Carter's Inc (CRI) 2008 Q3 法說會逐字稿

Good day everyone and welcome to Carter's third quarter earnings conference call. Today's call is being recorded. On the call today are Mike Casey, Chief Financial Officer; Joe Pacifico, President and Jim Petty, President of Retail Stores. 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. Again, that is 404-745-2889.

Carter's issued its third quarter earnings press release yesterday. The text of the release appears at www.carters. com under the press release section. Additionally, presentation materials for today's earnings conference can be accessed on the Company's website by clicking on the Investor Relations tab and choosing conference calls and websites on the left side of the screen.

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 differ from those contained in the forward looking statements, please refer to the most recent annual report filed with the Securities and Exchange Commission. Also on this call, the Company will reference various non-GAAP financial measurements. The reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the Company's release.

I'd like to turn the call over to Mr. Casey.

Good morning, everybody. Thanks for joining us for an update on our business. We've prepared a brief presentation on our third quarter result, which is available on our website. Before going through the presentation, I'd like to frame up what I believe is important for you to understand about our business.

In a tough retail environment, we exceeded our goals for third quarter, which is our largest quarter of our year. The trends in our business are good heading into the final weeks of the year. Our performance reflects the benefits of significant investments made over the past year to strengthen our organization and our product offerings. We're very fortunate to be competing in the young children's apparel space. It's a less discretionary purchase and its a very affordable purchase. The birthrate continues to be strong and parents and grandparents continue to spend money on their young children.

For years Carter's has led the young children's apparel market because we're providing consumers with significant product value. Our average unit price is less than $8. By comparison the value equation in recent years at OshKosh has been out of balance and we've been working hard to correct it. Over the past two years, we've refined our product and pricing strategies to strengthen the OshKosh product offering. In the second quarter, we started to see meaningfully better performance in our OshKosh segment. That positive trend continued through the third quarter and into the fourth quarter.

On our last call, we outlined a handful of milestones in each of the retail and wholesale segments to correct OshKosh's performance. We believe we're on track to achieve those milestones. Ideally, all components of our business would be performing at an optimal level. That's rarely the case. But the beauty of our business is that we now have multiple levels to enable growth.

Starting with the highlights of our third quarter results on page two of to presentation, our sales were up 6%, driven primarily by the strength of our retail store segments and earlier demand in our wholesale and mass channel segments. On a GAAP basis, our earnings were $0.58 a share including charges related to the write down of an OshKosh distribution facility. On an adjusted basis, excluding that charge, earnings were $0.60 a share, 3% better than last year. We'd say at least $0.10 of the $0.60 were reporting is attributed to the earlier than expected demand and the timing of spending. We continue to make excellent progress controlling the growth in inventories. Inventories were down 13% at the end of September, due primarily to the higher sales in the quarter. We're expecting inventories to be up 5% at the end of the year. Cash flow continues to be good. Through the first nine months, we generated $57 million of cash flow. The improvement was driven by better inventory management and we're expecting operating cash flow of at least $80 million this year.

In terms of our outlook based on the strength of our retail segments, the strength of our product offerings and the current trends in our business, our outlook has improved since our last call. On page three, you have a snapshot of the growth in sales for each component of our business. Here, you can see the terrific performance in both retail segments. We had growth in all but one segment, OshKosh Wholesale, which Joe will review with you this morning.

On page four, you have our third quarter P&L. Historically, our third quarter has been the largest quarter in terms of sales and earnings contribution. It typically contributes about 30% of annual sales and 40% of operating income. Our gross profit margin was comparable to last year. We're pleased with that performance given the very promotional environment. As expected, SG&A grew at a rate faster than gross profit. SG&A is up $10 million, which includes a $6 million increase in retail store expenses primarily related to new stores. The increase in SG&A also reflects a $4 million provision for incentive compensation. There were no provisions for incentive comp in 2007. At the bottom of the page you have EPS on a GAAP and adjusted basis.

On page five, we reconciled the GAAP to adjusted earnings and distribution effect of the facility writedown and closure costs. On page six, you have our third quarter segment profitability. On an adjusted basis, our operating margins, shown on the lower right-hand corner of the page, decreased 100 basis points, which has a value of about $4.5 million or $0.05 per share. The margin improvement in our OshKosh retail segment was offset by lower margins in our wholesale and mass channel segments. In Carter's' wholesale segment, profitability decreased 290 basis points from last year driven by a higher mix of sales to off price retailers and related provisions for excess inventory. Our Carter's retail store operating margin decreased 100 basis points, largely due to the impact of the new stores. The new stores generally start out less productive than the comping stores, but ramp up nicely over the first two to three years. We also had a decline in mass channel profitability due to performance of certain components of our Child of Mine brand and higher provisions for excess inventory.

At Osh Kosh, we're very encouraged by the recent trends in the retail segment, which represents more than 75% of OshKosh's annual sales. We believe that performance is directly related to the strengthening the product offering and better management of the stores. As expected, the OshKosh retail segment is posting better results than the wholesale segment. However, our wholesale customers are achieving much better over-the-counter selling with the OshKosh product and earning higher margins. We believe this will enable better performance in our wholesale segment beginning with spring 2009.

On page seven, you have a summary of our cash flow and debt structure. At the end of the quarter we had about $60 million of cash on hand. Given the environment, we believe it's a good time to be carrying more cash on the balance sheet. We haven't used our $125 million revolving credit facility for more than a year and we don't expect to need the revolver for the foreseeable future. We're very comfortable with our leverage because as you know, we've operated with significantly higher leverage in the past. We are fortunate to have refinanced our credit facilities a couple of years ago and negotiated very favorable pricing. We've made good progress on our share repurchase program. Since March of 2007, we repurchased 8% of our outstanding shares at less than $20 per share. For an update on our wholesale and mass channel segments, I'll turn the call over to Joe Pacifico.

I'll start by discussing our wholesale business on page eight. Sales were up 1% for the quarter despite canceling orders from high credit risk accounts. These results are better than discussed on our last quarter when we projected quarter three down double digits. The better results in quarter three were due to earlier than expected order demand driven by strong over-the-counter selling for our customers. In the third quarter over the counter selling was up double digits in all three of our product categories, baby, sleep wear, and play wear. These results include the benefits from our fall '08 strategies that we began developing a year ago. A more compelling product offering, increased product value and the implementation of an everyday low pricing strategy. Another of our initiatives is the rollout of the newborn to 24 month shops. These shops pull together our three product categories, baby, sleep wear, and play wear in the newborn to 24 month size range which we feel makes the shopping experience more compelling and more convenient and creates a dominant brand presentation. We believe Carter's dominance in the baby business makes this possible and serves as an competitive advantage.

By mid-November, prior to the holiday rush, we plan to have 400 shops at Kohl's and 15 at Macy's. We plan to roll out 300 shops in J.C. Penney in the first half of 2009. Looking at the balance of the year, well positioned with inventory heading into quarter four as a result of the better over the counter selling in the third quarter. From a sales perspective, because of increased sales in the third quarter, we now project fourth quarter and the year to be up low single digit in line with the plan we shared with you on the last call.

In regards to spring '09 we have orders in hand and are projecting sales up low to mid-single digits. We believe that the line will perform well over-the-counter due to our rolling forward same product and marketing strategies that we began implementing with the fall '08 line. We also anticipate ending the season with cleaner inventory than last year due to stronger sell through of fall product, which have improved the customers' and our profitability.

If you want to turn to the mass channel on page nine, in total mass channel sales were up 13% in the third quarter. We are projecting quarter four up mid-single digit, which would bring us to low single digit growth for the year. In the mass channel we have two different stories. Just One Year, our brand at Target, we have and continue to have consistently good performance. Our quarter three sales are in line with plan and Target's over the counter selling was good in the quarter. We're projecting sales up high single digits in quarter four and for the year.

Child of Mine, our brand at Wal-Mart, quarter three sales were plus 18%. This is a timing issue, driven by earlier demand in certain product categories. As a result to have earlier shipping in the third quarter, we now expect fourth quarter to be down 8% but the second half should be up 6% to 8%. We have product issues we are working through with Wal-Mart. We said on the last call we felt we had corrected our product issues for fall '08. I believe we have accomplished that objective for 75% of our mix. We still have more work to do on the packaged goods segment of the business. We're confident we will correct what is underperforming, but it will affect our ability to grow Child of Mine business in the first half of next year.

Turning to OshKosh wholesale on page 10, sales were down for the quarter. The decline in sales this year is a direct result of our customers reducing orders based on product performance last year. Our performance is in line with what we expected. We knew this would be a tough year because of our over-the-counter performance last year.

That's why our focus this year was accomplished two key initiatives, which will drive positive bookings in 2009. They were to one increase our product sell through percentages before permanent markdown and secondly improve the retailers' natural margin. We accomplished both of these objectives with our spring line, our summer line, and now fall. To put it in perspective for you, our spring summer line, our sell through before perm were at 55% this year versus 45% the prior year. Fall is currently trending in the 60% to 65% sell through before perm. On top of this, we are also increasing the customers' margins. We feel this is a direct result of our total repositioning of the OshKosh brand. We've gotten back to basics with much better product. The color and art is much more age appropriate and a greater focus on core products.

As we shared with you on prior calls, we've lowered wholesale prices to provide greater consumer value. We at the same time lowered product costs and are achieving our margin objectives. We are pleased with the consumers response to the brand. They seem to be clearly embracing the product and pricing strategies and this gives us confidence as we head into 2009. Looking ahead to spring '09 we expect mid-single digit increases in sales, based on the trend we are seeing we believe we can build a meaningful and profitable wholesale business for OshKosh.

In closing, I'd like to comment on our strategies and how we are positioned going into 2009. Last year we took a hard look at value equation and our product and brand positioning. We conducted a comprehensive competitive analysis, did broad consumer research, and a price elasticity study. We incorporated these learnings, (inaudible) which are driving great value to the consumer and positive results for both the customers and us. These same strategies are in place in 2009 and should continue to position us well in the tough economic environment.

Now I'm turn the call over to Jim Petty, who will discuss how the strategies are being executed at retail.

As we shared with you on the last call, retail continues to build momentum in both brands with strong consumer acceptance of its value equation and price clarity. Over the past year focused on improving both brands through better talent, inventory management, price clarity and an overall store shopping environment. Now as it relates to Carter's, our third quarter comparable stores increase of 6.1% and year-to-date increase of 11.3% reinforces our believe that our key initiatives are working. We have achieved seven straight quarters of positive comps. Third quarter results are highlighted by positive comp performance in all product categories, with the exception of accessories, which represents about 10% of the business. In this difficult environment gross margin improved over last year. This is mainly due to product performance and inventory management. I encourage you to visit our stores to see the strength of the product and the value to the customer.

As indicated on page 11, all key performance indicators improved as compared to last year with the exception of the number of transactions which were comparable to last year. Fourth quarter is off to a good start and our outlook remains positive. However, due to the increasingly challenging economic environment in last year's fourth quarter comparable stores sales increase of 9%, we are assuming flat to low single digit comp store performance for the fourth quarter. We expect that performance to be accompanied by gross margin expansion and better managed inventories.

Moving on to OshKosh, as you recall we began seeing an improving sales trend in the second quarter. This was due to strengthening of product offering and effective inventory management. This momentum is carried through the third quarter and into the fourth quarter. Our focus was and will continue to be on gross margin quality. For the quarter we significantly improved gross margin quality which resulted in an 850 basis point increase in operating margin - - 950 basis point in margin. In addition to gross margin improvement, comps were up 13.2% in the third quarter. This is a distinct change in the trend of business, comping positive for the first time since Q1 of 2007. We attribute the turn around to significantly better product assortment with stronger value for the customer, improved inventory management and improved in store execution with a focus on fixturing and on visual merchandising. All product categories comped positive with better margins.

As referenced on page 12, all key performance indicators with the exception of UPTs were improved as compared to last year. The decline in UPTs was mainly due to an aggressive liquidation of excess inventory last year. To reiterate while fourth quarter comped for OshKosh are expected to be up low single digits, our focus will continue to be improving gross margin quality. Early reads on Holiday are encouraging and we are well positioned from a marketing agenda and inventory perspective. Now back to Mike.

Our last call in July we outlined some important milestones that we have shone on page 13 to measure our progress turning the OshKosh business around. Our retail performance over the past five months provides a good indication that we're on track to rebuild this terrific brand. Based on the current trends in our business, we feel we're on track to achieve the milestones in both the retail and wholesale segments. On page 14 we've updated the assumptions supporting our 2008 guidance. We are currently expecting low single digit growth in fourth quarter sales, which supports earnings of $0.43 to $0.47 per share. For the year, we expect mid single digit growth in sales, earnings are now projected to be flat to down 3% for the year. This is better that our last update and we expect to invest about $50 million in CapEx, largely in our retail segment.

That concludes our prepared remarks on the business, we'll open up the call to your questions.

Ladies and gentlemen, our question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) And for our first question we go to Omar Saad, Credit Suisse.

Thanks, good morning. Congratulations, guys on a great quarter when a lot of these consumer stocks are dropping like flies lately. I wonder if you could help us understand how you've been able to improve your position with the consumer. That seems to be having a great impact on your business holding up so well. On top of the fact that the category is generally a more stable category. In an inflationary time, how have you been able to improve that proposition with the consumer where they feel like they're getting great value, given what we're hearing is happening on the inflation side.

This is Joe. As we said, we began over a year ago looking at how we were positioned in the market, price competitiveness, and we felt OshKosh needed more work than the Carter brand, but there was one area that Carter's needed. We focused as an organization, we reengineered - - we looked at every one of our core producted and reengineered to match benefits to what the consumer is willing to pay in the market and it's paid off. Our results in the third quarter are beyond our expectations for both brands. The total organization focusing on a few items and getting them in line with what needed to be in the market. And it's worked well for us.

I think companies who have a strong value message are doing well in this market. And Carter's has had a compelling value message and terrific product, good price. That hasn't been the price with OshKosh until recently. One of the good things we've learned with Carter's and in recent years with OshKosh we started to implement into the OshKosh product offering. To Joe's point our performance is largely a reflection of a lot of hard work to strengthen our product offering across all business segments.

Okay. And then switching gears a little bit on the -- in your wholesale business, are you seeing any trends with competitive brands? Are you seeing any of these in terms of private label becoming more or less prominent in this environment?

Omar, this is Joe again. I think everybody was on a pretty good roll from '03 to '07. Slowing of business puts a lot more pressure on the customer to make commitments. So a brand like us that does 25% of our business on a replenishment and we drive a lot of core products and common inventory does give us a little bit of a competitive advantage to pick up business in this type of environment.

Okay. And then last question, on the comp side on the Carter's retail, we saw a deceleration. Still a great number compared to everything else we're hearing from other companies out there. Do you think that's an appropriate run rate? Do you expect that to decelerate with the rest of the marketplace?

This is Jim. It's really been a pretty well balanced quarter from a comp store performance. And the momentum that we've achieved over the quarter is pretty much continuing. So we're feeling confident about things and we're on plan.

Great. Thanks, guys, great job.

Thanks Omar.

Our next question is from Margaret Whitfield with [Stern Age, Inc.].

Congratulations. Wondered if you could discuss at Carter's wholesale the level of over the counter sales at your key retailers and the level of your inventories at these key retailers. Could there be any up side to the forecast you just provided for Q4? That's the first question.

Sales in the third quarter as we said were up double digits and that was in baby, play wear, and sleep wear. Inventory is good position. Hate to say chasing a little bit of inventory. But we're chasing inventory in a couple of product categories. We feel very strong we're in a good position for the balance of the year. On order file is very clean. We think we'll end the year very well. I don't think we can get too much more specific than that. Definitely good position on inventory and sales over-the-counter has been better than we expected.

What has been the impact of the troubled retailers that were on the watch list and will they be a factor in the fourth quarter outlook at wholesale?

We've taken that out of our plan as we said on last call. To put it in perspective we're running about a 7% cancellation rate this year which is probably double -- it is double what we've experienced over the last three to five years. And that's directly related to those credit risk accounts. We took out in anticipation. We feel that's all taken out of our plan.

In terms of the earnings impact it's probable about $0.03. Most of that in the first half of this year.

What was the level of off price selling? I presume that's tied to the troubled retailers.

No doubt about it when business gets tough you find yourself with more goods particularly with us canceling orders from high credit risk accounts. And we moved that out through off price retailers and in this environment you get paid less for that.

Would you imagine you're through the worse of it?

I think we're in good shape heading into the balance of the year.

Okay. And for Jim, how did the comps trend at each unit during the quarter? And how are the comps trending thus far in October?

I'll give you both brands for the third quarter. For Carter's we were at a 4.9% in July. And then a 6% comp in August and a 6.8% comp in September and obviously we came in at 6.1% in OshKosh we were at an 11.4% in July. 16.8% in August and 10.9% in September. Coming in at the 13.2% And momentum is consistent. We're feeling guardedly optimistic.

So October is consistent with the run rate of the quarter overall?

We're feeling like -- things are good.

So your forecast could prove conservative potentially.

I think Margaret that we've got to be very guarded. We don't know what's happening around the corner. None of us do. We're being guardedly optimistic.

Two important months ahead of us.

The difference between the brand stores and the outlet stores. Any notable difference in the two units?

The brand stores are better from a comp perspective and that's been consistent with what we said at the end of Q2.

Thank you.

And for our next question, we go to Ben Rothbottom with Goldman Sachs.

Thanks. I was hoping you guys could provide a little bit more color on gross margin trends at Carter's wholesale in the quarter and what you're sort of factoring into the look the there.

Let me talk about the operating margins. The operating margin has been impacted by what's going on in the environment. We've had to cancel out orders from some high credit risk accounts. And when you do that you have higher provisions for excess inventory, higher provisions for the losses from marketing those products out to the off price channel. So that has weighed down the gross margin and the operating margins down year-over-year. My guess is you'll continue to see decline in that operating margin over the next quarter or so. I would encourage you to look at the absolute margin in that business. Carter's wholesale continues to be the largest and most profitable component of our business. It's a very efficient business model. But year-over-year the margins are down largely due to what's going on in the environment.

As you look forward into '09, from an inflation perspective, given the pull back in energy prices, what are you thinking there now?

Very good question. Oil is now below $70 a barrel. I look back to a year ago. Interestingly it was over $80 a barrel a year ago. A few months ago it was closer to $150 a barrel going to $200. There's a little bit of a silver lining and our outlook on costs is better than three months ago. We have visibility through spring 2009 where we saw a 2% product cost increase that was manageable. We were able to offset that with efficiencies elsewhere in our business. Fall '09, we have folks traveling to Asia now and negotiating fall '09 prices. A few months ago, I probably would have said the cost increases there would be at least 2%, maybe closer to 4%. Or more. And today we think it will be comparable to what we saw in spring '09. It might be a bit better. We'll plan it at a level at least equal to the spring '09 cost. There's a lot of capacity freeing up in the world now because of consumer demand is down and that's an opportunity for us.

Helpful once again. Thanks so much and best of luck.

You're welcome.

With that ladies and gentlemen we have no further questions on our roster. Therefore, Mr. Casey, I'll turn conference back to you for closing remarks.

Thank you for joining us. Appreciate your questions and support. Look forward to updating you again in February.

Ladies and gentlemen, this does conclude today's Carter's call. If you would like to listen to a replay it will be available beginning at 11:30 a.m. Today through the 31st of October. The dial in number for the replay is (888)203-1112 in the United States and Canada. And (719)457-0920 from international locations. The confirmation code is 724-3510 and again those numbers are (888)203-1112 and the (719)457-0920 internationally. And again the confirmation code is 724-3510. We do appreciate your participation and you may disconnect at this time.