Carter's Inc (CRI) 2010 Q3 法說會逐字稿

Good day, everyone. Welcome to the Carter's third quarter 2010 earnings conference. On the call today are Michael Casey, Chief Executive Officer, Richard Westenberger Executive Vice President and Chief Financial Officer and Jim Petty, President of Retail Stores. After today's prepared marks we will take questions as time allows. Today's call is being recorded. Carter's issued its third quarter press release before the market opens, the text of the release appears on the company's website at www.carters.com. Click on the Investor Relations section then News and Events on the left side of the screen. Additionally, presentation materials for today's release conference call can be accessed on the company's website.

Before we begin, let me remind you statements made on the conference call and on the Company's press release other than those containing 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 most recent annual report filed with the Securities and Exchange Commission. Also on this call the Company will reference non-GAAP financial measurements. A reconciliation of the non-GAAP financial measurements to the GAAP financial measurement is provided in the Company's earnings release. And now I would like to turn the call over to Mr. Casey.

Thank you very much. Good morning everyone. Thank you for joining us on the call. We have an update on our third quarter results which is available on our website. Before Richard and Jim walk you through the results, let me share some thoughts with you.

We are on the home stretch of another successful year. With two months left to go, we are on track to achieve a record level of sales and profitability this year. This growth comes on top of very strong results achieved in 2009. In fact, from 2006 to 2009, one of the toughest retail periods in many years, our sales grew about 20% and earnings grew more than 60%. We believe our performance over the past couple of years has been based on our Company's focus on a handful of key priorities.

As a reminder, our first priority is to lead the market in product value. We are a leader in young children's apparel. We own the largest share with plenty of room for growth. Our brands have a well-earned reputation for great value. Consumers have a lot of choices of where to shop for children. They choose our brands more than any other brand because we have most compelling offerings. The strength in the value of our product offerings this year -- we launched a rebranding of our core baby product line called Little Layette. The success of the Little Layette launch has strengthened Carter's position as the best-selling brand in newborn apparel. We refreshed our Just One Year at Target. We relaunched it as Just One You and extended the brand to older age ranges. And we relaunched a new baby essentials line in our Child of Mine brand and regained meaningful floor space at Wal-Mart.

Our second priority is to strengthen our brand presentation. Our brands have very high consumer awareness so whenever mom is shopping we stand out on the floor. Over the past two years we made significant investments in fixturing, point-of-sale branding in retail marketers to strengthen our brand presence in the market. In 2010 we invested about $8 million to refresh in most retail locations to bring the total investment in this initiative to nearly $30 million over the past few years.

Our third priority is to extend the reach of our brands. We have the largest presence in the market. Our brands are sold in more than 15,000 doors in the United States. We are the largest supplier of young children's apparel to largest retailers in the country. These retailers are great business partners and important part of our growth strategy. Over the past ten years, we have successfully extended our retail store model beyond the outlook centers. We believe our stores offer the best value and experience in young children's apparel.

In 2010 we plan to open up 45 stores largely in retail strip centers. These are our brand stores. The returns on our stores have been very good. Today we have 150 brand stores and believe over time we could have 600 of these stores, 300 for each brand. We believe this represents a $600 million sales growth opportunity for us. We are also extending the reach of our brands through e-commerce and international licensing arrangements. We launched our e-commerce business earlier this year, it's off to a very good start. We expect $15 million in e-commerce sales this year, and expect to double these sales in 2011. We believe this is a $100 million sales opportunity for us and a great way to strengthen the relationship with our consumers.

We have an established but underdeveloped international business. Our brands are sold in more than 40 countries largely through licensing arrangements. We also ship directly to international markets. International sales this year are expected to be $38 million, up 35%. The operating income from these sales and international royalties is expected to be $18 million, up 60%.

Our fourth priority is strengthen Oshkosh's performance. Oshkosh B'Gosh is one of the best known brands in young children's apparel. In fact, our research shows that Oshkosh B'Gosh is more recognizable brand name than Carter's, yet its performance is a fraction of what we have achieved with the Carter's brand. We expect Oshkosh sales to be $350 million this year with operating income of about $30 million. Over the next 4-5 years we believe this brand has the potential to achieve sales of at least $500 million and earnings of $60 million more than double the earnings this year.

To achieve this growth we invested in new leadership for the Oshkosh brand earlier this year. Our new brand leader has strengthened the merchandising and design teams, sharpened to the brand's point of view and improved product offering. The new Oshkosh team joined us in time to impact our spring 2011 product line and are wholesale bookings for spring are up about 10%. So they're off to a very good start.

Our fifth priority is to improve profitability. We expect to achieve an operating margin of nearly 14% this year, exceptional performance in our space. We expect to achieve this level of profitability on a record level of sales after funding significant investments to strengthen our leadership team, improve our product offerings, expand our store base, improve our information systems and launch our new e-commerce business.

For 2011 we are expecting sales growth of about 10%. We have good bookings for spring and identified most of our new store locations. Unfortunately the trend in product cost is not improved since our previous call with you. As you know, product costs are rising in Asia driven largely by historically high cotton prices. Labor and freight costs are also up. Our spring 2011 product costs up are up about 11%. We haven't finalized our fall product costs yet but expect fall cost increases will be higher than the increases we saw in spring. To minimize the impact of these increases we are evaluating our cost structure and we are raising prices beginning with spring 2011. I think it's very important to remember we have many opportunities to drive growth. We have a very long track record to managing to higher level of sales and profitability. At this time Richard and Jim will walk you through our third quarter results and we'll start with Richard.

Thank you, Mike. Good morning, everyone. On page 2 of this morning's presentation, we have some highlights of our third quarter performance. On the last call we indicated that we expected earnings per share in the third quarter would be down in the low teens as a result of higher transportation costs and the expectation of an extremely competitive retail environment. While these concerns were certainly significant issues in the third quarter our performance was better than expected as a result of several factors.

First, we had stronger than planned sales in our Carter's wholesale and mass channel businesses reflecting earlier demand and stronger replenishment trends particularly in the baby business. Second we had favorable timing of expenses between the third and fourth quarters. And lastly, we completed greater share repurchase activity in the quarter than we had anticipated. So it's reflected in the press release this morning, EPS was $0.83 per share versus $0.84 a year ago. We have estimated that between $0.04 and $0.05 of the upside in the quarter can be attributed to timing between the two quarters. That high level, a decline in earnings relative to a year ago, was primarily attributable to higher transportation costs in the quarter. Beyond our operating results we returned $44 million to shareholders through share repurchases and also refinanced our debt and secured a new resolving line of credit. I'll speak more about the capital structure developments shortly.

Turning to page 3, and our revenue performance for the quarter. Our sales for the third quarter increased $36 million, or 8% to last year, led by our Carter's brand businesses which increased 8%. Carter's wholesale sales increased $21 million or 13% in the third quarter with growth in all product categories. Recall that our first half sales in this business were up 12%. We will continue to see strong demand in this channel. Carter's retail sales increased $13 million in the quarter, driven by door growth, e-commerce revenues, and comp store sales increase 1.4%. Jim will comment on retail segments in a moment.

Oshkosh wholesale sales increased over $2 million or 9% to last year. This increase was due to the timing of customer demand. We continue to expect sales for Oshkosh this year will be comparable to a year ago. Mass channel sales declined $3.5 million or 4% last year due mostly to merchandising assortment changes and the timing of shipments. As Mike previously mentioned there has been tremendous work in our mass channel team winning this business back. We began re-shipping product to Wal-Mart towards the end of the third quarter. Sales of our Just One You brand at Target have also continued to show good growth. As I mentioned, mass channel sales in the third quarter were stronger than forecasted for the Just One You and Child of Mine businesses although still down to last year in total in part due to timing of shipments a year ago. Oshkosh retail store sales increased approximately $4 million or 5% to last year led by e-commerce, retail store door growth and comp store sales increase of about 1%.

Our third quarter P&L is on page 4. Gross margin in the quarter was down 130 basis points to last year. This decline was driven largely by higher air freight, and inbound air freight costs which were up about $6 million to last year. This air freight expense was incurred as a result of chasing higher than expected demand and in some cases expediting products delayed exiting Asia as a result of cotton availability or other production issues. Higher inbound costs reflect the significantly higher current market rates for ocean-going freight. Expenses increased 7% last year. In rate terms, we gained about 10 basis points of leverage to last year given our increased sales volume. I'll cover the changes in SG&A in a bit more detail in a moment. Gross income was down due to sales of licensed products on the Child of Mine brand wall. Excluding this impact, domestic and international royalties grew 3% in the quarter.

Interest expense was down about $1 million to last year reflecting lower market interest rates and our $100 million term loan repayment we made in the second quarter. We repurchased nearly 2 million shares in the quarter at an average price of $24 per share. Relative to our previous forecast share repurchase added $0.02 to our results for the quarter. From the bottom line perspective, our diluted earnings per share in the quarter declined $0.01 or 1% to last year.

On page 5 is a recap of our SG&A for the quarter. SG&A increased $8 million over last year. Expenses related to retail door growth, e-commerce operational expenses and higher distributional expense drove the increase in expense in the quarter. Partially off setting these increases were reduced amortization expense related to our licensing agreements and lower levels of incentive-based compensation. We have some favorability in our forecast in Q3 as some expenses forecasted to have fallen in the third quarter have shifted to the fourth quarter.

Page 6 summarized our business segment performance for the third quarter. Last year's third quarter represented record operating performance with our consolidated operating margin reaching nearly 17%. Our operating margin declined this year's third quarter largely as a result of higher freight expenses which I mentioned. To note Oshkosh in particular, profitability in the retail segment declined in the quarter due to higher costs related to new stores and e-commerce.

The next several pages include summaries of our year to date performance. Our year to date P&L is on page 8. Year to date revenue growth has been 8% and operating income is up 32%. Year to date earnings per share up 21% which builds on the 60% growth in adjusted EPS in the first nine months of 2009. On page 10 we summarized our year-to-date business segment performance. Carter's segment operating margin has increased 160 basis points and Oshkosh by 60 basis points over the last year. Our year-to-date operating margin expanded to 14.7% from 13% a year ago on an adjusted basis including the impact of our restructuring activities last year and reflecting improved product improvement across our businesses.

Turning to page 11, we have a recap of balance sheets and cash flow metrics. Our cash balance at the end of the quarter was $182 million. As we mentioned, we've begun using our excess cash by paying down $100 million of outstanding debt in the second quarter and $50 million in share repurchases to date. Working capital increased at the end of the third quarter due to higher accounts receivable balances and higher inventory. Accounts receivable were up $44 million reflecting heavy shipments to wholesale customers in the month of September. We believe the quality of these receivables is excellent. In fact, a good portion of these receivable balances have already been collected to date. Inventories at the end of the quarter were up $40 million or 18% generally in line with forecasted sales growth. Solid plan growth across our businesses including the wholesale channel, new retail stores, e-commerce and return of brand business at Wal-Mart driving up higher inventory requirements. Inventories are also up due to higher product costs.

Finally we've accelerated receipts in order counter recent production and supply chain disruptions which have slowed some product deliveries recently. Importantly the overall quality of our inventory remains excellent. Operating cash year to date is flow down $56 million compared to last year. This decrease in cash flow is largely attributable to the increased inventory levels and higher accounts receivable balances for the reasons I mentioned. Subsequent to quarter end, we completed the execution of a new five-year $375 million resolving credit facility. At the closing of this transition we drew on the new facility $236 million and used the proceeds to pay off our existing term loan and pay expenses related to the transaction. The new facility carries a variable interest rate tied to the Company's overall leverage level and is currently set at LIBOR plus 225 basis points.

While this interest rate is somewhat higher than our previous credit facility, we do expect interest expenses to be lower next year as a result of our reduced level of borrowing. No payments required under this facility, so we effectively pushed the maturity of our existing debt out by five years while also replacing our previous credit facility which was set to expire in June of next year. Turning now to a few more details on the wholesale and mass channel businesses. First in our Carter's wholesale business, which is summarized on page 12, as I previously mentioned we continue to see very strong performance with this component of our business. Sales in this segment were up 13% in the quarter and this is anniversarying extremely strong growth of 10% a year ago. Fall sales at our top seven accounts up mid single digits with approximately 50% of the season remaining.

We believe these retailers' margins have improved versus last year and that their inventory levels are well positioned. Fall sales on the balance of our account base have also been very strong. Our Little Layette product offering which we relaunched in the middle of this year is performing very well, with strong selling in all top wholesale accounts. We expect to post good revenue growth in the fourth quarter in part due to very good demand for spring 2011 products. Overall bookings for spring 2011 for Carter's wholesale are up in the mid teens. On the next page in the mass channel, sales were down 12% in the third quarter, reflecting the Wal-Mart issues which I've already covered. Sales for Target of our Just One You and Precious First brands continue to be strong, up approximately 6% in the third quarter and 16% year to date. We've added floor space to Target and introduced 18 to 24 month sizing beginning in the spring of this year. We feel good about our success in winning back the brand wall business in about 1800 Wal-Mart doors. These doors began to be stocked in October. We think this is a great start at building back our overall business with Wal-Mart and continue to have active discussions with them regarding expanding our presence. We are forecasting $110 million full year net sales in Wal-Mart this year, inclusive of the new brand wall shipments. For spring 2011, bookings to the mass channel are up in the low digit range.

Turning to the Oshkosh wholesale business on page 14, given the size of this business overall and the impact of timing that shipments can have on the metrics, I think it's best to look at the business on year to date basis. Sales in this channel on a year to date basis are up 1% and we continue to project Oshkosh wholesale revenues for the fourth quarter and full year will be comparable to last year. Fall sales in our top accounts up in the mid single digit range to last year and current bookings for spring product are up about 10%.

With that I'll turn it over to Jim for comments on the retail business.

Thanks, Richard. Thank you, good morning, everyone. Overall, the retail performance for the third quarter was good. On a consolidated basis retail revenue was up 8%. Both brands ended the quarter comping positively, with Carter's up 1.4% and Oshkosh up about 1%. These results were achieved against strong results from last year and a very competitive and promotional environment. The primary driver in the third quarter versus the second quarter was improved trend in traffic and conversion. As you may recall our retail stores during the second quarter were challenged as related to traffic, with both brands seeing decline as compared to last year. I'm happy to say that traffic has trended more positively in the third quarter.

As relates to the Carter's brand, again we are pleased with our overall results. The 1.4% comparable store sales increase in the third quarter was achieved against a 6.1% increase last year with all key performance indicators performing positively with the exception of average price which was expected. Carter's has produced positive comps in 14 out of the last 15 quarters. We believe our marketing efforts proved very effective. As we nail deeper into our database and more effectively utilize our e-commerce website. As a result traffic trends continue to improve. We believe our focus on windows and in-store presentation not only affected traffic but improved conversion.

As you see on page 15, unit through-put was very strong the quarter increasing 4% in our units per transaction. Our investments in our opening price point table programs as well as collections proved successful in the girls and boys play clothes businesses by exceeding planned expectations. Early reads on the Carter's holiday assortment have been very encouraging. It's important to note, while business was strong overall we believe opportunity was missed in the accessories businesses primarily due to supplier performance. In turn, we viewed this as a go-forward opportunity for next year. Moving on to the Oshkosh brand on page 16, here as with Carter's, traffic trends in the third quarter continue to improve. This increase in traffic was accompanied with large increases in conversion. Our conversion of traffic to transactions increased 8% over last year. Oshkosh performance was driven by strong selling in both boys and girls primarily had the mid tier tops, wovens and opening price point t-shirts. That being said we recognize the current assortment has room for improvement. The new design team's spring assortment which we believe to be much more relevant and focused on basics will hit the floor in December.

The Oshkosh major floor set is planned for mid February time frame. As relates to both brands, inventories have recovered from Q2 issues and are back in line with plan. We believe we have the proper seasonal mix and are in good shape as we enter the fourth quarter. We are also pleased with our overall marketing efforts and results from a direct mail and e-mail perspective. We continue to focus on growing our database from in-store and online customer information acquisition. In turn, customer response to our promotional efforts has been positive. We have a strong promotional cadence in place for Q4 that takes advantage of the larger database we have available. We believe both brands are well positioned for Black Friday where we have strong merchandising, marketing and door-buster strategies in place.

Our initiatives moving forward are centered around store openings, price clarity, inventory management and improved marketing effectiveness. We will also continue to invest in the retail business to provide a firm foundation for considerable growth. A few of these investments are as follows. First as relates to stores year to date we have opened 21 new Carter's and 8 Oshkosh stores. In the fourth quarter we plan to open an additional 9 Carter's and 5 Oshkosh stores. The majority of these stores are what we refer to as brand stores and located within locally trafficked shopping centers that offer easy access for our customers. I encourage you all to visit these new locations.

The second area we have made sizable investment is in our infrastructure not only from a field and personnel perspective but also in the operating systems used to run the business. Our planning and allocation system is now live, supplemented by an enhanced business intelligence platform allowing our allocators, buyers and planners to make better, thoughtful and forward-looking decisions. We are also in the process of implementing a regional pricing and markdown optimization system set to go live in the first half of next year. This will give us the agility to price geographically by store type and also cluster stores into groups so we can optimize price elasticity. And third as highlighted on page 17, our e-commerce site has been up and running for two quarters and received positively by our customers.

The performance thus far has continued to exceed expectations. We now offer an expanded assortment to our customers making it easier for busy moms to fill their child's apparel needs online. In conclusion our outlook is good for the balance of the year. However due to the unpredictable competitive nature of the environment, we are cautious regarding comp-store results with flat to low single digit expectations in Q4. Now I'll turn it back over to Richard.

Thanks, Jim. On page 18 we summarized our forecast expectations. We are expecting good revenue growth in the fourth quarter, up mid to high teens in total. This assumes good growth in the wholesale and mass segments and flat to low single digit comps for both retail brands as Jim just mentioned. Given that some of the upside in the third quarter represented timing shifts between the two quarters we expect adjusted earnings per share to be down in the low teens to down high single digits. Gross market expected to be down versus last year in the fourth quarter reflecting higher spring product costs, higher transportation costs and continued expectation for varied promotional retail environment and lower mix of retail sales. With our third quarter results and these assumptions for the fourth quarter we raised our expectations for the full year, with adjusted earnings up 12% to 14% over last year's adjusted EPS result of $2.15.

Year end inventory is expected to be up approximately 25% to last year due to higher spring 2011 product cost, strong unit forecasted for Q1 of next year across all businesses including e-commerce and the expanded Child of Mine and brand wall business. We have also brought in some products earlier in order to account for the recent supply chain delays and to maintain a high level of service to our wholesale customers and to our retail stores. Operating cash flow for the year is expected to be in the range of $100 million to $115 million and free cash flow in the range of $60 million to $75 million. This is lower than we had previously forecasted as we are expecting year end inventories to be up more than previously thought. As it relates to fiscal 2011, our visibility continues to be best for the first half of the year right now.

Consistent with what we mentioned on our last call, we expect our product costs for the first half of 2011 which began shipping at the end of this year to be up 11%. We've taken some selective pricing action in our wholesale channel and we are also planning price increases in our retail stores to help offset a portion of these cost increases. In terms of revenue growth, we are currently forecasting revenue for the first half of 2011 to grow by approximately 10%. The impact of the product cost increases on gross margin despite assuming benefit from some higher prices from across the assortment is expected to be significant. Our outlook for the second half of 2011 will depend on fall costs which will be finalized with our vendors over the coming weeks.

The situation for fall product cost is still very fluid. Costs expected to be up significantly more than the 11% which we secured for spring 2011 products. As the outlook for fall product costs firms up we will also refine our pricing strategies. Our pricing actions relative to our fall 2011 merchandise assortment are likely to be more aggressive than we had planned for the first half of the year. Given the strength of our brands and overall leadership in the market, we are confident in our ability to utilize pricing as one of our tools in offsetting the impact of product cost inflation. As Mike mentioned, we are projecting that our full year consolidated operating margin for fiscal 2011 could decline meaningfully from what we are projecting to achieve in 2010. We are continuing to develop our detailed plans for next year and will update you further on the next call. With that we'll open up the call to your questions..

(Operator Instructions). And for our first question we go to Scott Krasik with BB&T Capital Markets.

This is Steven Gregory from Mandalay Research. A couple of questions. Congratulations on the quarter. You mention e-commerce as a big part of your business. Can you provide color on where your e-commerce business is going forward and where you see the company in the next couple of years online, especially through your website.

We were a late follower to the e-commerce model. We launched it at the tail end of March this year. We are very pleased with how it's gotten off the ground. If you go online you will see the beauty of the two sites we have, Carter's and Oshkosh B'Gosh. I think we've got a nice balance of beautiful branding and a clear value message on-line. Consumers have responded very positively to it. Our current view, in the short time we've been up and running, over $15 million this year. We expect to double that business next year based on reasonable assumptions. We think that it's at least $100 million sales opportunity for us, not a question of if we can get to that level but how long it will take. But I'd say we're off to a good start and the feedback from consumers has been very good.

Are you building mobile apps like the iPhone or Android and media things out there to drive people to your site?

In time we will.

So that's down the road definitely should.

Yes, sir.

Final question, what are you doing to drive people to your site to provide promotions, incentives to upsell across certain products to get more new customers away from other sites to your site? How are you driving people to your site?

Most people are coming through our own sales so good marketing in our stores. So there's good marketing in our stores. There's good marketing collateral being sent to home. We have a fairly large database with customers with email addresses so we're pinging them through email. So I think we've got good ability to reach out to them.

This is Jim, one of the things that is encouraging is 60% of the traffic to this site are new to our file as well. People are clearly finding us as a destination on-line.

We had pretty good traffic even before we went on-line because of how strong the brand names are in the market. And the feedback that we've gotten in recent years was people loved what they saw on-line with us but very disappointed they couldn't transact directly with us. So that's what we responded to earlier this year.

And final question regarding what you said, 60% of traffic was new customers, new traffic?

New to our file, yes.

Guys, how did you find us, to expand on that and bring more customers in that route?

We haven't gotten down to that granular detail yet. That's an opportunity going forward. Right now, we look at it, there's been pent-up demand for a while, we believe, prior to opening our e-commerce business and with multiple search engine opportunities out there, they are finding us and visiting us frequently.

And for our next question we go to Jim Chartier with Monness, Crespi, Hardt & Co. Mr. Chartier, your line is open. Please press your mute button, sir. And hearing no response, we move on to Margaret Whitfield with Sterne, Agee.

Good morning. I know you can't do much about the commodity price of cotton but what other offsets do you have, Mike, in terms of maybe moving away from China? What are some of your other options to mitigate the impact of cotton in 2011?

Our outsourcing group is in Asia right now. They are working [inaudible] and with our top ten suppliers to look for every opportunity to minimize the impact of what's going on in cotton, looking for every efficiency that might be able to be gained. Because of our relationship, we have the ability to move it other parts of the world. We have been building capacity in Bangladesh, Indonesia, Vietnam, Cambodia. All steps that can be taken are being taken. Another lever that we have obviously is price. As Richard shared with you, more aggressive on our pricing assumptions. We have really no interest in managing lower margin business. This is just a head wind that every company in our space is going to be dealing with. What I was encouraged by -- I don't know if you saw the article in this morning's Wall Street Journal -- but the headline is cotton posts the worst fall in 15 years. So there is a lot of hype in the cotton market now. Hypersensitivity to any indications supply may be affected. Last Friday the news report was hail storms in Texas were driving cotton prices higher and this morning's article speaks to the fact that story was overblown and the cotton crops were not damaged significantly and cotton prices dropped about 6%. We're monitoring it. We do think the cotton issue is going to be short-lived. Our latest information from the folks we are dealing with in Asia is when cotton is planted again next spring it will be planted in significantly larger quantities and that is when we will get the first indication how quickly prices will drop. So it's a short-term issue and do our best to manage through it.

What kind of price increases are you taking for spring and what do you think you could take in the fall? And if you could give us a rough estimate where you see product costs for fall if they're up 11% in the spring?

Expect they'll be higher. The indications we are getting from our folks in Asia is that the costs for fall are expected to be higher. The increase will be higher than will be experienced in spring. I would rather not comment on this call on the extent of price increases. We've taken the price increases for spring. Those price increases were negotiated with our wholesale customers. They are in the same boat as we are so they understand why we need to get paid more for what we are doing. As Richard said, we'll likely be more aggressive in the second half of next year on pricing.

And how about SG&A, not much you can do on the gross margin line but any cost efficiencies you can put through next year on SG&A?

As you know, we've done a fair amount on SG&A already. Last year we had good structural opportunities we went after. And obviously, everything from a discretionary point of view is always on the table for evaluation. In general we are a very lean organization. But as you would suspect, given the magnitude of the challenge on the product cost side we are going back and discovering everything to see if with have an opportunity. But I don't think SG&A is our biggest opportunity as an organization. It's continuing to grow the top line. It's continuing to improve gross margin hopefully over time whether it's through the supply chain or having some of these fundamental product costs come back in line.

And on freight costs, you expect these pressures to continue into 2011 or see this as easing as you progress through spring?

It will moderate a bit. It's what we're hearing in the marketplace. We started to see some of the transportation rate inflation come down a bit. We are still watching it pretty closely.

And just for Jim, the weather has not been conducive to purchasing fall attire. Wonder if you can walk us through the trends and comps for Carter's retail and Oshkosh retail during the quarter itself and how October is starting out.

Yes. I'll give you some direction anyway because we don't get specific there, Margaret. Overall on the quarter things started out fairly strong but then kind of ramped up through the quarter. Overall the performance was relatively even with moderate gains as the quarter moved on. From a geographic perspective which goes to your question on really the climate, the East definitely kicked in later in the quarter but did in fact kick in. As soon as we had a weather shift and a cold snap, the East popped for both brands nicely. The stronger areas throughout the quarter from a geographic perspective in total were the West and the South. That's kind of directionally where it went. As soon as we got a bit of cold weather, business picked up.

How is October, though? The warm weather continues.

We are continuing on trend.

Positive comp.

Modest but positive.

Thank you.

And for our next question we go to Scott Krasik with BB&T Capital Markets.

Good morning, guys. This is the real Scott Krasik, I promise. I understand your reluctance to talk about specific price increases or to quantify it. But maybe give us a sense of how far along your conversations are for fall? And why do you think some companies are more positive or optimistic? Maybe you are equally as positive but more subtle about it?

The beauty of our business, half our business now is retail. We have got considerably more discretion to take prices up in our retail segment. The discussions with our wholesale customers in fall will take place in the December/January time frame. Early on fall. We have not locked down the fall so we don't know firmly what we're going to have to be dealing with in terms of price increases to help offset that. But you have to keep in mind our average prices for our products, less than $10. So for us to get a price increase, it's not like it's a significant incremental expenditure by the consumer. We're going to go for it. In this environment, I think the risk is that the consumer doesn't go for it, but you can always bring the prices down. We are going down a path we will take the prices up and do our best to get paid more for the beautiful product we offer the consumer.

Don't you think, particularly given your strength in the Carter's baby business, the strong brands are really the ones who will do the best in this type of environment?

Sure. Yes. Yes, I do.

Okay, good. What's the potential upside, the nature of the conversations right now with Wal-Mart about next year? My thought was always the dollar increases that you point to, but they are still small relative to the opportunity.

The conversations with Wal-Mart have been good. Expect that to be a nice part of our growth we shared with you on the last call. Hopefully that will do some portion of $110 million this year. That was otherwise going to be trending closer to $100 million before we brought the brand wall space back. We're hopeful that it's in excess of $120 million next year. The tone has been positive. They are reaching out to us to help them strengthen their baby product offerings. The conversations are going well.

Do you fit into their definition of branded basics when they mention that?

Yes, we do. We are told that their focus is on fresh produce and baby, and we are the national brand in baby so we fit into the growth strategy. So we absolutely do fit into their growth strategy.

Good. And then what was -- you took the bookings for spring 2011 and Carters accelerated since we spoke that -- what's the reason for that? Just a lot of momentum in your business in particular?

In the Carter's brand for spring, just firming it up. We feel really good about the growth we have actually for both brands, Carter's and Oshkosh. Carter's is a bit stronger than Oshkosh.

Okay. And Richard, I know it's early and you don't want to give specific guidance. Directionally SG&A for next year can you hold significantly below the level of revenue growth?

You're right, I don't want to say. Our objective would be to grow SG&A at a rate slower than sales. The issue next year won't be the top line, it will be the cost structure and expense structure for the company. We'll do everything we can to hold SG&A down. But the primary areas where we have been investing and growing SG&A have been the store base, and those have turned out to be a very good investments for us. And at this point we are planning good store growth for next year. On an absolute dollar basis, we will see some good growth in SG&A and hopefully we will be levering that with retail sales.

Any other one-time, not one time but investment type expenses that we may not be thinking about for next year?

I don't think any significant at this point, Scott.

Okay. Thanks and keep up the good work.

Thanks, Scott.

And for our next question we go to Omar Saad with Credit Suisse.

Good morning.

Good morning, Omar.

Good job on the quarter. And in the outlook, it looks like you are doing a really good job driving revenues. But I do want to focus on the cost side of the equation. I know you don't want to disclose the price increase, can you disclose whether the price increases are adequate to offset the majority of the price increases, at least in the first half of 2011?

I would say they will not be. Based on what we know today, half our business is wholesale. Those prices have already been negotiated with our wholesale customers. The approach we took for spring 2011 with our wholesale customers was to be selective on the price increases. When we had our last call, some indication that costs would subside the second half of next year. That's not the case today. So we didn't want to get overly bullish taking prices up and jeopardizing what we're seeing is very good momentum in sales and driving significant unit velocity. So we were selective. We picked our spots where we thought we could get paid more on a number of products, we kept the key item pricing the same year-over-over. We'll have to revisit that for the second half of next year. The first half of next year assuming the operating margins for our company will be lower.

And can you help us understand functionally how the price increases work -- wholesale versus your own stores? Did you keep the price the same in both channels? Something that you can logistically execute? On a six-month basis, how much of a lead time do you need to change stickers? Walk us through how that works.

The lead time is six or seven months depending on the product. We have time to impact fall pricing. But we look the at most of our business is done with 10 silhouettes. So we look at what the pricing is for each one of those key items. We consider what pricing is appropriate to the wholesale customers, given their margin expectations, and what prices are appropriate for the consumer to pay. Our objective is always that the pricing is comparable at both, the major retailers in the United States and our own retail stores. Level of promotions varies, obviously, but the objective is always the same. But given the fact half our business is in retail, we do have the discretion and we do have a history where we've charged higher prices in our own stores with success.

Very interesting. Very interesting. On the supply chain side, you work with [inaudible] on a lot of things, but it sounds like you have some of your own sourcing people there working to find lower cost channels. Can you describe how the partnership works? Does [inaudible] try to go out there and find the new factories? Who leads the process in terms of trying to manage the cost structure and supply chain?

I would say we lead it with their assistance. They've been terrific partners for us for many years. We have these issues for 2011 when you take a look back and look at the history of the company over many years. Particularly this year. We will deliver record level sales, record level of operating margin this year. Extraordinarily beautiful product and that's largely the good work of a lot of people including the supply chain folks with the help of [inaudible]. They are an important part of what we are doing now to find every opportunity to get lower costs in light of what's going on with cotton particularly.

Do you know what percent of your sourcing goes to [inaudible]?

The lion's share of it. We work with five agents so we have a competitive environment but I would say [inaudible] has 90% of what we do in sourcing.

Thanks for the insight. Very helpful.

Thank you.

And we go next to Susan Sansbury with Miller Tabak.

Thanks very much. I'm very please with third quarter results. You're to be congratulated. Can we go back to mass channel sales? You were specific -- well maybe you can reiterate what you expect for mass channel sales for the fourth quarter and for 2011? Breaking it down perhaps by Wal-Mart and Target?

We expect good growth in the first quarter, Susan, for mass channel. Both brands will return to growth. Importantly a number of quarters where Wal-Mart has been a bit of a drag on the top line, given that we were up against the comparisons to the brand wall. That reverses itself in the fourth quarter. Both will show solid double digit growth in Q4. A bit early to be talking about specifics for 2011 but we would expect both businesses to show nice growth next year. As Mike mentioned our target point at this point for Wal-Mart, our objective would be $125 million of revenue.

And do you expect Target to have positive year-over-year comparisons? Any marketing initiatives for the Target business?

We expect continued growth with Target next year as well.

I may have missed this, in terms of real estate plans for 2011, can you share with us roughly how many stores are going to be opened, outlet versus street location by brand?

Sure, Susan. We'll be opening some place between 55-60 stores next year and the majority of those will be in a non-outlet environment in the strip center type environments we see as our growth path.

The value center or strip center environment seems to be the focus of also a lot of your competitors. Is that raising rates or reducing the number of real estate, desirable real estate locations for you?

No. Not at all in fact. I personally welcome the company. Whenever you have a concentration of children's businesses, it generates traffic. And our brands due to the wonderful product really stand out. We succeed well in that type of environment. From an availability of real estate when you consider how underpenetrated we are from a geographic perspective, the opportunity for store growth is significant and landlords are very excited about us joining their mix. So the real estate process, we've got a good formula underway. We are diligent about it. And the opportunities are very significant.

Great. Thanks ever so much.

And we go next to Jim Chartier with Monness, Crespi, Hardt & Co.

Good morning, can you hear me?

We sure can, Jim.

Okay, great. First question, you guys raised your revenue guidance, I think you were originally expecting high single digit growth and now expecting 10%. Where is the upside in that?

We have primarily increased our forecast as it relates to the Carter's wholesale business. We continue to see very good demand there, Jim, and demand for spring products in particular has popped up since our last call and also modestly raised our expectations for e-commerce.

Okay. And sounds like you were expediting product and supply chain issues. Are there things you are doing for 2011 that will help you moderate that and not expedite as much product next year?

Yes we are. We are assuming lead times will increase by 30 days. We are tacking an extra month on to the schedule. We spent over $7 million in the third quarter in higher freight costs. A lot of that was to expedite goods that needed to be expedited to meet delivery dates because some of our suppliers couldn't get the cotton in and to the plants in time. The goods were running late so we had to spend the money. Knowing that things are running behind, we are adding extra time on to our lead times.

Were you able to pass through any of the additional transportation costs to the customers or have take that yourself?

We absorbed that. The costs were shared with our suppliers and with our agents.

And then next year is reasonable to expect that some portion of that will go away then?

We certainly hope so.

And then for Jim, can you just talk about the benefits you expect to get from the new systems next year and how that might be able to help you on the gross margin line?

We've really been working hard over the last 18 months and developing the processes from a G&A perspective and developing systems around those processes. As a result going into next year much more effectively positioned for buying the product at the right levels and allocating the products at the right levels to the right stores. And our anticipation is obviously that that will result in upside from a top line and a price elasticity perspective. We are also excited about the fact that we have a price optimization strategy underway, giving us the ability not to just take markdowns across the board but from a climatic perspective be able to hit the product where you need to and let it ride longer from a full price perspective where you don't. Both of those components we see as upside for the business in the years to come beginning in 2011 in a meaningful way.

In retrospect for third quarter, was the promotional activity from your competitors as severe as you expected and maybe got too aggressive on the promotional front?

It was competitive out there. There's no minimizing that. I think we played effectively, however. I wouldn't say we overplayed our promotional side of it at all. I think we are in a good position from an inventory perspective. We produced respectable comps in a very aggressive environment. Overall I think things worked out well. I am encouraged with the fact that in light of our miss on accessories as I mentioned earlier, there's opportunity next year for that. So I actually feel as though the teams did a nice job in executing the quarter overall.

Thank you.

And we go next to Marie Driscoll with Standard & Poor's.

Hi, thank you. Good quarter.

Thank you.

You're welcome. My question is a little bit on what's happening with the price increases. You foresee an 11% price increase on your costs next quarter, I'm sorry in the first half. What kind of a price increase would you have to execute to have this be a nonevent? Can you talk to that?

All things equal you cover it by 10% to cover a 10%ish increase in costs. To Mike's earlier point, we assume we've not raised price on everything in the assortment. At the time we put our pricing strategy in place for the wholesale business, the market and certainly we did expect some moderation in the trend for second half costs. Rather than disrupt the very strong top line momentum we've had with the business and the velocity with the business we chose to only take prices up selectively. We may end up being more aggressive in our own retail stores as we get to the first part of the year but that's the thought process that went behind the pricing strategy that was put in place on a portion of the assortment for the first half of next year.

Okay. And the most recent quarter, didn't you say that AURs were actually down?

They were, yes.

That means you didn't have price increases or they didn't stick. What happened?

Just be clear, the price increases will kick in for spring 2011. That product starts to ship to our stores later in the quarter. We did not have price increases in the third quarter. The important thing for everybody to understand, every company in this space, every company with dealing rising product costs have to figure out how to get paid more for what they are doing for a living. And that's a challenge in the back drop most folks are promotional. The paper this morning talked about how number of retailers are moving their Black Friday promotions up before Black Friday. So you have the Christmas music playing now and folks are going to be moving those compelling sales earlier than they were last year. But we're not alone in this challenge. We're committed to getting paid more for what we are doing. Our fundamental belief is the best margin is on a product that's selling well. What we won't do in light of the product price increases is dumb down the product. We'll keep the product offering very strong. The best-looking product on the floor, we believe and the results would back that up. We'll keep the product looking sharp. We'll do our best to get paid more for it. We have a number of initiatives around price clarity particularly in our own stores and we think that's going to help us. We would not give ourselves high marks today on price clarity. A lot of folks in our company working on that key initiative for our own stores and we think that's going to help us to increase our average unit retail in 2011.

Since you mentioned Christmas, what -- how do you guys see Christmas?

From a retail perspective, we feel pretty good about it. From an inventory standpoint, we're in good shape. We like to get it early here. That's pretty much been our strategy for the past few years. And we're very well positioned for Black Friday. From a marketing perspective, we have every bit as much from last year the number of times, number of different types of collateral we are sending out individually. And fortunately with the growth of our database being very significant over last year for the same time period, for each of those individual components of the collateral strategy, we are able to nail deeper into a richer file. We feel good about it. There's no doubt that it's going to be a competitive environment but we we've been playing competitively for a number of years now and we'll continue to stick to that strategy and we feel good. We've got door busters in play for the holiday weekend and the holiday period. We've got great marketing strategies and we feel prepared.

The holiday direct marketing pieces are hitting folks homes today. So if you're not on our mailing list, go on-line and sign up and get that mailer sent to your home. We've got beautiful direct marketing pieces to support our holiday plans.

And can I just ask you one last question on your fourth quarter guidance? When you say EPS will be down low teens to high single digit, is that off $0.61 or $0.66?

It's off an adjusted EPS of $0.61 a share.

Okay, great. Thanks.

And we go next to Garrick Johnson with BMO Capital Markets.

Good morning. I have three questions. One for each one of you guys. Richard, I think you said that product costs will be up 11% in the first half, did I get you right when you said pricing would have to be up an equal amount to maintain margin?

I believe directionally, that's correct.

Aren't product costs only about 40% of cost of goods sold so wouldn't pricing have to go up less than that?

Product prices in general are the majority of our cost of goods sold. There are some other things that can happen. Inventory provisions and such, but product costs are the lion's share of goods sold.

Mike, you've been doing this a long time. In your experience how long is the cotton cycle? How long does a take of shortage situation to go back to normal, to perhaps a surplus?

The history would suggest some portion of a year. Not some rare mineral. You have a whole lot of people planting cotton, given where the prices now. If you look over a very long history in time, these spikes in prices are not long-lived and should last less than 12 months.

Price of a lot of commodities are up. Other commodities they could switch to earn them even more than cotton? Can Pakistan only grow cotton? Is there really a substitution effect we have to worry about?

Not that I'm aware of.

Jim, finally, in the stores, I was looking for some Halloween items, specific items you were out of stock on in mid-September. And then about a week or two ago I noticed mort of your -- most of your store are completely out of Halloween. Using Halloween as a proxy, do you think you are running too late missing out on sales in retail stores?

Overall, no. I think inventories have been good. We actually just finished product meetings and we believe that Halloween being such a kid-centric holiday, we have opportunity there. Two weeks ago being out of product, I'm actual happy to hear that. September, I know I've left something on the table there. So we have opportunity going forward. That's not a reflection of our overall inventory levels. Halloween has been a building component in retail across all categories for quite a while now. Confidence is building to invest a little bit more there. We look at that as upside.

Thank you very much then.

And for our next question we go to Scott Krasik with BB&T Capital Markets.

Hey, guys. If somebody asked it, I missed it. Mike, what's your definition of substantial?

In the context of?

In the context of operatings may be down substantially next year.

What we are sharing with you, Scott, is there's a risk. Again if we are successful with these price increases, I think we'll do better than if we do. That's the challenge for our company. How successful will we be taking these prices up and getting paid more for what we are doing.

As we told you on the last call, the first half effect begin our product costs, it's about a $40 million issue to have a 10% or 11% increase in product costs and a bigger portion obviously in the second half of the year. That helps triangulate the magnitude of the product cost issues we are trying to deal with.

I appreciate that. So then to follow up, in terms of your thinking about next year, if pricing holds and you are successful without decrease in volume, there may not be an impact. You really can get the benefit from taking price increases. Is that a scenario possibly?

Certainly possible. Too early to call. The largest half portion of our year is unknown in terms of final costs and the price increases that will be taken.

Okay.

I think for purposes of our update today we are letting you know there's a risk that the margins could be substantially lower if we're in not successful with some of these initiatives.

And then in terms of the product mix obviously fall has non-cotton components or bigger percentage. How does that play out in terms of your thinking?

It helps. A lot of our sleepwear is polyester-based. As we've seen over a long period of time, when one commodity rides up, the other rides up with it. Polyester is not as much as cotton but it is up, up considerably over last year. We heard polyester prices up 15% to 20% year-over-year. Polyester prices are up as well.

You cited 90% of your assortment is cotton-based in spring. Do you have a similar number in the second half. year?

It's lower but still material. Cotton would still be over half of fabrications in the second half.

So the point is that substantial isn't inevitable if pricing is successful.

I think sitting here today, Scott, we are giving you directional sense there's a big challenge as it relates to product costs that we are facing. We are certainly hoping to get as much back from pricing as we are able to achieve.

Okay. Thanks, guys.

Thank you.

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

Thank you all very much for joining us this morning. We appreciate all your questions and look forward to updating you again on our next call early next year.

And ladies and gentlemen, this does conclude today's conference. Thank you for your participation.