Carter's Inc (CRI) 2012 Q3 法說會逐字稿

Good day, everyone, and welcome to Carter's third quarter 2012 earnings conference call. On the call today are Michael Casey, Chairman and 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. Carter's issued its third quarter 2012 earnings press release today before the market opened. A copy of the release and 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 a detailed discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the Company's most recent annual report filed with the Securities and Exchange Commission.

Also, on this call, the company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the Company's earnings release. Also, today's call is being recorded.

And now, your host for today's call, Mr. Casey.

Thanks very much. Good morning, everyone. Thanks for joining us on the call. Before we walk you through the presentation on our website, I'd like to share some thoughts on our business with you.

Since our last update, we've achieved a number of significant milestones in our business. We achieved a record level of sales and earnings in our third quarter. We opened our 400th Carter store. We surpassed $100 million in e-commerce sales, and we completed the transition to our new e-commerce fulfillment center.

Sales growth in the quarter was driven by our retail, e-commerce, and international businesses. Our profitability in third quarter was driven by the success of our product and pricing strategies and lower product costs.

We achieved our pricing objectives in the third quarter. This is particularly noteworthy given the challenge of maintaining prices in this highly promotional and relatively weak retail environment. Our Carter's brand continues to drive the growth of our business. We had very good growth in our Carter's retail segment. We're on track to open 63 Carter's stores this year, and our new stores achieved their performance goals.

Traffic to our comp stores was inconsistent in the quarter. There were more peaks and valleys in our weekly sales than expected. To drive more consistent traffic to our stores, we have strengthened our direct marketing messages to drive a higher transaction value per visit and encourage repeat visit. And we are investing in a national marketing campaign for Carter's that will launch next week. The objective of this marketing initiative is to further strengthen Carter's as the leading brand in young children's apparel in all channels of distribution.

Our holiday marketing arrives in homes this week. It's beautifully executed and focused on holiday dressing. It will be followed by Black Friday promotions which include several key items we believe will provide great value to consumers.

Promotions in the fourth quarter are planned at a level comparable to last year. Our focus has been to make our promotions more effective and the related sales more profitable.

Our e-commerce sales and profitability are up significantly this year. We now expect our e-commerce sales will be about $140 million this year. This is only our second full year with e-commerce capabilities. Given the strong response by consumers to the beauty and convenience of our brands online, we believe this component of our business has the potential to double in sales and earnings over the next five years.

All key commerce metrics improved since last year. The number of visits to our websites, the conversion rate, and the average order value, all improved. We had over 18 million visits to our co-branded websites in the third quarter, and 37% of those visits were from international addresses, up from 29% last year. With the help of a third-party resource, our brands are now available online in over 80 countries. We envision an opportunity someday to support international online demand for our brands directly and more profitably.

For the year, Carter's wholesale sales are on track to grow about 5%, which is better than what we had originally planned. Spring bookings for Carter's are also a bit better than what we had forecasted on our last call.

The second largest contributor to growth in the quarter was our International segment. Growth in this high-margin segment was driven by our Canadian operations and growth in Central and South America. As a reminder, our vision is to be the world's favorite brands in young children's apparel. We hope to replicate the successful multi-channel model we've built in the United States in global markets. We are the market leader for young children's apparel in the United States, with 17% share of a $22 billion market and 3 times the share of our nearest competitor. Our primary focus is in Canada China and Japan, and to a lesser extent, South Korea, Australia, and Mexico, given the relative size of those markets.

Collectively, the newborn to size 7 market in these countries is $25 billion. We currently do business in each of these markets, but we own about 1% share. A relatively small market share gain in these international markets could contribute meaningfully to our sales and earnings.

With respect to OshKosh, our focus this year has been to improve its profitability, and profits more than doubled in the third quarter. If we're successful with our balance-of-year plan, we should see meaningful improvement in OshKosh's earnings in the fourth quarter too.

This year, we've strengthened OshKosh's product offering, eliminated unprofitable sales, tested a new store format and built direct sourcing capabilities for OshKosh. As a reminder, we expect the OshKosh brand to grow to at least $500 million in sales, with an operating margin of 10% to 12% by 2016.

In our supply chain, we're excited about the potential of our new sourcing operations in Hong Kong. We expect to shift the mix of our direct sourcing from 5% to 50% over the next 5 years. Directionally, we plan to source about 10% of spring '13, and 20% of our fall '13 products directly. We expect to ramp that mix up over time to improve the performance of our supply chain.

Another big step forward in our supply chain this year was the investment in our new million square foot multi-channel distribution center. As I mentioned, we've completed the initial phase of the transition to this new facility by exiting the high-cost, third-party fulfillment center, and now, 100% of our eCommerce demand is being shipped at a lower cost from our new facility.

In addition to the new multi-channel distribution center, we're also investing in an important initiative to bring our retail and finance operations from Connecticut to Atlanta. For over 20 years we've operated separately. But as our business has evolved, we've determined our growth plans will be best executed if we're all together in Atlanta. We expect to complete this important initiative by this time next year.

Our outlook for the year has improved since our last update. Based on the strength of our third quarter performance, we are raising our forecasts for the year. We're refreshing our plans for 2013, and we'll share that plan with you in February. Based on what we envision today, we're expecting good growth in sales and earnings next year.

In summary, we're on track to achieve a record level of sales and earnings this year, our 24th consecutive year of sales growth. I'm grateful to all of our employees throughout our company, who make these results possible. Together, we've created a strong business model that we believe will enable us to build on our long track record of growth and deliver good performance for our shareholders for years to come.

Richard will now walk you through our third quarter results and outlook for the year.

Thanks Mike. Good morning, everyone. Hopefully you've all had a chance to access the presentation materials summarizing our third quarter performance, which are on the Investor Relations portion of our website. I'll reference this information as I make my remarks this morning.

So starting on page 2, with some overall highlights, as Mike said, we've had a very good third quarter. In particular, our earnings growth was ahead of our expectations driven by very strong gross margin performance and lower spending on our eCommerce in-sourcing project than we had forecasted.

Net sales grew 5%. This performance builds on our 23% growth in the third quarter of last year.

Our Carter's retail stores, eCommerce businesses, and international operations drove our revenue growth in the quarter. Recall that these results reflect the first quarter of comparable Canadian operations as we acquired this business at the end of the second quarter last year.

Adjusted operating income and adjusted EPS in the third quarter were each up over 50%.

On page 3, the chart at the left shows the components of our roughly $670 million of revenue in the third quarter. Our U.S. Carter's businesses represented about 74% of our revenue base, OshKosh approximately 16%, and about 10% of net sales in the third quarter came from international markets.

In the waterfall chart at the right, we've highlighted the contribution of each business to our overall profit improvement in the quarter. Our U.S. Carter's businesses drove the increase in year-over-year operating income, with good profit contributions from both wholesale and retail. Our U.S. OshKosh businesses and international each contributed about $3 million of increased earnings in the quarter. This growth was partially offset by approximately $10 million in higher corporate expenses, resulting in an adjusted operating income improvement of 52% over last year.

On page 4, we provided a more detailed look at our third quarter sales performance. In the U.S., total Carter's sales grew over 4%, driven by strong growth in our retail stores and eCommerce businesses. Carter's retail store comparable sales increased nearly 3%. Our U.S. Carter's wholesale business declined about 5% in the third quarter. This decrease was driven by a roughly $13 million decline in sales to the off-price channel, which was in line with our expectations. Our sales in the Carter's wholesale business were somewhat below what we had forecasted for the quarter. We experienced some delivery issues with a few of our vendors, which resulted in lower-than-planned shipments in the third quarter. The timing of product launches with certain other customers also contributed to the decline in sales in this part of the business. We are planning good sales growth in Carter's wholesale in the fourth quarter.

U.S. OshKosh sales were slightly negative, reflecting, in part, the effects of closing underperforming stores over the last year or so and lower sales to the off-price channel in wholesale. Our international business contributed approximately $10 million to net sales growth in the quarter, driven by our Canadian retail business and growth with our wholesale customers. I'll provide some additional detail on our business segment results in a moment.

Our third quarter P&L is on page 5. We've already covered the specifics of net sales, so turning to gross margin. Third quarter adjusted gross margin increased by 940 basis points over last year. Contributing to this increase was strong consumer reaction to our products, improved average unit retail prices, the benefit of lower product costs, and a higher level of sales from our higher margin direct-to-consumer businesses both in the U.S. and internationally, which increased to 50% of consolidated sales compared to 46% in the prior year.

Adjusted SG&A increased approximately $39 million over last year, which I'll go through in a moment.

So on a bottom-line basis, adjusted earnings per share for the quarter grew over 50% to $1.02.

Page 6 summarizes the key drivers of adjusted SG&A for the third quarter. Similar to recent quarters, our SG&A increases over last year were driven by our growth initiatives - namely, retail store growth in the U.S. and in Canada, as well as eCommerce. In Retail, we're operating a total of 53 more stores in the U.S. and Canada than we did a year ago, and eCommerce volumes and associated costs are up meaningfully over the same period.

Consistent with our forecasts for improved profitability this year, we've also provided for higher levels of performance-based compensation versus a year ago. Our marketing spend is higher than last year, driven by various branding initiatives for both the Carter's and OshKosh brands and higher CRM activities, including direct mail, new customer prospecting, and email marketing.

Finally, the all other bucket contains many smaller items, including provisions for accounts receivable reserves, personnel costs, and spending on international business development and information technology projects. For the fourth quarter, we expect spending for these initiatives will also be up year-over-year, although at a less significant rate than in the third quarter.

The next two pages summarize our performance through the first nine months, and I'll comment on just a couple items on page 7. We've delivered great performance so far in 2012. Our year-to-date net sales have grown 13%. This reflects nearly 10% growth in our U.S. Carter's businesses and 1% growth in our U.S. OshKosh businesses. Our International segment posted strong sales growth driven by the addition of our business in Canada and strong wholesale sales. Year-to-date sales detail by business can be found on page 8.

We're particularly pleased with our strong profit improvement this year, with year-to-date adjusted earnings per share up 34% compared to the first nine months of last year.

Pages 9 and 10 provide a detailed reconciliation of our GAAP results to our adjusted basis of presentation for both the third quarter and the year-to-date periods of 2012 and 2011. Please review these pages as you analyze our results.

Turning ahead to page 11, we've summarized a few highlights from the balance sheet and cash flow statements. Our balance sheet and liquidity remain very strong. Cash on hand at the end of the third quarter was approximately $250 million.

Our inventories at the end of the quarter declined 3% compared to a year ago, reflecting favorable product cost trends and ongoing inventory management and supply chain initiatives. Units are up about 10%, which reflects continued growth across our businesses. We believe inventory quality at the end of the third quarter was excellent. Based on our forecast for the fourth quarter, we anticipate that year-end inventories will be up low single digits in dollars and up mid-single digits in units compared to the end of fiscal 2011.

During the third quarter we amended our credit facility to take advantage of improved market rates and terms. We expect that we'll realize modest interest and fee savings over the 5-year term of the facility. Cash flow from operations in the first 9 months was about $130 million, a record for the company. This is an improvement of over $200 million from the prior year 9-month period and reflects the decline in inventory, higher earnings, and other favorable movements in working capital.

CapEx for the first 9 months of this year was nearly $60 million compared to $29 million last year. Most of our current year investments relate to retail store growth both here in the U.S. and in Canada, and to our new multi-channel distribution center

Page 3 (sic), summarizes our business segment performance for the third quarter. Some of these results are presented on an as-adjusted basis, excluding the impact of the previously described acquisition and facility closure costs. It's worth noting that operating margins improved for all businesses in the third quarter versus a year ago. As mentioned before, we've benefitted from the decline in product costs which negatively affected our profitability last year.

Also contributing to improved profitability in our retail businesses have been the strength of our product assortments, and better management of our promotional strategies and inventory. As discussed previously, we've reduced the volume of business with off-price retailers, which has contributed to the improved profitability of both the Carter's and OshKosh wholesale businesses.

Overall, our adjusted operating income growth of 53% in the quarter translates to a 450 basis point improvement in our consolidated, adjusted operating margin. While 14.5% represents solid performance, I'd point out we've actually achieved higher margins previously in the third quarter, including a nearly 17% adjusted operating margin back in 2009. So we continue to focus on building our profitability back to the levels we achieved before the global increase in product costs.

Now I'll cover third quarter business segment results in some more detail. Turning to Carter's wholesale on page 14, third quarter sales declined about 5%, reflecting a nearly 80% reduction in sales to the off-price channel, as well as the timing of certain product launches, which occurred later this year, as well as some impact from late deliveries from our vendors.

In the third quarter, our fall assortments delivered over-the-counter sales growth in the mid-single digits across our major national customers. Seasonal spring 2013 bookings for Carter's wholesale are now planned up about 6%, modestly above our prior view of 5%.

On page 15, we have some key third quarter metrics for Carter's retail. We delivered strong sales growth of nearly 18%, along with a comp sales increase of nearly 3%, which compared to a strong 5.5% comp in the third quarter last year. Both average transaction values and transaction counts were higher in the quarter versus last year.

Our compelling product offerings, coupled with our successful pricing, promotional, and inventory management strategies helped drive higher AURs in the quarter. During the third quarter we opened 15 Carter's stores and closed 2. We ended the quarter with 398 stores, an increase of 47 stores compared to the third quarter last year. And we remain on track to open 63 Carter's stores for the full year.

Our Carter's eCommerce business, which we include in the retail segment for financial reporting purposes, continues to perform very well. Third quarter sales were $28 million, up $12 million from the third quarter last year, with good growth in all key indicators. Our growth outlook for eCommerce continues to be strong. With the successful in-sourcing of the fulfillment functions of this business during the third quarter, we are focused on transitioning other third-party support functions in 2013.

Now turning to our U.S. OshKosh businesses, beginning with OshKosh retail on page 16. Third quarter net sales declined 3% in the quarter, reflecting growth in eCommerce sales. It was more than offset by retail store comparable sales which were below what we had planned, in part due to declines in consumer traffic to our stores.

As noted earlier on the call, total reported OshKosh retail store sales this year reflect that we closed 13 underperforming or low-potential stores in 2011, and another 6 such stores in the first 9 months of this year.

While comps were below our plans, we are pleased with the ongoing progress we've made with the OshKosh girls product offering. We focused on improving the fashion in girls, and consumers are responding positively. Girls represented the best performing product category in the quarter, both in terms of sales and gross margin.

Boys playwear comped down in the quarter. Our assessment is that boys knit tops, in particular, were too basic in their design. So we believe we have improved the level of fashion for boys for spring and summer 2013. We also comped down in denim, as we did not repeat some unprofitable promotional activity in this category from a year ago.

As Mike said earlier, we're pleased overall with the improvement in profitability of the OshKosh retail segment and expect continued improvement in Q4.

On the next page, we have a few photos of the new specialty store we recently opened here in the Atlanta area. It's a great looking store and it's off to a great start.

Now to page 18 and OshKosh wholesale. Sales grew nearly 7% in the third quarter, despite a meaningful decline in off-price channel sales. Our focus in OshKosh wholesale continues to be on improving the profitability of this part of the business versus an absolute focus on growing the top line. As an example, we've talked previously about consciously reducing the amount of business that we seek up-front bookings for in the promotional channel.

Our wholesale customers continue to provide very good feedback regarding the ongoing improvements to the OshKosh assortments. Spring and summer 2013 seasonal bookings are now planned up approximately 4%, which reflects a couple of wins with some national retailers which don't currently carry OshKosh product.

On a full year basis for 2012, we're forecasting that OshKosh wholesale net sales will decline in the mid-single digits, with a significant decline in off-price channel sales.

On page 19, we've summarized the components of our international segment in the third quarter. Our Canadian retail store revenue grew 22% in the third quarter, with same-store sales increasing 1%. The co-branded Carter's and OshKosh stores delivered a solid 11.6% comp. At the end of the third quarter, the majority of our stores in Canada are in the co-branded format, and this remains our intended model for future store expansion in this market.

During the third quarter, we opened 6 new Carter's & OshKosh stores, bringing our quarter-end total Canadian store count to 79 locations. We plan to open an additional 4 locations in the fourth quarter, which would bring us to a total of 18 new stores for the year. International wholesale sales grew 8% in the third quarter, principally due to growth in Mexico and Central and South American markets.

International eCommerce sales, which is a capability we launched in the second quarter, contributed $1 million in sales during Q3 in its first full quarter of operations. International royalty income, which is included in the international segment's operating income, was roughly comparable to last year.

Turning now to our outlook on page 21, we're pleased with our strong year-to-date financial performance and expect our full-year results will also reflect solid growth in terms of both net sales and earnings. For the fourth quarter, we're projecting net sales to grow approximately 10% over last year, driven primarily by planned growth in our Carter's domestic businesses and in our international segment.

We expect fourth quarter adjusted earnings per share to be approximately $0.81, compared to an adjusted $0.63 cents per share last year. Note that these fourth quarter earnings estimates exclude costs related to the Bonnie Togs acquisition and the facility closure costs which we have announced.

For the full year, we're raising our sales and earnings expectations. We now anticipate net sales growth of approximately 12% over 2011, an increase compared to our prior view of 9% to 11%. With respect to earnings, we now expect adjusted earnings per share to be approximately $2.77, compared to an adjusted $2.09 last year, which would represent growth of about 33 percent.

The principal risks that we're monitoring relate to the level of consumer confidence and demand and traffic in our retail stores. We're mindful of the very strong finish we had to last year and the difficult top-line comparisons that we face in this year's fourth quarter.

We continue to invest fully behind our growth initiatives with a healthy level of CapEx as summarized on this page. And we're also projecting a very solid year of operating cash flow generation.

And with that summary of our third-quarter results, we're ready to take your questions.

Thank you, sir. (Operator Instructions) Susan Anderson with Citi.

Morning, everyone, and congrats on a great quarter.

Thank you.

I was wondering -- I guess I just want to follow up on the Carter's wholesale top line in the quarter. Even ex off-price, it seems like it was below expectations, like I think you guys said. Is that primarily just the delivery issues? Because then it seems like you expect a pretty significant increase for the fourth quarter. So what's driving the difference?

I'd say Carter's wholesale, the sales were flat, excluding the impact of off-price sales. And we did have some delivery issues. We had a few suppliers who were running late on their production schedules that started in the second quarter, continued into the third quarter. It didn't have -- I wouldn't say it had a material impact on our performance, but it did affect some of the timing of deliveries. What we didn't ship in the third quarter, we expect to ship in the fourth quarter. I think it's probably best to look at the wholesale business on an annual basis. We're expecting good growth for the year, about 5% for the year. And then we've got some visibility now into the first half of next year with spring bookings, and those bookings are up about 6%. So health of the business is very good.

Okay. Great. And then I guess there's no or very little off-price in the fourth quarter too, which will help?

I'd say it's roughly comparable year-over-year, Susan.

Okay. And then maybe on the OshKosh retail business, I guess I was surprised by the negative comp, especially given [the easy] compare. Maybe if you can talk about kind of what's going on there and what you guys think needs to be changed to drive better performance there and I guess what you're doing to tackle that.

We had hoped the comp would be about flat. That's what our plan was for the year. And I think year-to-date, the comps are just slightly lower than flat. And, but that was the goal. And so we would have hoped for better performance. I think the decline is some portion of about $3 million from where we would have hoped to be. And on a $670 million quarter, it's not a huge decrease for us. And it's largely driven by some decisions we made to focus more on profitability over comp store growth.

So there were some promotions we intentionally did not repeat for last year. And when everybody went -- the back-to-school promotions started, everybody repeated the big $10 promotion sale for denim. And that's a big hook. It's a big traffic driver. We decided not to do that again this year. Interesting, if you just look at the denim category year-over-year, the sales were down but the profits were up.

So we have plenty of sales for OshKosh. It's a beautiful $400 million business. And what we're trying to do is make it more profitable. So we are intentionally changing some of the things that we've done in the past to focus more on profitability, and the profits doubled in the quarter. And you'll continue to see that going forward. So even into the fourth quarter, the comps are still running negative. We're probably about a million dollars off our sales plan right now, but the profits year-over-year are higher. The margins in recent weeks have been running almost comparable to Carter's, and we've never seen that before.

So with a lot good initiatives by the retail team, by the OshKosh team, we're seeing much better profitability out of OshKosh. So going forward, we're going to have very low comp store expectations as we try to change some of the things that we've been doing in the past to deliver better profitability from the brand.

Great. Yes, the profit did look good in the quarter. And then what about the mall-based stores? I think you said the Atlanta store was doing well. But maybe just touch in general on how the group is doing.

I'd say the -- in terms of the -- we have opened up our first specialty store at the Mall of Georgia. I think if you have a chance to see it, I would go [by and view the executed]. Smaller than the model we would have liked, but that was the best real estate available to us. And I would say it's off to a good start, beautifully executed, beautiful presentation of brand. Smaller product scope - it's newborn to 5T, size 5T. Other stores go up to size 12. And so the productivity, I'd say so far is good. It's going to be the first of what, Jim, 3 this year --

Right.

-- specialty stores we'll have this year? And we'll probably open up some portion of 5 next year. I would view these mall stores as continued R&D. We really have 3 types of stores that we're trying to manage right now - the factory stores, the outlets, what we call the outlets. And that's where the money's going to be made near-term. Those stores back in 2010, had very high profit [contribution for our] business. And then we got hit by cotton, and we gave up a lot of what we had gained. But we'll get that back. So the near-term focus is factory stores.

We also have brand stores. [I think we can] say we've got some portion of about 20 brand stores, which are outlet stores in strip-center locations. And the performance there, I would say has been good. And then we just decided, let's add one other dimension. Let's bring the brand even closer to the consumer with these specialty stores. And it's a, I think it's the best presentation of the brand. The feedback from consumers has been terrific. The store at the Mall of Georgia, 50% of the consumers shopping in it had never shopped the brand before, they weren't in our database.

And I think I referenced on previous calls, Consumer Reports last year did a survey of consumers who shop all the outlet centers. And they looked at over 50 brands in the outlet centers. And they rated all the stores in the outlet centers on quality, selection, service, value, all the things that are important to the consumer. Carter's ranked number 2 out of the 50, and OshKosh was within the top 10, higher than any other children's apparel company, higher than some, what I think are first-class retailers - Polo, Lucky Brand, some of the others. And so OshKosh and Carter's got very high scores on quality, selection, service, value.

The other -- the fifth dimension we're trying to add here for both brands now is convenience. How do you bring both brands closer to the consumer? This is all we do for a living. So it's just how do we make sure it's the very best value and experience in young children's apparel? And now we're trying to bring it closer to the consumer. We've done it beautifully for Carter's. We're trying to replicate that success for OshKosh now.

Great. Thanks. Well, I think the product looks great. So I think you guys are doing a good job.

Thanks very much.

Thanks. Congrats again on the quarter.

Thank you.

Susan Sansbury with Miller Tabak.

Good morning. I think you said that you picked up a couple of wholesale retail accounts for OshKosh. Can you share who these retail accounts are?

Sure, Susan. Costco and Dillard's. I'd characterize it as kind of a test order program with them to start. But we're encouraged. They're very high-caliber retailers, and we're pleased that they see what we're seeing, which is the great improvement in the OshKosh assortments.

Yes. This is the first time that OshKosh has -- well, in the time that I've been following Carter's that OshKosh has had a net-plus, I think, in retail accounts. Kudos. That's my question. Thanks so much.

Thank you.

Thank you.

Scott Krasik with BB&T Capital Markets.

Hi, everybody. Congratulations.

Thanks, Scott.

Happy for you guys.

Thank you.

So just a few questions, actually. The international eCommerce business, that was nice to see you getting some real numbers there early. I mean, is this something that you can really supercharge into next year? How do you see that ramping?

It's an idea that we're developing right now. So we're using a third party who's kind of the third party to the stars, the big brands in the United States, that enables U.S. brands to reach consumers in other parts of the world. So it's interesting to see where the demand's coming from - Rush, Japan, Brazil. I mean, places where we don't really have much of a book of business. So I'd say the sales right now are small, but we find it more interesting than having a meaningful impact on our business initially.

But there is an opportunity that we're exploring that with some investment, with some focus, in time -- I wouldn't say this would be a 2013 initiative. But I would say probably within 3 years, next 3 years, we could envision sourcing that demand and supporting that demand online directly.

So similar to what we did with the initial phase of eCommerce. We knew nothing about eCommerce. We were probably the last company in the world to go online. And so we used a third party a few years ago to help us get started. It's worked beautifully in the United States, a nice $140 million business for us this year. We're probably in -- well ahead of what we had envisioned initially when we went down this path. So now we're asking ourselves the question, could we replicate that model in other parts of the world? And so it is -- we think it's an opportunity that is worth of more [attention].

No, that's great. And then, Richard, what portion of the SG&A increases are related to bringing eCommerce in house? And when do we see that sort of be fully anniversaried?

Well, the expenses for the project are overall part of SG&A. And one of the sources of upside for us in the quarter, relative to our forecast, was that project delivered earlier and less expensively than we had forecasted last time we were all together. I'd say we've already started to see that operational benefit. So cost per units are down. The cost to actually process an eCommerce box through the facility are probably about 35% lower with our internal operation than they are with our outsource partners. So I'd say the P&L's already starting to show benefits from bringing that in house.

That's good. I guess I sort of misspoke. So then as we look to 2013, how much in SG&A would not be recurred because of that?

I think that's hard to say, Scott. In terms of transition costs, there's probably a few million dollars that wouldn't repeat that's more of a project management basis. But we'll give you some good insight on our spending plans for '13, when we get to the February call.

Okay. And then just this $2.7 million from distribution and freight, I think you talked about air freighting. Is that expect to recur as well?

I think that's purely volume-related. The fact that we've had such substantial increases in our top line, that's what's driving the distribution costs. I don't think I mentioned air freight. That was not a big part of the story for the quarter.

Okay. All right. Well, congratulations.

Thanks, Scott.

Steve Marotta with C.L. King and Associates.

Good morning, everybody. Let me offer my congratulations as well. Couple of very quick questions. First of all, from a bookings-versus-replenishment standpoint, can you speak in general terms for the 2 major seasons of the year, spring/summer and fall/winter, as a proportion of sales? What's pre-booked and what's replenished?

I would say about 25% of our business is [on] replenishment. The lion's share of our business is up-front seasonal bookings.

Okay. And that's similar in both seasons?

Correct.

No major differential. And the other question is, from a direct sourcing standpoint, can you quantify at all on a per-unit basis what the benefit is or roughly or on a larger scale what the margin tailwind will be from going from 10% to 20% and 20% to 30%, that kind of thing?

I would say we're going to start direct sourcing in a meaningful way with spring '13. So we're still working through what the ultimate savings is. -- we [had] to make some investments initially. I think a better way to think about this direct sourcing initiative is it's one of many components that enable us to work our way back to that 14% operating margin as a company.

The other thing too, I think it's important for folks to know is, we are seeing, even though cotton prices have dropped, cotton prices are higher than they were a couple years ago. Labor rates are going up, fuel is going up. So a big part of this direct sourcing initiative is to create a much more competitive supply chain environment. We'll continue work with Li & Fung on some portion of -- over time, the lion's share, 50% of the units we source. Hopefully we source the other 50% of the units directly. But I think it's going to be largely helping us offset what might otherwise be some inflationary exposure.

So for us to quote the cost per unit shipped, the overall objective is to improve our margins. This is one of several initiatives to do that.

Okay. Lastly, as it relates to cotton -- thank you for bringing that up. Can you talk a little bit about the costing delta in the fall of this year, as well as spring next year?

Sure. The costs are down last fall about 10%. So they were up 20%, if you recall, up over 20% last year in the fall, and now they're 10%, down 10%. So we're still -- costs are still higher. And as we looked [at it], we have some visibility into spring '13, and those costs will be down about 10%. And so --

Excellent. Thank you, sir. I'm sorry.

10% is good.

Yes, I can imagine. Thank you very much.

You're welcome.

Howard Tubin with RBC Capital Markets.

Thanks very much, guys. Great quarter. Can you -- Mike, you referenced just the overall promotional environment. Can you go into any more detail? What are you guys seeing out there? Whether it's through your wholesale partner customers or your retail stores, how promotional is it?

I'd say it's every bit as promotional as it was earlier in the year. I'd say it's as promotional as it was a year ago. I don't know if -- we'll get Jim's thoughts on this. But I don't think it's any more promotional. I think the messaging has been more aggressive. All I can do is think about what we've done as a company. I think this past year we decided we were going to focus on the effectiveness of our promotions. We wanted to make sure that we still had good traffic drivers to our stores, but we intentionally did not repeat some promotions that didn't have a lot of profits attached to them.

If you look at some of the materials going to your emails, to your home, you'll see some of the -- I think we've really stepped up the beauty. We're in the young kids apparel business. So we have -- we're known as we have the best photography in the business, the most emotional language in our messaging. So if you looked at our direct mail pieces year-over-year for both brands, they're far better than they were a year ago. We thought they were good last year. But they're far better this year.

So I would say, I think we've gotten better at our game. And as we've seen the success of some of our pricing initiatives, we're achieving this growth. And the growth that we're achieving is higher quality growth. We're getting paid for what we're doing. And we're very mindful it's a tough economy. So we are focused to make sure we provide great value to the consumer. But we're also mindful that we have a responsibility to improve the profitability of our business as well.

This is Jim. I agree with everything that Mike just said. And the one thing I've noticed, that while he competition out there seems to be much more overt in their form of promotion, I think they've been very aggressive from that standpoint. The beauty of our business right now is that we put in place some key initiatives over the past year to two years, more effective allocations, more effective use of our promotional vehicles, coupons, et cetera. And those have allowed us to be much more predictive in the way we run our business. So less reactive, more predictive.

I see the opposite going on in some of the competition. Events changing mid-weekend, a recent family and friends event in one of the competitors out there that I'll leave nameless, started out with a percent on one day, and the following day increased the percent off. My only kind of assumption there would be that it probably didn't work so well on day one. We haven't had to play our game that way. We've got a good game plan in place, and we are able to execute it.

That's great. And then maybe just to follow-on to my next question. I know you didn't comment specifically on gross margin in the fourth quarter. But any reason why it can't be as good as it was in the third quarter?

Well, I'd expect that gross margin, we're going to continue to show good progress, good recovery there. I'm not expecting it to be quite at the same level that we saw in the third quarter. And largely, that's based on just some more modest pricing assumptions than what we achieved in the third quarter.

Got it. That's great, guys. Thanks.

You're welcome.

Anna Andreeva with FBR Capital Markets.

Good morning. This is Tom Walton on for Anna. Congrats on another great quarter, guys. Could you give us some more color on the monthly comp cadence in retail by OshKosh and Carter's as well? Maybe any color by region? And also, is there any more color that you guys could give on the mass channel, Target verse Wal-Mart and that? Thanks.

Hi, Tom. You definitely didn't sound like Anna when you came on. From a trend throughout the quarter perspective, I'll stay away from just specifics about the months, but I will give a trend indicator. Both brands started very strong in July. And then the strength declined slightly as the quarter progressed. And in large part, we believe that's a lot to do with the unseasonably warm weather that hit across the country, especially in some of our Great Lakes areas and our what would expect to be colder climates. So the trend, again, started very strong, declined slightly throughout the quarter, in large part, we believe, due to weather.

As it relates to geography, it was pretty consistent across all areas of the country. We have 5 regions right now. And to my earlier point, the Great Lakes, which is in the Midwest, north Midwest, it struggled a little bit more from a comp perspective. But -- and that's in the Carter's brand. In the OshKosh brand, it was relatively well balance across the country geographically.

Tom, to your second question, we don't have a mass channel any longer in our financial reporting. We have a Carter's wholesale segment that includes those 2 customers. I'd say in general, we -- those are important customers and we love doing business with them, but that's the extent of our commentary.

All right. Great. Thanks.

Margaret Whitfield with Sterne Agee.

Good morning, and congratulations.

Thanks, Margaret.

I was wondering if you could elaborate on how October has trended at the stores, both OshKosh and Carter's. Did you see the same trends that you saw toward the end of the quarter or might there have been a pickup?

I would say consistent with the end of the quarter for OshKosh and an up-tick for Carter's.

And in terms of the international, you reported the overall comp up 1.1, but the cobranded up 11.6. What's going on outside of the cobranded stores?

I think it's the legacy Bonnie Togs locations, Margaret, which are about 37 locations, comped down about 5%. And that tracks pretty directly to the decline in private label assortments within that store. So we've shifted the balance of sales towards the Carter's and OshKosh product. We're now the majority of the balance of sale in those legacy nameplates. And so that's why the comp is down a bit.

And I think you said in quarter four you expect more modest pricing. What's going on in terms of the private label competition at the wholesale businesses for Carter's in particular?

My perspective is, I think the pricing has been comparable the last year. Yes, we typically run about a buck or 2 above private label, and I think that spread is comparable to what we saw last year.

Okay. And where will you start the direct sourcing? What product lines will be targeted at the early stages?

We're still working through that. So keep in mind, we bought Channel Industries last year, so they were doing a good portion of the product for us. So I think initially it's going to be a little bit more weighted to the playwear, and then it'll evolve over time.

Speaking of playwear, it seems like that has been doing better than baby and sleepwear within the Carter's wholesale area. What's going on there?

I think the level of design has come up. You've got good people working on it every day, the designers, the merchandising strategy. So it's making sure that the playwear looks every bit as good as the baby and sleepwear products. So it's just the -- it's all about the product performance, beauty of the product offering.

And final question, where are you on the search for an international head?

That search has been completed. Probably make an announcement within the next 30 days.

Great. Thanks. Congratulations.

Thanks, Margaret.

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. Thanks very much. Thanks for joining us this morning on the call. We look forward to updating you again on our progress in February. Good-bye.

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