Carter's Inc (CRI) 2011 Q3 法說會逐字稿

Ladies and gentlemen, please stand by. We're about to begin. Good day everyone and welcome to Carter's Third Quarter 2011 Earnings Conference Call. On the call today are Michael Casey, Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Jim Petty, President of Retail Stores; and Sean McHugh, Vice President of Investor Relations and Treasury.

After today's prepared remarks, we will take questions as time allows. Today's call is being recorded.

Carter's issued its third quarter 2011 earnings press release today before the market opened. A copy of the release as well as additional presentation materials for today's earnings conference call have been posted 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.

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 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 measurements 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. Thanks for joining us on today's call. Before we walk you through the presentation on our website, I would like to share some highlights on our business with you.

In the third quarter we achieved sales growth in every segment of our business. We achieved our pricing objectives in the third quarter. We gained market share, made good progress integrating our new Canadian business and we raised our forecast for 2011.

With respect to our third-quarter results, we exceeded our sales and earnings goals. We were successful raising our prices, which helped offset a significant increase in product costs. Based on our competitive reviews, we believe our pricing was in line with the markets.

The feedback I've heard from store employees about the new pricing, both in our stores and our customers' stores, is that it has not been an issue. My sense is that relative pricing has remained the same because everyone has moved up.

We believe we chose the right strategy of walking the prices up thoughtfully, mindful that consumers are watching what they spend. It continues to be a very challenging market. We're determined to stay very competitive with our product offerings and gain market share.

As I've shared with you in the past, over 70% of our product offering in our stores still sells for less than $10. We believe our brands continue to provide a great value to consumers.

A good portion of our growth in the third quarter was driven by our new business in Canada. We acquired a high-growth business and a very talented management team. We believe we can double this part of our business over the next five years. We also had strong organic growth in our Carter's wholesale and retail businesses.

The national retailers continue to support Carter's as their cornerstone brand and the young children's apparel departments. Our fall over-the-counter sales with top retailers in the third quarter were in line with our expectations. Our baby and playwear product offerings outperformed our sleepwear products. We believe sleepwear is a more discretionary purchase and may have been impacted by more cautious spending.

In the third quarter, we saw more customers shopping for wear now products. Like many retailers, we set our fall product offering in mid-July, which in retrospect was a bit too early. With consumer shopping closer to need, most of the demand in July was for end-of-season warm weather goods. As weather cooled, business improved meaningfully.

We're on track to open 60 stores this year. Collectively the new stores are achieving our sales and earnings plan. We expect to open 55 to 60 Carter's stores next year primarily in specialty store shopping centers. We refer to these stores as our brand stores.

A good portion of the 2012 store locations have been identified. The brand stores now represent about half of the Carter's store portfolio and they achieved comps well above our outlet stores.

We're very happy to see the good work we do in our outlet stores recognized by Consumer Reports recently. Consumer Reports surveyed over 17,000 readers who made nearly 39,000 outlets visits. 58 brands were ranked based on value, selection, quality and service. Our Carter's and fee OshKosh B'Gosh stores received the highest ratings of all children's retailers in the outlet space.

We're making excellent progress extending the reach of our brands through e-commerce. Carter's e-commerce sales tripled in the third quarter and are expected to be about 9% of store sales this year. We originally projected our total e-commerce sales to be $40 million this year. We're currently trending to $70 million in sales and expect to exceed $100 million in sales next year.

Consumers are clearly responding to the convenience and value of our brands online. We believe e-commerce will meaningfully contribute to our growth objectives and strengthens the appeal of our brands in all channels of distribution.

Our websites have become our most effective brand marketing tool. Our sites had 28 million visits in the first nine months this year. Nearly 30% of those visits were from international customers, reflecting the appeal of our brands outside the United States.

With respect to our OshKosh business, sales grew 3% in the quarter and are up 5% year to date. Similar to our Carter's brand, as the quarter progressed OshKosh sales improved. The best comps were in September and in the brand stores.

The largest component of growth at OshKosh in the third quarter was through e-commerce. Sales online also tripled in the quarter and are expected to be about 7% of our store sales this year. Oshkosh's baby and boys product offerings outperformed the girls offering.

We still have some work to do improving the girls line, and have strengthened the girls design team to help us with that effort. We previewed OshKosh's fall 2012 line this past week to some of our largest customers. The feedback on the girls line suggests we're making good progress.

Our focus with OshKosh continues to be on building a strong team of professionals across all functions and giving them the resources they need to strengthen the product offering, brand marketing and our performance.

Beginning with the third quarter our performance in international markets will be reported separately. We have a well-established but underdeveloped international business.

For many years, a small group of talented employees have done an excellent job developing relationships with retailers and distributors throughout the world. They did an excellent job of helping Bonnie Togs develop our brands in Canada. We liked the job Bonnie Togs was doing so much that we bought the business. What we accomplish in Canada, acquiring a very successful licensee, is possibly a model we could explore for future acquisitions.

With the benefit from the acquisition, total international sales this year are expected to be more than $130 million, contributing more than $30 million in earnings and nearly 20% of our consolidated operating income. Given the significance of this growth opportunity, we're adding resources to enable more active management of existing international relationships and we're exploring new relationships, new markets and new models.

We currently do business in over 40 countries. We will focus primarily on a handful of those countries to accelerate our growth internationally.

With respect to our outlook on product costs, cotton prices have continued to decline since our last call though they are significantly higher than historical levels. We expect to see the benefit of lower product costs in the second half of next year.

In the third quarter we began to lock into favorable costs for a portion of our fall 2012 product line. We have placed orders earlier with our best suppliers for the more predictable components of our product offerings. Our objective is to reduce our exposure to volatility in cotton prices.

The cotton market seems to have stabilized with prices around $1 a pound. If dollars were to rise we have some protection to mitigate that exposure. Other meaningful initiatives in our supply chain include improving inventory productivity and developing more strategic relationships with our suppliers, including building direct sourcing capabilities.

As we head into the final weeks of the year, 2011 is shaping up to be better than we originally projected. If we are successful with our balance of year plan, we will exceed $2 billion in sales this year. That is a significant milestone for us and reflects the good work of all our employees throughout the Company.

No other Company in young children's apparel has the presence our brands have established in the US market. We plan to strengthen that presence by leading the market in product value and brand presentation, and extending the reach of our brands with the help of our national retail partners and through our own stores, our e-commerce business and international markets.

We will share more with you in February about our plans for 2012. As we see it today we expect to achieve over 10% growth in sales and earnings next year. Given a higher mix of retail, e-commerce and international sales, and the strength of our supply chain initiatives, we expect to begin showing progress improving our operating margin in 2012.

In summary, we're very pleased with our third-quarter results. Our outlook for the year has improved since our last update and we're expecting good growth in sales and earnings next year. More importantly, we're very excited about the long-term growth potential of our business given the strength of our brands, our leading market shares across multiple product categories and channels, and the new opportunities to extend the reach of our brands to more consumers in the United States and abroad.

At this time, Richard will walk you through our presentation on our website.

Thanks, Mike. Good morning everyone. Turning to page 2 of this morning's presentation we have summarized some highlights of our performance in the third quarter.

As Mike mentioned we had very strong and broad-based net sales growth in the quarter. Our topline performance exceeded our expectations, both with and without the contribution from the business which we acquired in Canada. And our earnings were better than we had anticipated, down 19% on an adjusted EPS basis, and we achieved a 10% adjusted operating margin despite the significant impact of higher product costs.

Before I dive into the details of the quarter, I want to highlight that we have modified our segment reporting as a result of the acquisition of the Bonnie Togs business in Canada.

First, the results of the Just One You, Child of Mine and Precious Firsts brands are now included in the Carter's wholesale segment. Results for the Genuine Kids brand are included in the OshKosh wholesale segment.

We've also created a new International segment which includes our newly acquired Canadian retail business, wholesale sales in international markets and international royalty income. Prior-year results have been recast to conform to this new basis of presentation, and we have included a supplemental schedule in the appendix of today's presentation which summarizes the results for the past seven quarters in the revised segment reporting convention.

To our comments about our gain in market share on page 3, we summarize the latest data which we have, which shows that through the middle of this year our US market share between the Carter's and Oshkosh brands has increased to over 15%. This is up 250 basis points over the same period last year and 320 basis points over 2009.

An important objective for us, particularly in light of all the discussion around pricing, has been to stay true to our strong value proposition in the market place. I think these results demonstrate we have continued to win with the consumer and have strengthened our position as the market leader in the US and young children's apparel.

So in terms of our sales performance for the quarter on page 4, in the third quarter net sales overall increased 23% over last year. Every reporting segment posted growth with our International, Carter's Wholesale and Carter's Retail segments driving the overall growth. Excluding the contribution of Canada, which was not part of our business a year ago, net sales grew 17% over last year.

We had very good growth in the Carter's Wholesale segment in the quarter, reflecting growth in all of our principal brands, Carter's, A Child of Mine and Just One You. Our results were better than we had forecasted. We've estimated that about $16 million of demand came earlier than we had forecasted, at the request of customers who had previously planned to take these goods in the fourth quarter. We further estimated that this earlier shipments contributed approximately $0.04 to earnings in the quarter.

The Carter's Retail segment continues to show solid growth, with sales growth from new stores, e-commerce sales and a retail store comp of 5.5%.

OshKosh sales in total increased over $3 million or 3% with growth in both the Retail and Wholesale segments. E-commerce sales drove the overall growth in OshKosh revenues which we posted for the quarter.

As shown under the International segment bar, in addition to revenue from our Canadian retail stores we had good growth in wholesale shipments to markets outside the United States, with overall sales in this portion of the business roughly doubling over last year. I will speak a bit more about our business segment results in a moment.

Our third quarter P&L is on page 5. These results are presented on an adjusted basis where appropriate.

In the third quarter we recorded pretax charges of approximately $7 million related to the Bonnie Togs acquisition in June of this year. These charges are mostly related to the amortization of the stepped-up value of inventory.

Adjusted gross margin in the quarter was down 630 basis points versus last year. This reflects meaningfully higher product costs which were partially offset by our increased prices.

Adjusted SG&A increased approximately $21 million or 17% over last year, but we achieved 120 basis points of leverage given our strong topline in the quarter.

Royalty income was consistent with last year. This reflects continued growth in our domestic and international licensing businesses, which was offset by the loss of royalty income in Canada due to the acquisition of Bonnie Togs.

Interest costs in the quarter were comparable to last year. So, again, on a bottom-line basis, adjusted earnings per share for the quarter were $0.67, down 19% compared to $0.83 last year.

In addition to the roughly $0.04 of upside in the quarter created by earlier demand in the Carter's Wholesale segment, we also picked up a penny or so in SG&A as spending in a couple of areas will happen later in the year than we had previously forecasted.

Slide six summarizes the key drivers of SG&A for the quarter. As you can see, most of the 17% increase in SG&A over last year was incurred in support of our growth businesses -- namely, the expansion of our retail store base and our rapidly growing e-commerce business. Excluding the expenses for Canadian retail stores which are not comparable to a year ago, total SG&A increased 9% over last year.

We've controlled spending well across our business, mindful of the uncertainty of the macro environment. And all other expenses netted out roughly flat with a year ago.

On page 7 we have summarized our business segment performance for the third quarter. These results reflect our new segment reporting and are presented on an adjusted basis excluding the impact of the acquisition related costs that I described previously.

Overall adjusted operating income declined about $16 million in the quarter and our consolidated adjusted operating margin was 10%. Again, we think this is a good result given the issues we've been managing through with regard to product cost inflation. At a high level, the decline in our consolidated operating margin and the margins of our operating businesses reflect this impact of higher product costs which we have successfully partially offset with price increases.

The OshKosh wholesale and retail business were further impacted by the carrying costs of the new stores we opened over the past year, as well as investments in the OshKosh merchandising, design and creative teams to strengthen the long-term foundation for growth of this brand. Note that the International margins reflect the inclusion of Canadian retail stores in the current quarter's results. Prior-year International segment results largely reflected royalty income, which obviously carries a higher operating margin on its own than when blended with a retail store business.

The next two pages summarize our performance for the first nine months. I won't cover these pages in much detail, except to point out that our year-to-date net sales growth has been very strong at plus 20%. And adjusted earnings per share are down 22% to $1.46 as a result of the higher product costs I mentioned previously. And our consolidated operating margin was nearly 9.5% despite significantly higher product costs.

Page 10 is included for your reference and provides the details of the various adjustments which we have made to our GAAP results. The adjustments in the quarter were approximately $7 million and relate to our acquisition in Canada. We do expect additional adjusting items in the fourth quarter related to further Canadian acquisition-related costs.

Turning to page 11, we've recapped a few key balance sheet and cash flow metrics.

Our balance sheet continues to be very strong. Cash on hand at the end of the quarter was approximately $82 million, down from last year's quarter end position, reflecting the acquisition in Canada and higher year-over-year inventories. Accounts receivable were up due to higher wholesale sales in the quarter compared to a year ago.

Inventories at the end of the third quarter are 46% higher than a year ago, mostly due to higher product costs and growth in the business. Sequentially this compares favorably to second quarter year-over-year inventory growth of 76%.

Cash flow from operations is down year-over-year as a result of higher inventories and lower earnings. Our forecasts indicate we'll finish the year with operating cash flow in the $75 million to $85 million range, and a good year-end cash position. So we will continue to upgrade liquidity and excellent financial flexibility.

Turning to page 12, we have made good progress and met our forecasts in reducing particularly high second quarter inventory levels. Excluding Canada, which is a noncomparable to last year, inventories increased 36% and units at the end of the quarter were up 9% as opposed to being up over 30% at the end of last quarter.

The factors which contribute to our higher inventory position are consistent with those which we discussed with you on last quarter's call. Most significantly, fall product costs have increased about 25% over last year, driving up the absolute value of our investment in inventory by almost $70 million.

Second, business growth has also contributed to the third quarter year-over-year inventory increase with Canada, e-commerce acceleration and additional US retail stores being primary drivers. We continue to see better supply chain performance than a year ago when cotton availability in production capacity were issues in receiving product on time. This more stable product flow has also contributed to her inventories on hand this year versus last.

Overall the quality of our inventory remains excellent. Consistent with last quarter, roughly 5% of our inventory is characterized as excess, a consistent proportion of total inventory as a year ago. And we're well reserved for the expected losses on these items.

We expect to continue to work down our inventory position throughout the balance of the year. Excluding Canada, we're forecasting inventory units at year-end to be up slightly over a year ago, with dollars up in the low 20% range reflecting largely the ongoing impact of higher product costs. As Mike said, inventory management and productivity will continue to be areas of focus for us going forward.

Now I would like to cover the third quarter business results in more detail, turning to Carter's wholesale on page 13. Sales in the third quarter were up 15% to last year due to strong demand across our customer base with growth in the Carter's Just One You and Child of Mine brands. We made good progress increasing AURs in the quarter, with prices in the regular price portion of the business up about 10%. We're projecting good continued demand in this business, with spring 2012 bookings up about 8%.

On page 14, we have some key metrics for Carter's US retail stores. We delivered a strong comp store sales increase in the quarter of 5.5%. From a product perspective, baby and accessories drove the comp increase. We're pleased with this quarter's performance despite lower consumer traffic in the marketplace.

Results improved over the course of the quarter with particular strength in September. Our strong product offering resulted in an AUR increase of about 8%.

Geographically, the comp strength was very broad-based. All regions posted gains, led by our South and East regions.

By store format, our brand stores delivered the strongest comp performance. Brand stores now represent about half of our store base and our future store growth plans are focused on this format. We opened 23 new Carter's stores in the quarter, bringing our year-to-date store openings to 45 locations.

Now turning to our OshKosh businesses, we summarized some details for OshKosh Wholesale on page 15. Third-quarter sales grew 3%. Over the counter sales and margins at our largest accounts were comparable to last year and were achieved on lower customer unit inventories.

The business is tracking to achieve our full-year growth plan of a 5% increase in sales. Looking ahead, spring 2012 bookings are comparable to last year.

Turning to page 16 and the performance of OshKosh retail in the quarter. OshKosh US retail store sales declined about 1% in the third quarter, reflecting the contribution of the new stores which we opened over the past year, offset by a 2.2% decline in comparable store sales.

In terms of the down comp for the quarter, we do think the business was impacted at least in part by our transition to fall merchandise during what turned out to be a really hot July and August. Back-to-school also seems to be happening later and later each year, which probably contributed to the improved comps we saw as we progressed through the quarter, particularly in the month of September.

AURs were also up in OshKosh Retail with particular improvement once cooler fall temperatures arrived. We've begun to more aggressively assess and manage the OshKosh store portfolio. We're focused on improving the top volume stores which contribute a disproportionate share of sales and earnings.

To that end, this year we have closed some underperforming stores at the expiration of their leases. These are stores which were in declining centers with little prospect of long-term improvement. These actions will allow us to better focus on improving the core of our store portfolio and on continuing to develop new retail formats.

Now to our e-commerce results on page 17. Our e-commerce business continues to deliver very strong growth. In the third quarter e-commerce revenues were $21 million, $16 million from Carter's and $5 million from OshKosh. These third quarter e-commerce sales represented almost 9% of combined US retail store sales.

This business also delivered its third consecutive profitable quarter with margins continuing to improve. Year to date, we have generated nearly $47 million in revenue from our website. As Mike mentioned previously, given our strong performance to date we're now projecting full-year 2011 e-commerce sales within the neighborhood of $70 million. For 2012, we're forecasting sales in excess of $100 million, which is several years ahead of our initial goal for this business.

Turning to page 18 and our International segment, Canada's underlying retail business performance was very strong in the third quarter with a retail store comp of 6.4%. The strongest area of performance in our Canadian stores has been the OshKosh brand.

We opened five new Carter's OshKosh cobranded stores during the third quarter, bringing our overall Canadian store count to 64 locations. We're focused on developing additional growth opportunities in the retail, wholesale and e-commerce channels in Canada. Near-term we remain focused, though, on building out our retail store opportunity and expect to open 18 to 20 new stores in Canada in 2012.

We also had excellent performance in the rest of our International business. Net sales in the wholesale portion of this business roughly doubled in the third quarter, reflecting growth overseas for some of our US wholesale customers and growth in the Middle East.

Turning now to our outlook on page 19, we've raised our forecast for the fourth quarter and the year in part due to our strong third-quarter performance. We're expecting good continued revenue growth in the fourth quarter, an increase of 15% to 17% over fourth quarter of last year. We expect the growth will be led by Canada, Carter's retail and e-commerce. We also expect that adjusted earnings per share will be in the range of approximately $0.40 to $0.45 compared to $0.60 last year.

The principal driver of lower year-over-year earnings in the fourth quarter will continue to be higher product costs.

We will continue our store opening activity in the fourth quarter with plans to open 8 new Carter's brands stores and one new Carter's OshKosh cobranded store in Canada. For the full year we're forecasting that adjusted earnings per share will be in the range of $1.88 to $1.93, which again is above our previous forecast.

Looking past the fourth quarter, we started to refine our perspective on 2012. It remains early in our planning cycle and our detailed plans will continue to be firmed up over the next couple of months, but we are expecting growth in both sales and earnings in 2012. We're expecting good revenue growth across our businesses particularly from Carter's retail and e-commerce, and we'll benefit from the inclusion of a full year of our business in Canada.

We're expecting earnings will be down in the first half of the year and up in the second half of the year as we begin to benefit from lower product costs in our fall 2012 assortments. We will share more on our outlook for 2012 on our next call in February.

With that, operator, we're ready to take questions.

(Operator Instructions) Susan Sansbury, Miller Tabak.

Hi. Thanks very much. Nice job. Everyone should be congratulated.

Thank you, Susan.

A couple of questions, one for Richard. We're all [analysts] out here, so can you help us out a little bit in terms of [pro forma] providing some sort of analysis of the Carter's and OshKosh sales change, ex the mass channel, ex the -- you know these are all restated numbers. Is that correct?

The data that is in the appendix of today's presentation, Susan, has all that information that has been recast to conform with our new segment basis of reporting. So I think you have all that data.

Okay, I apologize. Could you specify what the acquisition related charges will be in the fourth quarter?

At this point I would expect it to probably be around $1 million or so, Susan.

And is there -- now that we have a 50/50 mix of branded stores versus outlet stores, can you specify what the lift from these branded stores has been and whether you expect that lift to continue to improve?

Susan, this is Jim. The brand stores, as you said, that make up 50% of the portfolio right now, are comping very positively. In fact they're the strongest comping stores within the fleet.

And we are also able now to rollout our newest version of the Carter model, which was first opened in our Locust Grove location. I don't know if you have visited that or not, but it's a much more attractive and actually beautiful showcase for the brand. One of the more recent stores that we opened in this format is in, for example, Alpharetta, Georgia, the Northpoint location.

And coincidentally, we had an opportunity to do some exit surveys and the feedback from the customers regarding this particular store format have been terrific. 97% of the respondents that participated in this survey said they like the store very much, and close to 90% of them plan to make a return visit. So the overall feedback regarding the new store format has been great, so this speaks well to the growth vehicle of the Carter's brand and retail model.

What we're encouraged by Susan is that the strength of the OshKosh portfolio is also in the brands stores. So, we have fewer. A fraction of the OshKosh stores are at brand store locations, but the brands stores have been the strength of the portfolio for both brands.

Okay. Do you anticipate or are you being conservative about when you might expect to accelerate the rollout of OshKosh branded stores?

Yes we are. So next year we will open up some portion of 55 to 60 Carter's stores and we will probably open up about a handful of OshKosh stores. There's more money to be made with the stores that we have at OshKosh, so -- as we continue to work through some of the product opportunities particularly on the girl side. Boys continues to be good at OshKosh, very good.

As I've gone into the stores and I've talked to the store employees, the feedback I consistently get if we can do for girls what we have done for boys, we will see meaningfully better performance. So we've beefed up the team over girls' design, and the feedback that we are getting from a couple of our largest customers previewing the line with them for fall '12 is encouraging. So we will get there, but there is no -- given the strength of all the other components of our business, there is no need to be more aggressive on the OshKosh store rollout right now.

You know, the interesting thing, Susan, about the OshKosh stores is, as Mike mentioned, our brands stores comp quite positively. But out of the five categories of stores that we do have in the OshKosh model, the stores such as the brand, the trade area stores and the Mills locations, all of which tend to be closer into where the population live, have comped positively over this past quarter. So there is some momentum in that business.

Okay, that is good to know. I will get back in the queue and ask, if there is time, ask a couple more questions. Thanks ever so much.

Helena Tse, BofA Merrill Lynch.

Hey guys, great quarter.

Thank you.

I just wanted to elaborate a little bit more on sort of the cost pressures on the costing side. Can you sort of talk about the FOB components, so for instance raw materials but then also manufacturing and other, and how you see each component trending into 2012, either in the back half -- probably not only in the back half but first half and back half of 2012?

Just at a high-level? Directionally?

Yes, yes.

We will start to see more meaningful improvement in cost in the second half of next year. Got an e-mail early this morning that we have teams over in Asia right now and they are encouraged by what they are hearing. But we won't see any meaningful benefit until fall 2012, which we start shipping at the tail end of the second quarter next year.

But fabric costs will be down, cotton prices are down, labor costs are up. Last analysis we saw, freight costs are actually I think a bit better, neutral to a bit better. So the general direction on cost will be lower.

I think it is important to note that although cotton prices are down, they're still significantly higher than they were a couple of years ago. So we will start to show meaningful progress with margins in the second half of next year. And as we shared with you in the past, the lion's share of our product cost is fabric-based.

Got it. And then you spoke a little bit about sort of the direct sourcing initiative. Can you maybe talk about the timing of when that initiative would come into fruition and when we would see some of the benefits of that?

Yes. We will, at some time in 2012 -- I will be more specific next year, but in 2012 we will establish an Asia-based operation; purpose of that office is to enable direct sourcing capabilities. That will take some time.

We will go from what is nearly 95% agent sourced and very little direct source. We won't shift those percentages meaningfully next year, but over time, I guess over the next five years you will see more of a balance. It may be as much as 50/50 balance between agent sourced and direct source over the next five years. But that will take some time.

The agents have done an outstanding job for us. The service levels have been extremely high. But we just think from creating more of a competitive environment, it is better to have a balance and we will work toward that balance over time.

The other purpose of the office is to support our international efforts, our international growth initiatives and there are some cases where we source product from Asia, bring it into the West Coast of California, into Stockbridge Georgia where our distribution center is and then ship it back to Asia. It doesn't make a lot of sense. And so we're going to have some good people based in Asia, understanding how we support our international partners in a better way, helping them accelerate their businesses. Help them be more profitable and in turn, make ourselves more profitable.

That's great. And then I just have one other question related to retail. As you sort of shift and expand into retail, can you just remind us what type of gross margins those Carter branded stores would have versus maybe either the rest of retail or just the Company average? And to clarify, that 55 to 60 new stores in Carter's, is that domestic only so that it excludes Canada?

It does.

Without quoting the numbers specifically from a gross margin perspective, the outlet store model is an incredibly rich model. It is where most retailers kind of go at the end of their retail expansion. We started from there.

That being said our new stores, which are brand stores located closer into where the customer lives, are not only performing well from a sales perspective, but they are performing very well at an operating income perspective. So it is very meaningful to the overall profitability of the business.

Great, thanks so much guys.

You are welcome.

Susan Anderson, Citi.

Good morning guys, congrats on a great quarter.

Thank you.

I think I want to nail down a little bit more on the OshKosh brand at wholesale. I wasn't sure if AURs were excluding the B'Gosh brand.

In the wholesale channel AURs were up in what we call the regular price portion of the business, so we did have a bit more of off price channel activity which is pulling down the metric, which I believe is in the presentation. But we were up in the mid to upper teens in terms of the regular price business at wholesale in the quarter.

And when you say bookings are comparable to last year for spring, does that mean they are flat?

Correct.

Okay. And then, I guess maybe if you could just give a little bit more color on what is different in Canada for the OshKosh brand. That sounds like it is doing really well and it is driving the strength there. And maybe can you leverage these learnings for the US?

And then maybe if you could provide a little bit more color on what you're doing to improve the girls' OshKosh product in terms of new hires and styles and product image, etc.

Right. What I am told from the head of the Canadian business is that for over 20 years the Bonnie Togs stores, that is the nameplate on their stores, was known as the OshKosh stores. So the brand had a very strong following in Canada. And probably five years ago they started to put both the Carter's and OshKosh brands in the stores, their own stores, and saw success with that. And then they started to open up the cobranded stores, and those stores are going to be the growth vehicle for Canada going forward. So it's just the [following] of the brand.

The other thing important to note in Canada -- these stores, these cobranded Carter's OshKosh stores, are specialty stores. They're closer to the consumer. To Jim's point earlier, most of our stores for OshKosh are in outlet store locations and only about 5% of children's apparel in the United States is bought in outlet stores.

So the brand is closer to the consumer. It is more of a specialty store format and they've changed some things in terms of the mix for the third quarter in terms of outerwear and footwear, putting more of those products into the OshKosh product assortment. And it has worked beautifully for them.

So, if you haven't had a chance to go see these stores, I think it would be helpful for you to see for yourself how beautifully the brand is presented in Canada.

And then with respect to the girls, it's simply a case of getting the right people on it. We had some gaps in talent over the past year. Girls is always tougher. Even though the mix of girls and boys in the store is about 50/50, girls, whether it is any brand, girls is always tougher. It is more fashion-oriented.

And so, we've got some very talented people working on it. I will tell you the feedback I had last week from our largest customers is they have noticed the improvement. So we're getting good feedback internally, and more importantly externally on the progress we're making with girls.

Great. And then in terms of the product in Canada, is it the same as in the US except for more probably colder weather stuff?

Well, it is the same product offering. Right? The outerwear is probably a broader assortment given that it is Canada.

Okay. And then I'm not sure if you broke out yet kind of the driver behind the inventory. I think you broke it out last quarter in terms of prices and units. And maybe just comment a little bit on -- I think it is up about 46% this quarter versus about 76% last quarter.

Correct. We did have some information on the presentation on that topic. In the US portion of the business, units are up about 9% at the end of the quarter. They were up over 30% at the end of the second quarter.

Dollars will continue to be up because the inventory itself is just more expensive than it was a year ago. So where we were up something like 76%, we're up 46% at the end of the third quarter and we will continue to work that down in the fourth quarter.

Great, thanks guys and congrats again.

Steve Marotta, CL King Associates.

Good morning everybody. I'm putting together some of the comments that were on the call as it relates to guidance for 2012. Profits expected to be down in the first half but up in the second half. Mike, I think you said that overall operating margin is expected to improve next year. Is that accurate?

That's our plan.

As it relates to the pricing and costing environment in the first half of next year, you mentioned that costs are expected to increase in the midteens. What would you think as a percent of pass-through will you be executing?

Steve, I'm not sure of your term of pass-through. We continue to think that pricing is not going to be sufficient to completely offset the higher product cost that we're seeing. So we are planning that prices will be up again, but not sufficiently to cover the product cost inflation. So we continue to think that gross margins will be under some pressure through the first part of next year.

And do you think that is about a 70% pass-through? In other words, if costs are up in the midteens, that you're going to -- your prices will be up 10% or 11% give or take? Can you quantify it somehow?

I think in the 10% range is probably right year-over-year to think about.

So, about two-thirds pass-through. Okay, that's fine.

And as it relates to second half costing and pricing environment with cost abating a bit for you, do you expect to capture 100% of the raw materials rolloff? Or do you think that there will be pushback from the retailer to add units per pack or do something that would prevent you from capturing 100% of that rolloff?

I think the challenge is there's multiple things that are moving right now in the product costing environment. You certainly have favorability, as Mike suggested, in the cotton and fabric dimensions. Labor continues to be going up, so we will see where the final costs get locked down.

Our teams are there now. We will have a better sense over the next few weeks exactly the kind of cost we locked into. But certainly I think we would like to maintain the pricing that we have achieved in the marketplace, and certainly if we are successful in that regard, it would benefit us meaningfully in the second half in terms of our profitability.

The intention is always to strengthen the product offering. So there is no plans for price increases in the second half of next year, but the plan is always to strengthen the product offering for the consumer.

Sure, no, I understand. But I'm curious as to the discussions that you're currently having with retailers while you will maintain pricing to them, or are there going to be demands from them as it relates to what you are delivering to them either, again, units per pack or cotton weight or some other incremental cost on your side which would prevent you from capturing 100% of the rolloff.

Too early in the cycle yet. We haven't even finished the fall '12 line. We will start to preview it before -- between now and the balance of the year, so we will have a better view on that in February.

Great. That's very helpful. Thanks guys.

Nicole Shevins, Goldman Sachs.

Good morning. Thanks for taking my question.

Good morning.

A question was on SG&A. You know, you leveraged that nicely during the quarter. Were there any particular areas where you were able to cut expenses? And should we think about a midteens run rate going forward?

There were a lot of puts and takes in SG&A. As we depicted in the presentation, Nicole, most of the spending has related to our growth initiatives. We're continuing to rollout new brand stores in the US.

Certainly the addition of the Canadian store basis has been additive in dollar terms to our SG&A base. We have been offsetting some of the spending with lower, I would say, performance-based compensation this year. Because earnings are down, we're making lower provisions for that portion of the business. And I would say we continue to control discretionary spending reasonably well in the other parts of the business. So, where we can hold the line on spending we're doing so.

Fourth quarter I would expect our growth rate in SG&A to be a little bit less than what we saw in the third quarter, just because last year we did take some more significant provisions for performance-based compensation in that fourth quarter. But we will share more of our detailed plans for '12 when we get to the February call, give you a little but more color on SG&A then.

That's great. And then on gross margins, obviously in 2011 there were a few factors that pressured your gross margins. How do you think about the long-term potential there? And in your view is there anything that would prevent you from getting back to a 38% gross margin?

No, I think we're very bullish on the long-term outlook for gross margin. We had excellent gross margins last year. We weren't hitting on all cylinders and all corners of our business a year ago, so we think is plenty of opportunity to improve margins over time.

We will continue to emphasize growth in the businesses that carry the greatest gross margin potential. That is our retail business, that is our e-commerce business, International, so feel really good about the long-term outlook for margins.

Okay, thanks for taking my questions.

You're welcome.

Howard Tubin, RBC Capital Markets.

Hey guys. Maybe just a question on International. Just bigger picture, maybe near-term and longer-term, what kind of opportunity do you see in terms of other countries or percentage of total business International could represent one day?

Well, there's three ways we plan on growing. Certainly with the retail business that we just acquired up and Canada. We have a nice wholesale business. We have a very profitable licensing business.

And then next year, we hope to share with you our plans to support the demand online from international customers. We don't have the ability to do that efficiently today, but we will work on some plans to support that demand and we will share more about that next year.

But the markets we're looking at are Canada, Mexico, Japan, Korea. We actually do quite a bit of business in those countries right now. We do a little bit of business in China. We do almost no business in Brazil.

But if you add up those markets I just shared with you, collectively, the newborn to size 7 market in each of those countries collectively is about $26 billion. So there's a huge market. The United States market is about $22 billion. We own the larger share of the US market. We own a fraction of the share of that $26 billion market.

But of those countries I just shared with you, we actually have a good book of business today. I would describe what we have done historically as weighted mostly toward licensing arrangements -- very profitable licensing arrangements. It's been described as a bit of a low touch model, working some really good retailers throughout the world and them representing the Carter's and Oshkosh brands. If you were to see the pictures of the stores that they have outside of the United States, beautiful presentation of our brands.

The focus we have now is with a bit more of an active engagement of these international partners. Can we help them accelerate their business? Can we convert some of these licensing arrangements to more wholesale arrangements? Leveraging our supply chain to support them better so they make a better profit, and we can make more money doing that for them.

That sounds great, thanks.

Gerrick Johnson, BMO Capital Markets.

Hey, good morning. A question for Jim here. At your retail stores have you seen any sort of change or shift in the ratio of cash versus credit card purchases?

No, nothing that has been noticeable at all.

Okay. And Richard can you please give us the shares and the effect of the restricted stock units on the EPS calculation for the quarter?

Gerrick, I think the number of shares that you typically are looking for is 58.3 million in the quarter.

And the effect of the restricted stock units?

There were around 121,000 shares in the quarter that went into that calculation. That's restricted stock; about 465,000 options.

Thanks.

Helena Tse, Bank of America Merrill Lynch.

Hey, sorry for the follow-up. Can you just elaborate a little bit more in your mass channel? I know you mentioned that both the Wal-Mart and Target brands are up. Can you maybe talk about sort of how you're thinking about that go forward, as you just sort of anniversary the restocking and square footage gains you had over the last three quarters on Wal-Mart?

Helena, we no longer have a mass channel. We just incorporate those very important customers into our Wholesale segment. We had good growth with both of those brands in the third quarter.

I think the outlook over time is very, very good. We continue to build our business back with Wal-Mart. I think the long-term prospects there are very, very positive.

Got it. And so your spring bookings that you listed is inclusive of the mass channel?

Correct.

Okay. Thanks.

You're welcome.

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

Okay, thank you. Thank you all very much for joining us this morning. We appreciate your questions, the support you're giving our Company. Look forward to updating you again on our progress in February.

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