was just wondering with regard to the OshKosh and Carter's stores, have you given any further thought to possibly consolidating some of your store locations and possibly doing combo stores in retail to gain more efficiencies? Or to help maybe the OshKosh brand benefit from some of the traffic and strength of the Carter's brand?

The answer is yes. Are we changing that strategy Monday morning? No. Because we have such opportunities to fix the fundamentals of the business, but I would assure you we will test that.

Seems to make sense. And with regard to the new line, the new OshKosh lines, and the retailers' perspective on that, can you talk to how they are looking at, say, boys versus girls? Are you stronger on one side versus the other?

Yes definitely I think we have acknowledged that girls has been a lot tougher than boys. But we think we have corrected that for spring. Overall, we felt the art was a little bit too old. The color is a little bit too trendy and we addressed that with each line a little bit but I think significantly for Spring '08. That's, I think as far as a booking standpoint there's not a lot of difference between the boy and the girl.

Yes OshKosh is traditionally done well with both genders and so has Carter's.

Yes, we are also addressing the retailers' economic model for spring. We are going with higher IMUs but the best improvement will come through definitely better sellthrough. So we are addressing it a couple of different ways.

Jim Chartier with Monness, Crespi & Hardt.

Not to beat a dead horse here but I just wanted to ask a question that has been asked but in a different way. Has your outlook for the potential for the OshKosh brand changed from either a long-term sales or margin perspective?

No. What's changed is we are going to work this thing through phases, not overpromise. But our confidence in having a large wholesale business and store growth and far greater profitability remain unchanged.

And then with the stock downward is now -- have you thought about accelerating the buyback at all?

We have given that some thought. That is an opportunity for us. We have got a $100 million program authorized by the Board. We have done $40 million so far that's certainly not (technical difficulties).

Thank you.

You're welcome.

This does conclude our question and answer session. I would like to turn the conference over to Mr. Rowan for any additional or closing comments.

Thank you. We appreciate your attendance and questions. Not to beat a dead horse either but we are -- remind you we are fully focused on, first and foremost, making sure we continue to grow the Carter's brand and we are dominant in our agenda there. Fixing OshKosh beginning Spring '08, it will improve but it's not the panacea we will improve in Summer '08 which we'll be showing to our customers and their future and then Fall '08. We are investing in the vital areas. We are going to lower our costs substantially. And we are committed to a high-growth model.

Thanks again and we will see you at the next call.

This does conclude today's Carter call. If you would like to listen to a replay of this call it will be available beginning at 11:30 AM Eastern time today through midnight, Friday, August 3rd. The dial-in number for the replay is 888-203-1112 in the U.S. and Canada and 719-457-0820 from international locations. The confirmation to access the replay is 7480429. Again that is 888-203-1112 in the continental U.S. and 719-457-0820 internationally, and the confirmation code is 7480429. You may disconnect at this time.