Carter's Inc (CRI) 2007 Q3 法說會逐字稿

Good day and welcome to Carter's third 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 third quarter earnings press release yesterday after the market close. 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 measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurement is provided in the Company's earnings release.

Now I'd like to turn the call over to Mr. Rowan.

Good morning. We're pleased with the progress we made during our third quarter. We positioned our Company well before the quarter to concentrate on certain vital initiatives that would both fix some problem areas and lay the groundwork for restoring us to high-quality growth.

Those initiatives are recruit and retain key talent; fix the operational issues affecting our retail stores; fix the OshKosh product value; make every core product in all our brands significantly more competitive; make our wholesale customers more profitable; and raise the level and breadth of investments.

We have made lots of progress in each. The benefits are being tempered somewhat by market conditions. I think any logical thinker would admit this marketplace is still uncertain and that all levels of distribution are feeling the effects of reduced consumer traffic.

Nevertheless we take some comfort in the fact we can make up ground correcting mistakes we made in '07, which were not market-related. They are lack of sufficient inventory in our stores; miscues and lack of key management skills; poor retail execution; and mispositioning the OshKosh product value.

We also benefit in that we have brands whose templates are core essential high-value products. We have organic growth in each brand and all channels of distribution.

We will begin the session today by walking you through the details of our progress, beginning with Joe Pacifico and then Mike Casey; and as usual we will allow plenty of time for Q&A.

Thank you, Fred. On a consolidated basis, our sales in the Company were +5% in the third quarter. In the quarter we achieved positive revenue growth in five out of our six business segments. Our strategy of having a balanced portfolio of strong young children's brands, multiple distribution channels, and essential core products delivered good results in a difficult environment.

Overall we are pleased with our results and feel good about the ongoing potential in each of our businesses. Our Carter's wholesale and mass businesses performed well and we sell good improvement in the Carter's retail business.

Current OshKosh performance, product performance as expected is not good. We have targeted spring and summer '08 to begin the turnaround. The progress [at] the floor where we measured in the first few months of 2008.

I will now walk you through the performance of each of our brands on a stand-alone basis, covering third quarter performance; our expectations for the remainder of the year; and our outlook on the first half of 2008.

Start with Carter's wholesale. Another good quarter at Carter's brand wholesale. Excluding off price we finished +7 overall. Baby was +16, sleepwear +7, playwear was a -7, which is due primarily to the timing of fall shipments. When you combine quarter 2 and quarter 3, we were +9 in playwear.

For the balance of the year we are projecting that fourth quarter will be +3%; and that is due to the timing of shipments with the retailers calendar shift. More of our spring orders are falling into quarter 1 of '08 versus quarter 4 that we had last year.

For the year we continue to project baby +8 to 12, sleepwear flat and playwear +8 to 12 leading to +7% overall growth, in line with our guidance and another strong year in wholesale.

Spring -- based on spring quarters we are forecasting positive review growth for the first half of '08 in all three product markets in line with our plan of +6 to +8%. Most of that growth will come in the second quarter.

Baby should continue its strong performance with sales of 8 to 10%. We expect playwear to follow suit at 8 to 10%. We are estimating sleepwear will grow 3 to 5. Sleepwear is still our most challenging product market. We put this business under the leadership of our Baby team and are incorporating stronger creative with younger looks, more mainstream color palettes, and reduced style complexity. This team's first line will be fall 2008.

In addition to our anticipated toplines performance in spring '08, we expect each business will be more profitable for the retailer, presenting with a higher margin and that each of the businesses will also be more profitable to Carter's with higher product margins than last year. This is due in large part to our having lower costs, which was driven by sourcing leverage and a significant reduction in complexity.

OshKosh wholesale quarter 3 performance, we had a good quarter with sales up 10. There we were affected favorably by the retailer calendar shift and the timing of fall shipments after being impacted negatively in quarter 2.

We continue to provide sales guidance of +four to +6 in the second half and will finish the year down 10%. We anticipate product performance continuing to be a challenge until our spring line hits the floor. We've devoted a lot of attention to the spring '08 line. For this line we have focused on key items, younger art and color versus previous lines. We have lowered our prices over 10% to both the retailer and the end consumer in order to increase velocity. We improved our initial customer margins. We are investing in better branding at the floor. We've reduced complexity by more than 20% in the amount of style colors. At the same time, we have lowered costs which should lead to improve internal margins.

For spring we achieved double-digit unit growth in orders, which should translate to dollar sales growth of approximately 8 to 10% on top of strong margin growth.

We are now currently showing our summer '08 line. We've reviewed this with consumers. Very positive feedback. We believe it's a much improved offering to last year and even an improvement to the spring '08 line. We expect strong double-digit unit bookings growth, which should translate to double-digit sales and margin growth.

The mass channel, as we guided mass channel saw growth of +2% in quarter three. This brings us to +10% for the year to date for each of the brands; and we continue to project to consolidate mass channel at +10 for the year.

For the quarter our business at Target was good, and our sales dollars were +7%. At Wal-Mart, Child of -- sales were down 1%. We are disappointed with Child of Mine quarter 3 results despite being in line with our expectations.

Business was difficult for the combination of the following reasons. Wal-Mart is struggling from reduced traffic. Product performance in several of our programs did not hit our plan. And Wal-Mart's tighter inventory initiative. We are aggressively addressing these issues by elevating our product benefits with no increase in prices and in some case actually lowering prices.

We are lowering their inventory requirements with no deterioration in service. We have the ability to lower our cost, thus enabling us to maintain margin quality. Until we can quantify all of these action plans, we are accordingly taking a more conservative view on fourth quarter sales.

For the first half of '08, we are projecting consolidated mass channel growth of +8 to +10%.

Carter's retail. I will first discuss the Carter's side of the business followed by OshKosh and an outlook of '08 for both brands.

Solid performance for Carter's in the quarter in a very difficult environment. We had overall revenue increase of +9.6% and a comp increase of 4.1%. We now have had positive comps in each of the last five months in addition to each quarter this year.

By product category, baby comped up 20% and accessories were up 13%. Sleepwear in total was a -3.8 for the quarter, but +30 in fall product. Playwear in total was a -64 for the quarter, but +2 in fall product. Really where we missed, we missed sales by having low inventory in spring sleepwear and playwear which would have driven clearance sales in July and August. So our fall product performed. Our miss really was in not having enough inventory in spring carryover.

Heading into quarter 4, we are in good shape regards the inventory. We have the appropriate inventory levels that are needed to drive the business. That being said we still have opportunity to maximize efficiencies in the planning and allocation of inventory especially on a per door basis, but feel good that we have the inventory necessary to drive the business. We can no longer use this as an excuse.

Talk about OshKosh retail, comps for the quarter were -5 which led to total revenue being flat for the prior year. As I stated earlier our focus is spring '08 product, which is much improved.

We are confident we have found the right prices to drive unit velocity and have impacted cost to support the strategy. We have added opening price points to the spring mix which should continue to contribute to total revenue and strengthen our offering, making us more competitive and also providing more product to the value conscious consumer.

Going forward, our plan is No. 1, increase the volume of key items; 2, deliver a high percentage of denim in our mix. Boys denim is working very well for fall. We feel we will have a much stronger assortment and selection in girls going in the spring. Increase a percentage of product in everyday low pricing and two for's. Improve the store environment. Fixtures, product displays, photography combined with more dynamic seasonal floor sets. Execute more impactful consumer promotions and restore inventory to appropriate levels.

Retail for the first half of '08 I feel very good about our business for several reasons. [Jim Petty] is doing a good job. We have made a number of changes in leadership that will impact this business. We have a new Senior VP of stores. We have a new senior VP of planning and allocation. We have a new GM at OshKosh. We have a new VP of marketing.

We now have strong hands-on leadership in each functional area. Execution is better and will continue to improve. We feel confident the spring product in both brands is better, especially in OshKosh where product has been the primary issue behind our results.

We believe our product and price clarity is much improved. Inventory is better, more impactful consumer marketing initiatives for both brands and enhancing the in-store environment. Based on our team and initiatives I'm confident you will see improvement in sales and margin in 2008.

In closing, we are pleased with our performance during a challenging third quarter retail environment. Our business is driven by powerful mainstream consumer brands. Our focus is core central products differentiated by color and art, with value pricing and distributed through a multichannel strategy.

We reach consumers where they want to shop. Because of our value proposition and our strong consumer following, we are well positioned to succeed in the difficult retail environment.

2007 has been a year dedicated to turning around our retail business and improving the OshKosh product. As I have said, I'm very pleased with the progress that has been made. The Carter's retail results at OshKosh spring bookings serve as evidence.

A lot of hard work has been put it to these endeavors and I'm confident we will be pleased with the results of the ongoing attention and improvements to each. We are very optimistic that we will achieve +six to +8 consolidated revenue growth in the first half of '08, based on our initiatives and based on the people we have in place across all functions of our Company.

I will now turn it over to Mike Casey.

Thanks Joe. Good morning, everybody.

Last night we reported our third quarter results, which were in line with our guidance. Sales for the third quarter were $411 million, a 5% to last year at the midpoint of our guidance. Third quarter earnings were $0.58 per share up 2% to last year and are [pending] better than our guidance.

In terms of sales growth for the third quarter by segment, Carter's on a stand-alone basis represented nearly 80% of our third quarter sales and increased 5% to $320 million. OshKosh sales were $91 million up 3% to last year. Our mass channel sales were $68 million up 2% to last year and were in line with guidance. Keep in mind our second quarter mass channel sales were up 16% due primarily to the timing of brand [wall] launches. Year-to-date mass channel sales were up 10% and expected to be up 10% for the year.

With respect to profitability, our consolidated gross margin in the third quarter was 35.5%, again in line with guidance and 210 basis points lower than last year due to OshKosh product performance and related markdowns in the retail segment. Gross margin in our OshKosh retail segment decreased from about 50% last year to 40% this year. That erosion in margin quality impacted third quarter earnings by $6 million or $0.06 per share and lowered our consolidated gross margin 150 basis points.

Demand for customer combinations in our wholesale segment was also higher than last year, given the promotional environment and cost us about 50 basis points in gross margin.

With respect to spending in the third quarter, SG&A was in line with our guidance at 100 basis points better than last year. The improvement in SG&A reflects our control over discretionary spending, including reducing our provision for incentive compensation. SG&A for the quarter includes $3 million of reorganization charges which were $2.5 million more than last year and $1 million higher than we had assumed in our previous guidance.

In the third quarter we executed a plan to upgrade key positions in our retail business. We also elevated certain people and other functions to further strengthen the organization. Part of this reorganization included reducing our corporate workforce by about 50 people or about 5% of the workforce. The annual savings from this workforce reduction is about $5 million, a good portion of which will fund the investment in our new retail team.

Our fourth quarter estimates include an additional $2 million of reorganizational charges which were not included in our previous guidance.

For the year, we will invest about $8 million in reorganization. That is twice what we spent last year and $3 million or $0.03 for than our previous earnings guidance.

With respect to our licensing business, our royalty income for the quarter was up about 11% to last year. We had good growth at both Carter's and OshKosh and in the third quarter our operating margin was 14.7%. That is in line with guidance and down 100 basis points from last year, driven largely by the decline in gross profit in our OshKosh wholesale and retail segments.

Our interest expense for the third quarter was down 8% to last year driven by a $28 million or 7% reduction in average borrowings. In terms of liquidity, earlier this year our Board of Directors authorized a $100 million share repurchase plan. Through the end of the third quarter we used $47 million of excess cash to repurchase approximately 2 million shares of our stock or 3% of our outstanding shares at an average price of about $24 a share.

We plan to continue repurchasing shares during the balance of the year. The benefit from the share repurchase this year will be at least $0.02 per share.

Cash flow used in operations in the first nine months was about $39 million compared to $5 million last year. This change in cash flow reflects the build in inventories. Our inventories at the end of the third quarter were $247 million, up 23% to last year and in line with guidance.

As we have discussed on previous calls we ran too lean on inventories last year and that had a negative impact on our retail business. At the end of September last year, our inventories were down 5% to the previous year. A better way to view our inventory growth this year is over a two-year period. On that basis, our average growth in inventories at the end of this September is about 8%.

Given the strength of our Baby product we are carrying higher levels of safety stock for Baby inventories and doing a better job of supporting higher demand. Our retail inventories on a per door basis at Carter's are up about 3% to last year. OshKosh inventories are up about 11%. We are doing a much better job flowing inventories to our retail stores.

We expect our inventories at the end of the year will be up about 20% compared to the end of 2006, again in line with previous guidance. This is average growth over the past two years of about 10%.

CapEx for the first nine months was about $13 million, primarily for retail store openings and system upgrades. We expect CapEx for the year will be about $30 million or 2% of sales. That is consistent with guidance and historical levels. We ended September with about $22 million outstanding on our revolver and we cleaned up the revolver in mid-October.

With respect to guidance our year-to-date results including non-cash charge of $2.59 per share related to the impairment of OshKosh intangible assets, which we took in the second quarter. Our year-to-date results also include charges of $0.08 per share related to the closure of our distribution center in Tennessee earlier this year.

I will comment on our fourth quarter and annual guidance excluding these charges, which we have outlined in our press release.

Given the current retail environment and the impact of additional reorganization charges, we expect to achieve the low end of our previous earnings guidance for the year, which is $1.42 per share on sales of $1,407,000,000. Our fourth quarter earnings are expected to be $0.50 per share on $388 million in sales.

As Joe mentioned we have taken a more conservative view on fourth quarter sales relative to our previous guidance. We have lowered our fourth quarter sales estimate by about 3% to reflect our latest forecasts for the Carter's wholesale and mass channel segments.

For our Carter's brand we expect fourth quarter sales will be $291 million, up 3% to last year. Carter's wholesale sales, excluding off-price sales, are now planned up 3% in the fourth quarter and up 8% for the year. Mass channel sales are now planned up 9% in the fourth quarter and up 10% for the year. Carter's retail sales are planned up 7% in the fourth quarter with comps flat to up 2%. Carter's retail store sales are expected to be up 8% for the year and comps are expected to be up 2%.

That brings total estimated sales for Carter's on a stand-alone basis to $1,089,000,000, up 7% for the year.

For OshKosh we expect fourth quarter sales will be $97 million, up 2% compared to the fourth quarter of last year. OshKosh wholesale sales excluding off-price sales are planned up 2% in the fourth quarter and down 9% for the year. OshKosh retail sales are planned up 3% in the fourth quarter with comps down 2 to 4% to the fall and holiday profit performance. Total sales for OshKosh retail stores will be up about 2% for the year with comps down 4 to 5%.

That brings total estimated sales for OshKosh for the year to $318 million, down 2% from 2006.

On an adjusted basis, we expect our consolidated gross margin in the fourth quarter will be 35.9%, down 10 basis points compared to the fourth quarter of 2006 due primarily to lower margins from the OshKosh business segments. That brings adjusted gross margin for the year to 34.6%, down 180 basis points compared to 2006, and in line with our previous guidance.

We expect SG&A will be 70 basis points better in the fourth quarter end of the year, reflecting control of discretionary spending and lower incentive compensation provisions. In the fourth quarter royalty income is expected to be $8 million, up 7% last year, up 6% for the year.

On an adjusted basis we expect our consolidated operating margin in the fourth quarter will be 13.9%, up 7 basis points compared to the fourth quarter of 2006. That brings our consolidated operating margin to 11.3% for the year, down 100 basis points to last year and 20 basis points lower than our previous guidance, due largely to the reorganization charges. Interest expense for the year is expected to be about $24 million, down 12%.

With respect to cash flow. cash flow from operations is expected to be about $50 million for the year consistent with our previous guidance. We are assuming depreciation and amortization of $32 million for the year and an effective tax rate of 37%, excluding the impact of the impairment charge. Our diluted share count for the year is expected to be 60.3 million shares.

That concludes our business update and we will open up to all of your questions.

(OPERATOR INSTRUCTIONS). Robby Ohmes, Banc of America Securities.

A couple of quick follow-up questions. The first question, I just was hoping we could get a little more detail on the inventory levels versus your forward sales growth guidance and just how does it break out retail Carter's versus OshKosh?

And then you talked about an increase I guess in back stock and Baby. Is that a wholesale increase or is that to support the retail stores and I guess what I'm looking for is connecting the -- I know the inventories were low last year but you brought them back up and I -- you know, beginning at the end of I guess you saw it even at the end of the second quarter. You would be looking I think for more powerful revenue growth acceleration and I'm wondering why we haven't seen that. If you could just walk us through that.

Then the second question I think I missed it, Mike, in your comments on the people investment in '08 and $0.03. And can you just give us some more detail on that as well? Thanks.

Sure. be happy to. The important thing to understand on the inventories we were underinventoried last year and certainly in our retail stores and that had a significant impact on our performance, starting in the second half of last year. So we have been looking at the inventory as we looked at the inventory models when we saw that they would be up 20% at the end of the third quarter end of the year. We dug into it and we are very comfortable with where we are.

We are supporting our retail stores with a better flow of inventory. If you break it down, we are probably carrying about $30 million more than what you would ordinarily expect in inventory and I would break that into three pieces.

Our Baby business has been on fire across all the segments and of that $30 million I attribute that -- at least a third of that to higher safety stock levels in our Baby category. That is low risk inventory to support the higher demand. I would say that another third of that $30 million increase is supporting our retail stores in a better way. If we were to break down the components of the growth you'd see significant comp increases in Baby category in our Carter's retail stores and in the accessories category. And those were a couple of areas where we were running short on inventory last year.

And then the last component, the final third of the increase in inventories I would attribute to better supply chain performance. We had a key supplier last year who ran into some issues and we were delayed getting playwear product to our customers; and our shipping performance year-over-year was much better than it was a year ago.

So we would attribute our performance in this quarter in a very difficult environment to the fact that we are carrying a better inventory position. So we are not concerned, I don't -- I think as a company our excess inventory position has never been better. And so we are in good shape as we head into the balance of the year.

But I think as you analyze the inventories you absolutely have to give consideration to the fact that we were underinventoried last year.

You had a question in terms of investments. And as I said in my notes the investment in reorganization charges is twice what we spent a year ago. So in terms of the people investments, the focus has been on the retail business. As Joe mentioned we certainly have a terrific new leader in Jim Petty; and Jim has helped us beef up and upgrade all the key positions including the Senior VP of Store Operations. We have a new Senior VP of Planning and Allocations and that is an area that has hurt us significantly getting the right product to our stores.

We have a new head of marketing. We have a new GMM for the OshKosh retail segment. We have a new senior design director for OshKosh Girls business where we have been struggling and we are close to having a new merchant for OshKosh.

So the investment in people have been significant particularly in the third quarter. And we are making higher provisions in the fourth quarters for that as well.

In addition to the procurement of new people we promoted a number of qualified people here recently. We have spent a lot of time on retention, making sure we don't lose important people as well. We restore this business. We have gone in some cases to a flatter organizational structure where we can make decisions a lot quicker.

As Joe mentioned we put the sleepwear under our Baby leadership which is a supercompetent team. So I think overall we've looked at this at the macro level as well not just filling in some key spots.

So to wrap that up you gave us some help with understanding review guidance for the first half of '08. When we wrap up everything going on with more people and your inventory position and everything else, should we expect operating margins to be rebounding against what you guys went through in the first half of '07?

Yes you should expect the operating margin to improve in the first half. That is the visibility we have on next year based on the spring bookings. But we are expecting to return to good growth in both sales and earnings next year. We won't have visibility on the full year forecast until we get the fall bookings in January.

So we will give a full year view on '08 when we chat again in February. But Joe said based on the visibility we have on the first half we are expecting topline growth to be up some portion of 6 to 8%. And earnings up to finalizing our spending pants over plans over the next month or so we would hope that that would be up in the range of 10 to 15% in the first half.

Brad Stephens, Morgan Keegan.

Historically I know you targeted SG&A to grow at two-thirds the rate of sales. But next year you are lapping -- hopefully, you're putting the variable compensation back into the business. So should we expect next year to be at two-thirds the rate of sales?

I am going to hold off giving you any specifics on and the late model but suffice to say we will continue to manage the growth in spending at a rate that is not in excess of the growth in gross profit dollars. The big opportunity for next year is a turnaround in that retail business.

You have to keep in mind where we got off-track. We got off-track in terms of retail leadership and execution issues. We have a terrific new leader and with a far better team; and as Joe said we're seeing better results from better execution.

We also got off-track by how the OshKosh brand was positioned and that is being positioned differently, beginning with spring 2008. So that is why we are encouraged by the moves that we made this year to position us better for '08.

In your fourth quarter guidance gross margins are down 10 bips. What is implied for the degradation of OshKosh margin in Q4?

We are going to expect to continue to see that we are going to struggle there. So we get that product behind us and move then. I don't think I want to be so specific on each of those based on the segment profitability the best information I can probably give you is our view on what we'd ultimately put in the segment profitability.

At the gross margin side OshKosh, a year ago at wholesale, had probably a 23% gross margin of probably closer to 10. And that is baked into the guidance. And OshKosh retail last year was around 45% and we are assuming it'll probably be closer to 38?

And that's what's been holding us back and that's reason you should expect to see improvement next year.

Alright. Then last question on the mass channel. You said 8 to 10% in the first half of next year. Is that the go-forward rate or do expect to get some things straightened out at Wal-Mart and we get back to 10 and hopefully a little bit better longer-term there?

Yes Brad, this is Joe. 8 to 10 for the first half. We expect it to get better. We put allow plot of plans into action. It is hard to quantify them right now but we definitely think that has more potential. More upside.

[Brian Goss], Morgan Stanley.

Just had a question on your investment spending. Really a follow-up to what Robby hit on. But your sales in the quarter grew about 5%. Your SG&A grew less than 1%. If I exclude the reorg costs that looks like SG&A was actually down. So you've noted a lot of the reinvestments of these cost cuts into other parts of the organization, but Net Net it still sounds like the SG&A base is coming down when some might argue that in a tough environment it should actually go up.

So I guess I'm wondering what's your confidence level from a long-term standpoint that you are reinvesting enough back into the business in order to reaccelerate growth on a sustainable basis?

From our point of view we have been investing in the business. We have been investing in the business for years. Our style has always been earn and invest and because the earnings were going to be off this year we reined in spending where we could. I will tell you there is no investment that we believe is important to grow this business that we haven't funded. As we said before there's two areas where we got off-track. It was in retail and in OshKosh, both of which we have taken the time needed this year to get better performance beginning next year.

But I will tell you that for our Company the way we have had historically invested like, say, our level of investment was much higher this year. It was funded from among other things incentive compensation, but we view that as a balance sheet. You don't get it unless you earn it and we will fund that as we earn it next year.

So it sounds like a high confidence level.

We do, yes.

You know we've also invested beginning to invest heavily in research which we had not done; and we invested in understanding each of these brands more and we've done this tax-free search. Completed that on finding the optimum price and margin thresholds for each of every core product under our brands. We've begun online consumer surveys. We are doing consumer panels on every one of our product lines.

And you can't understate the importance. We've put $20 million into upgrading our core products since we move into '08. So it's far beyond just a people issue. Insufficient inventory cost us a hell of a lot of grief and that's going to pay its way.

And as we move through the next couple of years having a senior executive both of planning and allocations we will get a lot better, not only of having a proper level of inventory but the proper mix and that will materially improve profitability. So I don't think investments -- we don't have a lack of investments. Let's put it that way.

Great. That's great color. Thanks.

Omar Saad. Credit Suisse.

Fred, I wanted to see -- you talked about some people investments and it sounds like despite writing off some of the goodwill associated with OshKosh, you guys are really sticking to it and believe in the brand long-term.

Do you think -- do you have an opportunity to put in some leadership kind of at the top level, the president of the OshKosh brand to really give it the focus that it needs from a long-term basis. Someone who is devoted to the brand or are you going to kind of continue to manage it the way you have been in the last six -- six months to 12 months?

We are going to put somebody over that business. We are getting very close to making that move. I prefer not to say anything but we are just weeks away. And we feel that will help materially because there's just a lot of things that need to be looked at other than just say better product, better pricing. There are lots of issues like branding and just administratively that will help strengthen the Soho area.

So we are getting ready to do that. We haven't lost faith in OshKosh. If anything our research that we've done has reinforced the power of the franchise with the consumer and, as Mike mentioned, the new positioning should be material. It's just going to take some time here. We know spring and summer better. We got to make up some ground.

So I wouldn't get to make is about it. We are heavily into fall product development and we are all micro involved in that process and we are encouraged that fall '08 will be even stronger. So we are optimistic there and we are going to put somebody over it.

Excellent. That's helpful to know that. In terms of a comment that was made at the beginning I think it was Joe -- and Fred this was one of our goals you highlighted in the beginning, in the opening statement. One of your goals has been to create product, improve the product margins and profitability for the retailers and you talked about being able to that as well as improving product profitability for Carter's, and being able to get leverage in your sourcing and restructure.

Can you talk about how you're able to pull that off in this kind of environment where a lot of the input costs arising and there's some wage inflation in the Far East, how you're able to get leverage and the sourcing in the product cost that you are developing in this kind of environment?

As Joe said and as Fred said, the whole focus is to get the product and the price right and so there's no question we are going to be much more competitive in terms of our product benefits and we've adjusted the prices in a way to improve the profitability for the retailer and we are doing that so we can improve our own profitability. Because the product will sell better and you'll have less end of season markdown support.

We continue to say good progress on the sourcing side of our business and there's no question. Costs are increasing in China, but we only have about 50% of what we do in China. We continue to narrow the vendor base. We are giving more volume to fewer vendors. We are moving more to vertical suppliers, who have the higher efficiencies and lower costs. We are building our capabilities in other parts of Asia.

Places like Malaysia, India, Thailand we've had very good performance in our sleepwear business in Cambodia and Vietnam. We are connected at the top with [Lin Fung]. We met recently with William Fung, who has been a terrific adviser to us in terms of how to continue to leverage our significant unit volume to get better prices. I would say, again, based on spring visibility, our spring '08 visibility and early summer I would say in every case where we have lowered prices, our sourcing group has been able to fund that with lower product cost.

I think it also starts with the product market scope, you know we're reducing fabrics 20 to 30% on some of these lines. Reducing the amount of style colors so -- and coupled with our combined topline revenue we may be increasing some styles and colors 20%. So we are going in there with a lot of volume leverage by reducing some of that complexity.

But you're not taking quality out of the product or quality of the fabric.

No.

We are very careful about that.

Last question. Weather the retail, especially in the Carter's business I think 4%. I think you guys talked about 1 to 2% came in better. What are you saying out there with -- how is weather impacting your business. You know kind of the colder winter product -- fall winter product versus some of the lighter product? Are you seeing an impact in the business?

Well I'd start with the fact we are in the outlook business. So we -- one of the reasons we don't give monthly conferences because we can be affected by weather patterns. So we do it on a three-month basis. But we do say weather and probably with the global warming you know you need to be a lot more sensitive to summers are longer, springs are earlier.

So we do take that into account with our mix as simple as a short sleeve and a long sleeve. And in certain regions we target the Southern regions with more appropriate products. So that becomes more important.

Okay, but it doesn't sound like you are seeing a tremendous impact from the warm weather, or at least you hadn't through September.

I would say tremendous.

(multiple speakers)

A big effect is when there's a monster snowstorm in January. Or a late storm in March. Those things you never can predict.

R.J. Hottovy, Next Generation Equity Research.

Good morning, everyone. Just wanted to ask one big broad-based question here about some of the retail improvements that you've outlined in the last couple of months here and just get an update on some of the progress. Namely how customers are reacting to some of the better pricing clarity messages you've put in the stores as well as an update on the customer loyalty cards. And then just one quick follow-up after that.

Definitely getting better. We are starting to see some good successes in OshKosh to start building a baseline. Which has been, even though the overall is not good putting some of these key items like boys denim, sweats, tees, we are starting to see the key items definitely led by boys performing well. That is helping us build a baseline for the future.

So we are -- that price clarity of going for the right price and staying there. Also I think we said for next year we are adding a lot of opening price point products to the mix that we [didn't] have this year. So you know last year if you had walked in our store you probably would have seen a T-shirt at OshKosh $16 at 30 to 40 off. This year you'll see two for $12 T-shirts. Two for $15 T-shirts.

So each classification we have had a significant opening price point product. So that, and we think approximately 70% of the mix could be at everyday low pricing and/or two-for pricing. So probably compared to 30% of it this year. So we are very pleased with that.

Second question on the loyalty program, just started it. We definitely believe it's -- probably we have a list right now -- it's probably 15 to 20% of our customer base. We know from past experience, the potential could be 50 to 75% of the mix.

So I think it's too early to comment on results, but we know these customers spend more. And we really have -- Jim has a lot of experience in this area coupled with our VP of Marketing. We definitely think this will be a plus going forward.

Fair enough. My second question just has to do with essentially the plans for Black Friday this year compared to past years. Talking with the (inaudible) it sounds like you guys have really put a priority on this for this year. Just a sense of what your expectations are there?

We definitely will be better than we were the year before. We are much more prepared from inventory and promotion and Black Friday. So I tell you, what's going to happen -- I don't know -- but we are much better prepared. We expect it to be better.

Margaret Mager with Goldman Sachs.

Hi, good morning. Just a couple of questions. Could you talk about why is it that the Carter's wholesale business is growing as much as double-digit when the customers that you sell to are not growing double-digit? So how is that happening?

And then your royalty business what is driving that? That's been a strong part of the business. What are your best licenses and can you talk about your Wal-Mart strategy and what is having there, given that they are making some changes in their business and also experiencing traffic challenges.

So are you still rolling out playwear in Wal-Mart or what's happening in that piece of your business? Thanks.

I will answer the first went with Carter's wholesale. No. 1, I think we -- some of our customers and our top three customers are really high-growth retailers. I think you look at Kohl's opening stores, JCPenney opening stores and Babies R Us opening stores is definitely a plus. So we still think Kohl's is a big opportunity. Committed to brands.

I think you have got to be a top one or two brand to do well with these these people but I think that is what we have. We have the top -- potentially the top two brands. We still only have a 7% share in Carter's in 0 to 7. We are making as Mike said more investments on the marketing side of the business and fixed during next year and advertising so -- and we are increasing our customers' profitability.

So if you are delivering volume and increasing their profitability and making the investments, I think we are good partners. So, and we have proven it over a period of time and they continue to support us for that.

I will let Mike talk about the royalty. Mike, you want to talk about -- ?

The trends in royalty, you know, royalty -- trends -- both the royalty business is a significant part of our profitability and the performance there has generally been (technical difficulty). If you remember we talked about in the second half of last year that we were upgrading the mix of product and that had a negative impact as we transitioned out in our retail stores.

But compared to this time last year, we have a new bedding licensee. New hosiery, new plush toys. So there's been a focus on upgrading the mix of our licensees and we are still combining the Carter's and OshKosh licensees, trying to do more business with fewer and better suppliers. So generally speaking that business has a long track record. Having very good performance and it's largely because of the leadership and because of the focus on picking better partners.

I will answer Wal-Mart. I think we talked about it a little bit. Part of it we both need to get better. Their business has been tough. They have been lowering inventory requirements and we have had a couple of products that we are not pleased with the performance.

So we got aggressive. We are addressing those whether it's through elevated products, getting the products to the right prices, getting the inventory line is not an issue for us. Because I think we do really well at that.

As far as the potential, again, we've got a playwear rack I think for the first half of the year in there. There is a lot of potential with that. I don't think we can comment on -- it's more of a second half '08 issue there if we get additional playwear. But plenty of opportunity. I mean we have 5 or 6% share of these guys' 0 to 7 business. So (multiple speakers) lack of opportunity.

The wall space that they have assigned to your Child of Mine brands. That's consistent. It's not being changed, is it?

No, not being changed.

Do you have different design teams for Child of Mine, Just One Year and the Carter brand? Are they different product teams?

Yes.

Then lastly, just follow-up on the wholesale piece for Carter's. Are the -- if you looked at it on a comp store basis, are you comping positive at Penney's, Kohls and Babies R Us, and then separately, you know Macy's has really gotten much more aggressive about brands that are sold in those competitors. Vis a vis, their position with that brand.

Are they doing that or is there any discussion along that line in at Macy's, that they are not happy about you selling at Kohl's and Penney's?

As far as I would say, definitely our growth with these guys exceeds their or matches or exceeds their comp store growth. So definitely Kohl's -- Federated has always, they are always going to want exclusives. We understand that. We are trying to partner with them to make it -- but it is -- we plan that business down a little bit. I think it was down last year. We plan it down this year.

We do have a couple of initiatives with them. We just put a new any shop on 34th Street I encourage you to go look at.

So there's a will there. We just need to get it together. We are not doing as well as we could there, but we just put in this new shop which I think will bode well for our performance. And of a couple of weeks looks real good. So we will see where we go from there.

I want to wish you the best of luck going forward and let you know that it's been fun covering you and the highlight of my career at GS that we were able to take you public back in the day. So you've done a great job since then and keep it up going forward.

(OPERATOR INSTRUCTIONS) Robert Jordan, Morgan Stanley.

Wondered if you could just -- on your last conference call you talked about your repositioning of the OshKosh brand and you mentioned sort of somewhere you mentioned Children's Place and mentioned Gap. And to my mind that's kind of like Dodge and -- I don't know -- Volvo.

If you could talk a little bit more about the OshKosh brand. Also how you are protecting the brand value to your retail partner that you sell to wholesale as you are moving towards this everyday low pricing and two for selling on the outside?

This is Fred. With OshKosh, not to rehash a long story here but we position the product benefits and the prices too high as we started fall '06 and that continued until we found an opportunity to reposition for spring. But we didn't reposition to both Gap and Children's Place. I do believe Gap is Volvo, but I think you had to call our position more like a Honda. It's a very valued price, super quality and terrific core items.

So we are not positioned directly at Children's Place but we have a lot more competitive prices and we take a lot of the bells and whistles off and made it not so fashionable as it was. So we feel we are right in line. We have run this through consumer panels, right to our research with the stacks, threshold studies and everything is confirmed and our position is right.

So we are confident that OshKosh is positioned well.

Can you remind me SKU overlap between what you're selling retail and what you ultimately sell in the outlets versus made for outlets on the OshKosh line?

I think as far as your earlier question about the opening price and everyday -- most of that is really done on the categories that were compared to the retailer's private label. Not really compared to the brand. So we don't carry those products in wholesale. You'll have a T-shirt. These opening price T-shirts really go. We had to have a second tier of T-shirts that you would find in Kohl's and possibly in our stores and those are priced comparatively.

So as far as overlap I'd probably say about half the mixed falls probably 40 to 50% of the mix would be overlapping.

Jim Chartier. Monness, Crespi.

Just a quick question. Just looking, just curious about your guidance for retail sales, given you've got an easier comparison from fourth quarter last year, why you are expecting a slowdown in fourth quarter this year from third quarter?

I wouldn't characterize it as a slowdown. I think this is the environment to be bullish on the guidance. We are focused on having positive comps on Carter's and hopefully starting to have positive comps on OshKosh beginning next year.

Having no further questions I would like to turn the conference over to Mr. Rowan for any additional or closing comments.

Thank all of you once again for your attendance and questions. We really do appreciate the quality of those. I would only say in closing that our Company is more energized and more focused than ever. We are certainly more talented and we are investing not just in the short run but investments are geared so we can guarantee that we are going to have continuation of high-growth as a company. Also management, key management of this Company is very invested. So you should take great confidence in that we are energized to do well for our shareholders. We look forward to our next call. Thank you.

This does conclude today's Carter's conference 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 October 31st. The dial in number for the replay is 888-203-1112 in the U.S. and Canada and 719-457-0820 from International locations. The confirmation code to access the replay is 749-8164. (OPERATOR REPEATS INSTRUCTIONS) You may disconnect at this time.