Carter's Inc (CRI) 2013 Q2 法說會逐字稿

Good day, everyone. Welcome to Carter's second-quarter fiscal 2013 earnings conference call.

On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, VP of Investor Relations and Treasury. After today's prepared remarks we will take questions as time allows.

Carter's issued its second-quarter fiscal 2013 earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted on the Investor Relations section of the Company's website at www.Carters.com.

Before we begin let me remind you that statements made on this conference call and in the Company's presentation materials about the Company's outlook, plans, and future performance are forward-looking statements and actual results may differ materially from those projected. For a discussion of factors that could cause actual results to vary from those contained in these forward-looking statements, please refer to the Company's most recent quarterly report on Form 10-Q filed with the Securities and Exchange Commission.

Also on the 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 presentation materials. Also, today's call is being recorded.

And now I would like to turn the call over to Mr. Casey.

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

As you see in the press release this morning, we outperformed the macro retail trends in the second quarter. We achieved our sales and earnings goals. We had strong demand for our Carter's brand in all channels of distribution. We had a significant increase in international sales and we made good progress with our growth initiatives.

From my perspective, we saw the continued benefit of our multichannel business model in the second quarter. We achieved growth in our core wholesale business and have strong bookings for our Carter's fall and holiday product offerings.

Carter's retail stores, both new stores and comp stores, are achieving their sales and earnings objectives. We saw a strong demand online for both Carter's and OshKosh B'gosh with total e-commerce sales up 36%. Sales outside the United States grew 45% in the second quarter with good growth in our retail, wholesale, and e-commerce businesses.

And we meaningfully reduced the losses incurred by OshKosh, which we expect to be significantly more profitable on a global basis this year. Given our strong first-half performance, we continue to expect good growth in sales and earnings this year.

With respect to our growth initiatives, we had good progress with our top four initiatives in the first half. These initiatives are focused on consolidating our operations in Atlanta, improving our supply chain capabilities, integrating our new operations in Japan, and strengthening our IT capabilities.

We are on track to consolidate our Connecticut and Atlanta-based teams into a new headquarters in Atlanta by the end of this year. We are already beginning to see the benefit of our teams working together in one location.

We have begun shipping product from our new distribution center to our stores. The build out and automation of this facility is on track and on budget. This new facility has supported a 47% increase in e-commerce sales so far this year. Our fulfillment costs are significantly lower than last year, and we are expecting more meaningful savings after the build out of this new distribution center is completed next year.

With respect to product sourcing, on-time deliveries from our agent-based and direct-sourcing operations have been lower than expected. We saw certain factories fall behind in their production schedules, and as a result, we expect higher air freight charges in the third quarter to meet our delivery commitments. These delays and related costs to expedite shipments are included in our estimates and are not expected to impact our ability to achieve our growth objectives this year.

We continue to evaluate our exposure to product cost inflation. Thankfully, cotton prices have been relatively stable, but are higher than last year. Earlier this year some of our largest suppliers told us to expect modest inflation driven by rising wages in Asia.

Since our last update we have negotiated spring 2014 product costs. Those costs will be higher than last year due to rising wages, improved product benefits, and changes in our product mix. We plan to offset product cost increases with pricing and other margin improvement initiatives. By February we will have visibility on fall 2014 bookings and related product costs, which will enable us to firm up our growth plan for next year.

With respect to our new business in Japan, sales trends are improving. The start-up costs and the estimated dilution this year are in line with what we shared with you previously. We view Japan as a long-term initiative. Near-term, we don't expect it to have a meaningful impact on our results.

And with respect to our technology investments, we are upgrading [key] systems this year to support the growth we are seeing in our business. These investments are focused on supporting our new distribution center and workforce consolidation initiatives.

We are upgrading our order management systems to support our e-commerce and international businesses. And we are upgrading our supply chain systems to improve our visibility to production and shipments from Asia. These investments are an important component of our long-term growth strategy.

There are a few noteworthy developments since our last update that I want to share with you. Just prior to our last update in April the world learned about the tragedy in Bangladesh. Thankfully, we were not directly impacted and we are closely monitoring the work being done there for us.

About 8% of our production is in Bangladesh. We have a rigorous process for engaging factories throughout the world. Our experience in Bangladesh, with respect to product safety, quality, reliability, and cost, have generally been good. That said there is always a risk that someone takes a shortcut and puts worker safety, product quality, and our brand names at risk.

To mitigate that risk Carter's has joined a coalition of North American retailers to fund an alliance for Bangladesh worker safety. It is a five-year initiative intended to improve the safety and working conditions at factories in Bangladesh. This initiative requires an investment proportional to our presence there and we believe it will strengthen the source of supply for us over time.

Separately, as you have seen in the release this morning, we recently acquired trade names previously owned by H.W. Carter & Sons. This company established its operations in 1859, six years prior to the founding of our company, previously known as the William H. Carter Company. Similar names, no relation, both selling children's apparel.

Years ago we took legal action against H.W. Carter to get superior rights to the Carter's brand name and were unsuccessful in that effort. We believe the coexistence of two Carter brand names in children's apparel has caused confusion in the market and put our brand name at risk.

In some cases H.W. Carter had priority rights to the Carter's brand name for children's apparel in markets very important to us, including China. To gain superior rights to the Carter's brand name for children's apparel, we purchased the H.W. Carter trade names in June. No liabilities were assumed in the transaction.

And with respect to our capital structure and capital allocation initiatives, as you have seen in our operating results in recent years, we have strengthened our retail store model, launched a highly successful e-commerce business, acquired our largest international licensee, improved our distribution capabilities, and built direct sourcing capabilities. Collectively, we believe these initiatives have strengthened our business model and may generate significant levels of excess cash flow in the future.

Our priorities for cash flow include maintaining a healthy liquidity position, investing in high return organic growth opportunities, evaluating acquisitions to supplement our organic growth initiatives, and returning excess cash flow to shareholders through dividends and share repurchases.

As you know, in recent years we have been underleveraged and generally been in a net cash position. In May our Board of Directors approved a $300 million share repurchase plan and declared our company's first quarterly dividend since going public 10 years ago. These actions reflect our positive outlook for our business and our commitment to return excess capital to our shareholders.

Since our last update we have been working closely with our Board and our financial advisors to help us evaluate opportunities to improve our capital structure and deliver additional value to our shareholders. Given the favorable credit market, we believe there is an opportunity to improve our capital structure and reduce our cost of capital by adding a prudent amount of leverage. We are actively pursuing this opportunity and we expect to update you on our progress with this initiative in the near future.

In summary, we have made good progress in the first half strengthening our business and we believe we are on track to achieve our growth objectives this year. We plan to continue our focus on providing the best value and experience in young children's apparel, extending the reach of our brands, improving our profitability, and strengthening our performance-oriented culture. We have built a very talented organization over the years and we believe we have strengthened our company with our office consolidation initiative.

I'm grateful for the support provided by current and former employees who helped make this initiative successful. I want to welcome the many new employees who have joined us in Atlanta this past year. We are committed to help all of our employees build successful careers with us in the years to come.

Richard will now walk you through the presentation on our website.

Thanks, Mike. Good morning, everyone. Our presentation materials this morning are available on the Investor Relations portion of our website. As these materials provide a lot of detailed information, I will try to just point out some of the highlights as I move through the presentation.

So beginning on page two, we delivered a strong second quarter. Net sales grew 10% compared to last year. The increase was comprised of strong unit sales growth and a modest improvement in average unit pricing. In terms of contribution by business, our Carter's brand retail stores here in the US, international, and e-commerce drove our top-line growth.

We saw solid expansion in gross margin of 370 basis points, which was somewhat better than our internal forecast for the quarter. On the bottom line, adjusted earnings per share grew 24% to $0.46. Second quarter completes a strong first-half performance for our company with growth in net sales of 8% and an increase in adjusted earnings per share of 34%.

Page three breaks down our second-quarter sales results. Total Carter's sales in the US grew 9%, driven by good growth in our retail store and e-commerce businesses. Carter's retail store comparable sales increased nearly 4%.

Carter's wholesale segment sales grew modestly in the second quarter. Sales growth was affected by fiscal calendar differences between us and our wholesale customers, which have a 53rd week in their calendars this year. We are projecting good full-year growth in Carter's wholesale at the mid single-digit level.

Total US OshKosh sales declined 5%. Retail comparable-store sales were down 5% in the quarter and e-commerce sales grew nicely, up 25%. International sales increased 45% in the second quarter, reflecting solid growth across the wholesale, Canadian retail, and e-commerce segments of the business. Our new Japanese business contributed nearly $5 million in net sales in its first full quarter of operations, trending in line with our expectations.

I will provide more detail in our business segment results in a moment.

Moving to page four and our second-quarter P&L, beginning with gross margin. Second-quarter gross margin improved to 42.5% driven by better average unit product costs and slightly higher average unit pricing. A higher mix of sales from our US and international direct-to-consumer businesses also contributed to the year-over-year margin expansion.

Adjusted SG&A increased by 260 basis points over last year, in line with our expectations. I will discuss this in more detail in a moment. Adjusted operating margin improved by 100 basis points to 8.7% with adjusted operating income growing 24%. Again, on the bottom line we were pleased with the strong growth in adjusted earnings per share of 24%.

Turning to the SG&A summary on page five, second-quarter adjusted SG&A was $183 million compared to $154 million in the prior year. SG&A increases over the prior year continued to be principally driven by our growth initiatives, specifically our US direct-to-consumer businesses and the growth in international. Distribution and freight increases reflect increased sales volumes across our businesses as well as the start-up costs associated with our new multi-channel distribution center here in Georgia.

We have seen some higher expenses from employee benefits, as well as higher stock-based compensation, which is up in part due to the strong performance of our stock. The All Other bucket principally reflects higher HR and personnel-related expenses and spending on our technology initiatives.

From a rate perspective, the largest contributors to SG&A rate deleverage were our Japanese operations, which are not comparable to last year; expenses from new stores, which are not yet at their full level of productivity; and distribution expenses, which reflect some of the inefficiencies in ramping up the new DC. We do expect the growth rate in expenses to be lower in the second half than our first-half experience.

The next three pages summarize our first-half performance and we have included this information for your reference.

Pages nine and 10 provide a reconciliation of our GAAP results to our as-adjusted basis of presentation for the second quarter and the first half of the year. Page nine covers our second quarter, where the most notable adjustment is $10 million in charges related to our office consolidation initiative.

As Mike has said, we're making very good progress in the operational transition from Connecticut to Atlanta. We are happy to have our employees together and we are looking forward to moving to our new headquarters facility later this year.

As noted in today's press release, we expect to incur expenses over the balance of the year as we move to substantially complete this initiative by the end of the year. We also expect to normalize out the amortization costs related to the trade name acquisition so we will give good visibility to those costs going forward.

Page 11 highlights several balance sheets and cash flow items. Our balance sheet and liquidity remain very strong. We ended the second quarter with a cash position of $312 million.

Quarter-end inventories increased 14% compared to a year ago, reflecting our expectations for good top-line growth in the third quarter as well as supporting more than 60 store openings in the second half of the year. The overall quality of our inventory remains excellent.

First-half cash flow from operations was solid at $70 million. CapEx for the first half was $71 million compared to $38 million in last year's first half. As noted on previous calls, we are executing a more significant investment agenda in 2013 to support our long-term growth objectives.

We made good progress in repurchasing shares in the second quarter. During the second quarter we bought back approximately $29 million worth of stock. Through yesterday our year-to-date repurchases totaled approximately $46 million, or approximately 704,000 shares, and we have approximately $275 million remaining under our current Board authorization.

Also in the second quarter, we initiated our first-ever dividend of $0.16 per share, which represented a total distribution of capital of $10 million. So far this year we have returned a total of $56 million to our shareholders via share repurchases and dividends.

Since I have been discussing the balance sheet, this is a good spot to provide my comments on the trade name acquisition and my perspective on our capital structure review.

Page 12 summarizes our recent H.W. Carter trade names acquisition. Mike has already covered the key strategic points related to this asset acquisition. We have included some branding and creative imagery used by the H.W. Carter & Sons and Carter's Watch the Wear brands. I think you will see the potential for consumer confusion with such similar brand names on children's apparel in the marketplace.

Consideration for this transaction was $38 million in cash. This was an asset acquisition only. We are not acquiring any continuing operations or assuming any liabilities. H.W. Carter is required to wind down its operations over the balance of this year. We have recorded a trade name asset on the balance sheet as a result of this transaction, and we plan on amortizing this asset on an accelerated basis over the next three years.

With regard to our ongoing capital structure review on page 13, earlier on the call Mike mentioned our guiding principles. I will provide my perspective on these important issues as well.

First, we intend to maintain a comfortable level of liquidity. We have seen some volatility in our business over the past few years in terms of product costs and the impact this can have on working capital, so we feel it is prudent to have a sufficient level of liquidity available to us at all times. We define our target liquidity as cash on hand as well as the capacity under our revolver, and we have a target of approximately one year of EBITDA, which is currently about $350 million.

Second, as Mike pointed out, and consistent with the strength in cash generation capabilities of our business, we have been actively exploring ways to improve our capital structure and to deliver enhanced value to our shareholders. We are in the process of adding a prudent amount of new leverage to our balance sheet, which we think will improve the overall efficiency of our capital structure.

We use a lease adjusted debt-to-EBITDAR metric when thinking about the level of leverage which is appropriate for our balance sheet. This is the most relevant measure since it includes balance sheet debt and the very significant fixed obligations we have in the form of leases.

Finally, in terms of capital distribution, returning excess capital to our shareholders is a priority. On a go-forward basis we are targeting the return of 50% of annual free cash flow in the form of share repurchases and dividends. We will, of course, keep you posted on our progress in these matters.

Page 14 summarizes our business segment and financial performance for the second quarter. As noted earlier, adjusted operating margin in the second quarter improved by 100 basis points. Both Carter's and OshKosh businesses in the US contributed to this margin expansion with the profitability of our US OshKosh businesses improving by 500 basis points.

International segment margin declined compared to last year, largely due to the operating loss of our Japanese operations. We are forecasting a full-year operating loss in Japan of about $0.10 per share, in line with our prior expectations.

I will move to page 15 for some specific comments on each of our segments and their second-quarter performance.

Turning to Carter's Wholesale on page 15, Carter's Wholesale second-quarter sales grew 1% compared to last year. We planned the first half of the business at a lower level, given the calendar and shipment timing differences that I referenced earlier. Again, we are planning on good growth for the full year.

Season-to-date spring 2013 selling at our major national customers is up in the low single-digit range with prices comparable to last year. Segment income and margin declined in the second quarter compared to last year, principally due to the timing of customer support and the mix of customers in the quarter.

As we look ahead, we are expecting good growth in fall 2013 sales given our high single-digit bookings. Our spring 2014 bookings are up in the low to mid single-digit range.

Moving on to page 16 and Carter's Retail. This business delivered another quarter of strong sales growth at plus 18%. Growth was driven by the addition of 53 net new stores versus a year ago, e-commerce sales growth of 39%, and a strong store comp of nearly 4%. Store comp was driven by higher average transaction values.

From a product category perspective, girls' and boys' playwear were the strongest performing parts of the assortment. Carter's Retail segment profit grew 67% and operating margin improved 490 basis points. This improvement reflects a strong product offering, effective pricing and promotions, and lower product costs.

Operating margin improved in both the retail store and e-commerce components of the Carter's Retail segment with the e-commerce operating margin above the retail store margin.

Turning to OshKosh Retail on page 17, second-quarter net sales for the OshKosh Retail segment declined 3%. This reflects e-commerce growth of 25% and new store revenue that was offset by lower comp store sales and the impact of closing underperforming stores. We continue to have good success with girls play clothes, particularly the more fashion oriented components of the assortment. Boys play clothes was the most challenging category for the quarter.

As we have said, our focus this year is on improving the profitability of OshKosh, and consistent with this objective, profitability of the Oshkosh Retail segment improved by $3 million compared to last year. Profitability improved in both the retail store and e-commerce components of the business.

We have embarked on a new path which we hope may represent a good retail store growth vehicle for Oshkosh, which we refer to as the side-by-side concept. As you know, we have had great success over the past few years in presenting the Carter's and OshKosh brands together in Canada in the co-branded store concept and with our co-branded website here in the US. We consistently hear from consumers that they love the ability to shop the two leading brands in children's apparel in the same location.

The side-by-side concept is essentially two stores side-by-side, as the name implies, but with a pass-through between them. Customers can easily shop the best of both brands and check out in either store. This model looks to have the potential to drive improved OshKosh store productivity by taking advantage of the historically higher Carter store traffic patterns.

We think this model may also yield capital and expense efficiencies in constructing and operating the stores jointly. We plan to open approximately 18 of these stores over the balance of the year and to remodel an additional seven locations to this format.

On page 18 we have included a picture of our newest side-by-side store which is located in Woodstock, Georgia, just north of Atlanta. The store had a terrific grand opening last week. For those of you in the New York area, we are planning on opening a side-by-side store in Yonkers later this year, so hopefully you will have a chance to go and see it for yourselves.

Moving to page 19 and OshKosh Wholesale. Sales declined 12% in the quarter with segment operating margin improved by 550 basis points. We expect full-year profitability in this portion of our business to be up nicely. Current spring 2014 seasonal bookings for OshKosh are planned down in the high single digits which equates to about $2 million in sales.

Moving on to our International segment on page 20, second-quarter segment sales grew 45% driven by strong wholesale channel sales, continued growth of our Canadian retail store business, and our recently acquired Japanese operations. Canada retail comped down 1%; the co-branded Carter's and OshKosh stores comped up 4%, while our legacy Bonnie Togs format stores comped down 7%.

Unseasonably cool temperatures and the transition away from private-label product in the legacy Bonnie Togs stores weighed on Canadian comps in the quarter. New Canadian stores continue to perform at a very high level and we are particularly encouraged by the strong start of our new stores in Quebec. We have included a photo of one of the new Quebec stores on page 21.

Japan contributed approximately $5 million in net sales in the quarter and an operating loss of approximately $1 million. Our priorities in Japan are focused on better merchandising, brand presentation, and sourcing initiatives to strengthen this business.

Second-quarter net sales in International Wholesale were particularly strong at plus 64%, principally driven by growth with US-based multinational retailers. Our Target Canada business is off to a good start. We look forward to supporting Walmart Canada this coming spring. Overall, we are very pleased with our progress in replicating our successful US multichannel strategy in Canada.

Segment operating income in International grew 16% compared to last year, reflecting strong top-line growth across all the components of our International operations.

Turning now to our outlook on page 23. For the third quarter we are projecting net sales to increase approximately 12% with our US Carter's and International businesses contributing the most to this growth. We expect adjusted earnings per share to be up low-single digits versus last year's adjusted $1.02 per share.

Our third-quarter outlook now includes more meaningful airfreight expenses than originally planned due to do some production delays which we have experienced with a specific vendor in China. We have also moved certain marketing expense into the third quarter, expense which fell into the fourth quarter last year. When excluding these airfreight expenses and the timing of marketing investments, our third-quarter adjusted earnings per share growth outlook would represent an increase in the low double-digit range.

We are expecting solid growth in net sales and earnings for the fourth quarter. For the full year we expect growth in net sales of 8% to 10%. Given our first-half performance and confidence in our second-half plans, we are raising our full-year earnings per share outlook to growth in the range of 15% to 17%.

Note that this guidance excludes the effect of any additional share repurchase activity we might execute in the balance of the year.

Our full-year capital expenditures continue to trend to approximately $200 million for the year. Significant investments this year include adding over 100 new retail stores in the US and in Canada, spending on our new corporate offices here in Atlanta, continued build out of our new multichannel distribution center, and upgrades to our information technology infrastructure. Lastly, we expect solid operating cash flow for the full-year.

With those remarks we are now ready for your questions.

(Operator Instructions) Taposh Bari, Goldman Sachs.

Good morning, everyone. Mike, I was hoping you could maybe provide some comments on how the retail environment transpired this past quarter from your perspective. I know that the first quarter was pretty unseasonably unfavorable, but wanted to see how the second quarter transpired, maybe provide some context as to how you actually performed versus that.

Sure. You are right, I think the first quarter was pretty bumpy because unusually cold -- it was unusually cold, but it was spring. It just happened to be up against gorgeous weather the previous year in the first quarter.

Second quarter was better. Carter's comped positive April, May, June. Fourth of July best holiday we have seen all year long compared to Presidents' Day weekend, Easter. Fourth of July was the strongest holiday, both brands, both Carter's and OshKosh have seen all year. So I would say the trends in the second quarter were good.

OshKosh had a bumpy start. I think the April comps were down, but had positive comps in May and June against very strong comps over the Fourth of July. The long weekend. We measured Wednesday through Monday or Sunday, rather, as I recall. Good top-line growth, good profit margins over the Fourth of July weekend.

I would say since Fourth of July business has slowed a bit. Carter's comps quarter-to-date, third-quarter-to-date down about 1%. I think OshKosh down about 2.5%. I think Canada down 2.5%.

So it is not unusual when you have a big surge in sales as we did over the Fourth of July weekend. The comps were up double digit and the profits on the sales were up double digit, so it wasn't like we were getting those sales by deeply discounting the brands. So when you see a big surge in sales over a holiday weekend it is not unusual to see business slow.

July is a -- I would say July is the smallest of the three months in the third quarter. I think it represents less than 25% of the sales, less than 25% of the profits for retail. August, September those are the big months. Feel really good about the fall product offering.

We were out in the stores last week looking at this new side-by-side store that Richard referenced. It looks beautiful. So we are set right now for the fall floor set at Carter's; within the week will be set for OshKosh.

We feel good about the current business trends. I think we are going to have a good, solid third quarter. Carter's we are assuming positive comps.

My guess for OshKosh comps -- we would be disappointed if the comps for OshKosh are not better than they were in the second quarter. We continue to be focused on improving the profitability at Oshkosh. I think we're making good progress with that.

I would say, in a word, business trends have been good and we are expecting a good third quarter, good second half.

Thank you. I was hoping just to follow up on that point on the Carter's wholesale side. So I might have missed this, but second quarter came in slightly below your guidance. You are reiterating the back-half guidance for wholesale growth, up high-single digits.

Then I look at your spring bookings for Carter's up a little bit less than that, low single to mid single. So if you could just help us understand what is happening there.

Taposh, this is Brian. A couple things. First of all, our plan is low to mid single-digit growth for the wholesale business. We feel really good about our prospects. For the year we are going to be up mid-single digits in totality, so there is timing differences and what have you, but we feel really that business is very solid.

I think as Richard mentioned for the first half of 2014, spring 2014 bookings, we are currently up low to mid singles. And the launch of our new replenishment businesses and early reads in fall are positive. So we feel it is a really solid business. Again, there is some timing differences but overall we feel really good about that business.

Great. Just a last question for Richard, this idea of capital structure. I know you have given a lot of detail, but can you help us better understand I guess what the upper bounds of leverage or comfort are? I know you had mentioned quality investment rating, but help us understand what you are thinking in terms of target leverage or just how you are approaching that in general?

Well, as the comments reflected this morning, Taposh, it is reasonable prudent amount that we feel comfortable adding to the balance sheet. We are not going to add anything that we think stretches us too far or is reckless in any regard.

We think flexibility and liquidity are important in our business. We have seen some shocks to the system over the years, so it is an appropriate amount of leverage. We have a transaction that is underway at the moment so we don't feel it is appropriate to be specific until that officially launches in the marketplace, but once we do that we will share all that with you.

Okay, thanks a lot. Good luck.

Thank you.

Scott Krasik, BB&T.

Congratulations, great job. Mike, is H.W. Carter is that in China already? Do they have a business there? And if not, what does this mean for the timing of when you could enter China?

I think it is fair to say, Scott, they didn't have much of a business at all, I would say, here in the United States or China. But they did have superior rights to our Carter's brand name in China and so we made that investment.

This is a brand that has been, I would say, drafting off of our success for a number of years and they were entitled to do that. They opened up their doors about six years prior to us establishing our operations years ago. So it was a small business, but it was in the market.

And in some cases they took advantage of, perhaps, our lack of focus years ago in certain markets to protect our brand name or the rights to our brand names in those markets. So if they had a presence in China it was small, so we decided to make the investment and take that brand name out of the market.

And just in terms of timing for a strategy now to enter China?

I would say I don't expect any meaningful announcement in the balance of the year. Our focus right now is on Japan, integrating that operation. Thankfully, we are seeing improving trends in that business.

We are focused also on bringing the international team down here to Atlanta and getting the resources that we need. So I would say we have taken some good steps. We have scoped out the market. We have looked at potential partners in China.

Our strategy is to find a great partner in China, preferably a retailer, and then leverage their local market knowledge, their local market expertise. And combine that with our great brands, our merchandising expertise, our supply chain capabilities, and build a better book of business in China over time.

We have a presence in China through a licensee. One thing I have learned, perhaps with the exception of Canada, if you have a licensed business it will never be big. And we think the opportunity in China is big, but that is a long-term initiative. There won't be any meaningful announcement, I don't believe, in the balance of the year with respect to China.

Okay. Then, Richard, can you just parse out what the airfreight cost is going to be in Q3 and then what the marketing additional cost is going to be please?

Sure. On balance the airfreight we are expecting is in the range of $4 million to $5 million and the marketing expense, which relate to the Count on Carter's campaign, we are shifting that a little earlier in the year, is about $6 million.

Awesome. Thanks, guys, and keep doing what you are doing.

Susan Sansbury, Miller Tabak.

Good morning. Just a cleanup question in terms of these trade names that you bought. Other than China where were they being used?

They were being used here in the United States, Susan, tended to be a lower tier of distribution --

They were up in Canada.

-- and in Canada.

But no place else?

Not in any meaningful way.

Correct.

All right. This is not on topic, but I am always curious about what is going on at JC Penney. Did you get your shop-in-shop open and in place and/or can you say anything more about what is going on at JC Penney?

Sure. I think if you went to Penney's today you would see a beautiful presentation of the Carter's brand. The OshKosh presence has been shrunk. We are launching the OshKosh overall bar in their top stores later this year.

But our business with Penney's has been good. I think that what was shared on a previous call, Susan, is that we put a pin for now in the big shop, the big hard shop so to speak. I think that is the lingo that has been used in the past.

But I was down at Penney's recently, had a meeting with Mike Ullman and his team, and I think our brands are being viewed very favorably. We have had growth despite some of the issues that they have had in recent years, and we expect that to continue to be a very good customer for us and a good source of growth for us.

Okay. Then back to this capital restructuring initiative. When do you expect the transaction to be effective, Richard?

We are working on it right now, Susan. We have been to visit the rating agencies. We have had a number of discussions with our Board. They have approved our action plan and we will move as quickly as we can to execute it.

Okay, great. You are executing extremely well and to be applauded, and we wish you the best for the back half.

Thanks very much, Susan.

Bye-bye.

Howard Tubin, RBC Capital Markets.

How do you feel about inventories in the channel going into the back-to-school season, I guess maybe both wholesale and your inventories in your own retail stores in terms of carryover product and quality?

Howard, I think overall we are in pretty good shape. Our retail stores, going into the quarter we were down slightly on a per-door basis in Carter's. Flat to last year in Oshkosh. So we feel like we are in good shape there.

From a wholesale standpoint, I would say the inventory has trended a little higher than sales. The folks did have some challenges with weather early in spring and they had to clear that out, so it got a little bit more promotional toward the end of the quarter.

So we don't think it is a concern. We haven't had any significant cancellations or what have you, but I would say it is slightly higher than probably the sales rate has been in wholesale.

Got it, thanks. Maybe just overall plans for inventory level at the end of 3Q. Should be expect an increase similar to what we've seen at the end of 2Q?

Yes, in that neighborhood, Howard.

Got it. Great, thanks, guys.

Stephanie Wissink, Piper Jaffray.

Good morning, it is actually Maria Vizuete for Stephanie. Thanks so much for taking our call.

We just had a couple of questions relating to the balance between the third and the fourth quarter. Is there any calendar timing shift that we should be mindful of?

I don't think significantly. The wholesale business is a little bit larger in terms of the share of the pie in the third quarter. The direct-to-consumer businesses kick up and are a more significant piece of the pie in Q4, but other than that not anything significant.

Great, thanks. Then can you just remind us what tax rate we should be using for the year?

I would say in the upper 36% range.

Got it. Thank you so much. That is all my questions. Best of luck.

(Operator Instructions) Anna Andreeva, Oppenheimer.

Thanks so much and congrats, guys, on a great quarter. Speaking to Carter's wholesale, just did you guys quantify by any chance the magnitude of the shift from the second quarter to the third quarter? I guess looking at the sales guidance up 12% for 3Q retail comping down low singles, should we think that acceleration in sales is entirely wholesale shift related?

Again, on Carter's, operating margins declined in that bucket. Can you maybe talk about what drove that? You obviously refer to higher inventories in wholesale, so maybe a little bit more color on that would be great.

Sure. The shift of revenue from Q2 to Q3 was not all that significant. To Brian's earlier comments, we tend to look at the business on a full-year basis because you can have differences in the timing of shipments that fall over quarter-end dates, so it wasn't that material. I don't think the performance relative to our forecasted revenue guidance was that meaningfully different, to be very candid.

The decline in operating margin for the Carter's wholesale segment largely had to do with the mix of customers. There are various support rates that are in effect for different customers and that mix of customer base can skew from quarter to quarter. So it is largely timing and mix of customers that related to the change in profitability.

Okay, and I guess the acceleration in sales, Richard, for the third quarter, this is obviously the wholesale bookings being up high singles. Is that how we should think about sales, being up 12%?

For Carter's wholesale your question is? We are expecting very good growth across our businesses for the third quarter. A piece of that is the shift in revenue; a piece of it is this 53rd week issue that I mentioned where some shipments that normally would've been in Q2 before now will be in Q3. But expecting good revenue growth, and in particular in international we are expecting a good third quarter.

On gross margins obviously we have been seeing some nice upside for some time. What kind of a gross margin are you guys implying in the third-quarter guidance and just for the back half? How should we think about AUC for the back half?

It sounds like you are placing your spring 2014 orders now and just the magnitude would be helpful. And just with the production disruption issue I am assuming that is contained to the third quarter and that shouldn't continue into the 4Q.

There is a lot of questions there. I think, as it relates to the production delays, yes, it's largely a Q3 issue. We hope to be through that certainly by the end of September.

Product costs for the second half were up about 3%. I would say we have good strategies to more or less offset that with mix and with pricing. We are seeing a trend towards product cost inflation for spring of next year that it's above that 3%, so we are still working through those plans.

In terms of gross margin, we are expecting good gross margins in the second half of the year. We are not anticipating the hundreds of basis points of upside that we have seen or expansion that we have seen similar to the first half. The benefit from product costs has started to moderate and so now we won't have that going forward, but we are expecting good gross margins for the back half.

That is helpful. Just maybe to Mike, just the bigger picture on OshKosh. If the business has been difficult for some time, you are kind of operating more for profitability here in 2013.

But I guess I am curious; the girls' side has been challenging. It sounds like that has improved now, which is great. Boys sounds like a little tougher now. Maybe talk about what is going on in this business. Is it just the landscape of the older kid a little bit more competitive out there? Just kind of your thoughts going forward.

I actually have a different point of view than you do. I actually think we have made great progress with OshKosh. I think the brand point of view has never been stronger. We are very excited about the side-by-side store initiative.

Girls' performance was extremely good. Boys was tougher. Boys is always tougher in the spring. You are selling polo shirts, T-shirts, and shorts and try to make that look particularly beautiful. Girls you have an opportunity to put more fashion into the product and that has resonated wonderfully with the consumer.

And the strategy we have taken over the past year or so is it is a wonderful business. It will probably do some portion of $460 million in sales this year. It has grown; it will be good growth over last year. We are focused on meaningfully improving its profitability.

I wanted to focus on the profits. This brand earned some portion of $30 million for us back in 2010 that got wiped out with cotton and not much we could have done about that. It showed some profit improvement in 2012; on a global basis earned some portion of about $11 million. This year we hope it earns closer to $15 million to $20 million, excluding some of the start-up costs for Japan. So we're making progress.

I think it is a wonderful brand. I think it has got a wonderful future. I continue to believe it is going to meaningfully contribute to our growth objectives.

So a lot of times when people view it as difficult -- OshKosh always looks weaker when it is compared to Carter's. There is very few brands that look better than Carter's.

Carter's is just this wonderful brand. We have been working at it a long time. It is the top-of-mind brand for new moms. And so now what we are doing is we are attaching the OshKosh brand to Carter's in the side-by-side store initiative to draft off the natural traffic that Carter's gets from consumers. And the feedback on that initiative is good, so we are pretty excited about that.

So we are pretty bullish on OshKosh. I think we are making good progress with the brand.

Okay, awesome. Best of luck, guys.

Thanks very much.

Steve Marotta, C.L. King & Associates.

Good morning, everybody. Could you please remind us from the direct sourcing initiative standpoint what percentage of sales that was in the spring of 2013 and what you expect in the fall of 2013 as well as spring of 2014, the cadence of growth there as a percent of sales?

Yes, just directionally I think spring 2013 was in the teens, fall 2013 is somewhere around 25%, and my guess is it will ramp up closer to 30% for spring 2014. So what we are trying to do is have a slow climb up to 50% direct sourcing mix by 2017. That has run ahead of what we had anticipated for a number of reasons.

One, we saw some new opportunities, and in some cases -- one major factory who did not perform well for us last year had the good sense to say, you know what, I would rather have smaller business on the Asian-sourced side of the business. And we took that business over from them.

I would say it has ramped up quicker than we had planned. In some ways that has been good, some ways it has not. I would say the performance from both Asian-sourced and direct sourcing has been a bit disappointing. That will result in some higher airfreight charges that we have worked into the estimates for the balance of the year.

So I would say the direct sourcing operation right long-term strategy, absolutely the right thing to create a more competitive sourcing model over time. We are seeing some of the usual first year start-up bumps that we are working through, but it will be -- I think for all of those reasons I think it is prudent to ramp this up slowly to a 50% mix by 2017.

Michael, you just intimated that the air freighting is both laid at the feet, if you will, of agency as well as direct. Is that accurate or does it skew one or the other?

I think it skews more toward the -- I believe it skews more to direct.

Lastly, and this is just intimated but I would like to be perfectly clear, the acquired trademarks will be completely extinguished, correct? They will not be resurrected in any form under your umbrella?

Yes, sir. That is correct.

Okay, that is what I needed. Thank you.

You are welcome.

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.

Thanks very much. Thanks, everybody. Appreciate you joining us on the call. Appreciate your questions and your interest in our business. We look forward to updating you again on our progress in October.

Thanks very much. Bye-bye.

Ladies and gentlemen, this will conclude today's conference. Thank you for your participation.