Carter's Inc (CRI) 2013 Q3 法說會逐字稿

Good day, everyone, and welcome to Carter's third-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, 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 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 the 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 this call, the Company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the Company's earnings release and presentation materials.

Also today's call is being recorded. And now I would like to turn the call over to Mr. Casey. Please go ahead, sir.

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

In the third quarter, we continued to outperform the market. We achieved a record level of sales and profitability, saw higher demand for our Carter's brand in all channels of distribution, meaningfully improved the profitability of OshKosh, and gained market share. We also improved our capital structure in the third quarter by adding low-cost leverage which funded an accelerated share repurchase plan.

Our Carter's wholesale business drove the largest portion of our growth in the quarter with sales up 16%. We saw higher demand in all three product markets, baby, sleepwear and playwear. The core of our Carter's brand, our baby business, continues to be our best performing product offering.

Our wholesale growth in the quarter reflects high single digit growth in Fall bookings, favorable replenishment trends, and the timing of shipments. Year to date our wholesale sales are up about 6% and we are expecting about 5% growth for the year.

We continue to partner with our largest wholesale customers to invest in brand presentation. We view these investments as an important component of our brand marketing. Our objective is to help drive traffic to our wholesale customer stores with the best presentation of young children's apparel in the market.

Spring bookings provide visibility into the first half of next year. We currently plan mid single-digit growth in Carter's Spring wholesale shipments. By our next call in February, we should have visibility on Fall demand and product costs which will enable us to firm up our plan for 2014.

We also saw strong demand for our Carter's brand in our retail business with sales up 16% in the third quarter driven by door growth and over 50% growth in eCommerce sales. Baby and girls playwear were the best-selling products in our stores. And online, we saw significant increases across all product markets with sleepwear and outerwear posting the highest growth rates.

We are on track to open over 60 Carter's stores this year and our new stores have been achieving their sales and earnings goals.

We saw good comp store increases through the back-to-school shopping period. Comp store sales in the United States were up about 2% to 3% for both Carter's and OshKosh through August. We began to see negative store comps mid-September and that trend continued into early October. This past week with cooler weather arriving in many parts of the country and end to the government shutdown, we've seen store comps trending better. We are expecting positive comps in the fourth quarter for both brands.

We saw strong growth in our eCommerce sales and profitability in the third quarter with total sales up 50% and earnings up 100%. Consumers clearly love the convenience of shopping for our brands online. We launched a new website experience in the third quarter which strengthened the shopping experience especially for consumers using mobile devices.

We also upgraded the eCommerce order management system to support our growth plan. This new system processes orders more efficiently at a lower cost and improves customer service.

The outlook for eCommerce sales continues to be very good. We expect to exceed $200 million in sales this year.

We made good progress this year improving the profitability of OshKosh. This has been a priority for us. Third-quarter sales were comparable to last year. Our retail sales grew 5%. That growth was offset by lower wholesale sales.

The boys playwear business was particularly strong in the third quarter. We focused on a compelling presentation of denim for the back-to-school period and consumers responded very positively to that product offering. OshKosh eCommerce sales grew nearly 40% in the quarter. It's a very high margin business for us and has enabled us to improve the convenience of shopping for the OshKosh brand.

Consumers are responding positively to our new side-by-side store initiative. They like the convenience of shopping for their children from a newborn to a 10-year-old child in one convenient location. We expect to have 24 side-by-side stores by the end of this year.

We continue to see strong demand for our brands in international markets. Our growth in the quarter was largely driven by our business in Canada. The decline in earnings reflects the startup costs in Japan.

We are encouraged by the strong international demand for our brands online. Nearly 45% of our eCommerce sales are from international guests. Based on this experience, we see an opportunity to build eCommerce capabilities in international markets and plan to launch an eCommerce business in Canada by the end of 2014.

We made good progress in the quarter with other key initiatives which include consolidating our operations in Atlanta, improving our supply chain performance, and strengthening our IT capabilities.

With respect to the office consolidation, the move of our retail and finance teams from Connecticut to Atlanta is largely completed. The international team will also be based in Atlanta next year. They were previously based in New York. We are currently in the process of moving all of our Atlanta-based teams into a larger headquarters in Atlanta and we expect to complete that move by the end of this year.

We believe we've meaningfully improved the collaboration and effectiveness of our workforce by bringing these teams together in Atlanta. Our focus now is integrating many new employees who joined our Company this past year to support this important initiative.

With respect to our supply chain performance, our direct sourcing operation is ramping up ahead of plan. We expect to source over 30% of our total units directly in 2014. Our plan is to source at least 50% of all units directly by 2017.

As we shared with you on our last call, we saw some slippage in on-time deliveries from both direct and agent-sourced factories. To improve on-time deliveries, we have strengthened our capacity planning disciplines and have better systems to monitor production performance.

We also organized a recent summit in Asia with our largest suppliers. We made good progress exploring opportunities to help them improve their performance for us. We are expecting better shipping performance as we head into next year.

We have made very good progress this year strengthening our distribution capabilities. In the third quarter, we officially commenced multichannel operations in our new distribution center in Georgia. This new facility has enabled a 50% increase in eCommerce sales this year. It has helped reduce eCommerce fulfillment costs by $8 million or 24%. It is also enabling a higher service level to our retail stores and wholesale customers. Additional cost reduction is expected as the facility becomes more fully automated in 2014.

And with respect to technology investments, we made good progress in the third quarter upgrading key systems to support the growth we are achieving in our business. These investments are focused on supporting our new distribution center and our new headquarters. We are upgrading our enterprise order management system and we're also upgrading our product development and supply chain systems. These investments are an important component of our long-term growth strategy.

In summary, we believe we have made good progress this year by providing the best value and experience in young children's apparel, by extending the reach of our brands, and by improving our profitability and capital structure.

Our outlook for the balance of the year is consistent with what we shared with you in August. We believe we are on track to achieve a record level of sales and profitability this year.

I am very grateful for the support provided by all of our employees this year. Their passion for our brands and commitment to strengthen our business are reflected in the strong performance we're reporting this morning. With their help, we have built a multichannel business model that has enabled us to weather a very challenging consumer market.

We are expecting good growth in sales and earnings next year. We continue to evaluate the impact of rising labor costs in Asia and we should have a better view on that exposure when we update you in February.

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

Thank you, Mike. Good morning everyone. Today's presentation materials are available on the Investor Relations portion of our website. I'll provide some highlights of our third-quarter results and then comment on our expectations for the fourth quarter.

Beginning then on page 2, we delivered very good performance in the third quarter with strong topline results and solid growth in adjusted earnings. Net sales grew 14% compared to last year as growth was led by the Carter's brand across all of its channels and our international business.

Overall unit growth drove our topline in the third quarter with unit sales up 13% and average pricing up about 1%. Our adjusted earnings per share grew 10% to $1.12. This was ahead of our expectations and we have estimated $0.03 to $0.04 of the outperformance to our forecast reflects favorable timing of some net sales and expenses, favorability which we expect to get back give back in the fourth quarter.

Page 3 summarizes the drivers of our third quarter sales growth. Total Carter's domestic sales grew 16% driven by good growth across our wholesale, retail store, and eCommerce businesses. We had a great quarter at Carter's wholesale where sales growth was also 16%. Third-quarter sales benefited from approximately $4 million of volume that we had previously forecasted to fall in the fourth quarter but occurred in the third quarter due to strong customer demand.

Third quarter OshKosh domestic sales were comparable to last year. ECommerce sales were strong at plus 39%. Retail comparable-store sales grew 1% which represents our best performance in several quarters.

International sales increased 21% in the third quarter driven by solid growth across the wholesale, Canadian retail and eCommerce components of this segment. Our new Japanese retail business contributed nearly $4 million in net sales in the quarter which was in line with our forecast.

I'll discuss business segment results more in a few moments.

Our third quarter P&L is on page 4. Note that certain line items are presented on an as adjusted basis. We have included a reconciliation to our GAAP results in the appendix of today's presentation.

Third quarter gross margin improved slightly versus last year to 40.7% reflecting modestly higher average unit pricing and unit product costs which were comparable to a year ago.

Adjusted SG&A was consistent with our forecast expectations increasing by 100 basis points over last year. Adjusted operating income grew 7% with an adjusted operating margin of 13.7%.

Our third-quarter tax rate was favorable to last year driven by a greater contribution of profitable international operations at lower statutory rates than here in the US. We are now forecasting our 2013 full-year effective tax rate to be approximately 36% compared to 36.9% last year.

The higher interest expense stemming from our recent financing transaction and the subsequent share repurchase activity more or less offset each other and had a neutral effect on EPS in total in the third quarter. So again, our adjusted earnings per share grew 10% in the third quarter to $1.12.

Now moving to page 5 and the summary of changes in SG&A in the third quarter. Third-quarter adjusted SG&A was $216 million compared to $183 million in the prior year. Our growth initiatives continue to be the principal drivers of the increase in SG&A.

These initiatives include investments in new US and Canadian retail stores, eCommerce, international, and our new multichannel distribution center in Georgia.

With respect to the increase in marketing expenses in the quarter, this largely represents a shift of our Count on Carter's marketing campaign into the third quarter versus the fourth quarter last year.

The all other bucket reflects legal and other administrative expenses and spending on technology initiatives.

In terms of SG&A rate in the third quarter, the largest contributors to the year-over-year deleverage were our Japanese operations which are not comparable to last year and marketing. As we have said previously, we are forecasting the growth rate in expenses in the fourth quarter to be lower than our year-to-date experience, in part reflecting our expectations for lower levels of performance-based compensation versus a year ago.

Pages 6 and 7 summarize our year-to-date performance through the third quarter and are provided for your reference. We have been pleased overall with our performance in 2013 with 10% growth in net sales and expansion in EPS at twice this rate.

We've had a busy quarter of balance sheet activity. We have included some highlights on page 8.

Our balance sheet and liquidity remain strong. We ended the third quarter with a cash position of about $200 million. Consistent with our targets, total liquidity is nearly $380 million when including our revolver availability.

Quarter end inventories increased 17% versus a year ago reflecting our expectations for good sales growth in the fourth quarter as well as planning for some of the operational transitions between our distribution centers as we exit the year. Inventory quality overall is very good.

Consistent with our efforts to improve our capital structure and to take advantage of historically attractive interest rates, we executed a $400 million financing transaction in the third quarter. As previously announced, this debt has an 8-year term and an interest rate of 5.25%.

Also as previously announced, we committed the full proceeds from the financing to share repurchase. During the third quarter, we executed an accelerated share repurchase transaction in the amount of $400 million. These transactions are reasonably common in the marketplace but for those of you not familiar with them, at the initiation of the program we paid $400 million to our counterparty, JPMorgan, and JPMorgan delivered approximately 4.6 million shares to us up front having a market value of $328 million.

These initial shares have been retired and we're now operating with a lower share count than before the transaction. We are now in the execution phase of the program during which the ultimate number of shares repurchased under the ASR program will be determined. This phase will take some time to complete possibly up through April of next year.

At the end of this execution period, we will have some additional settlement to record depending upon the movement in share prices. While we are awaiting settlement of the ASR transaction, we do not expect to be in the open market making share repurchases.

Prior to executing the ASR, we also repurchased $16 million worth of stock in the open market during the third quarter. Through the end of the third quarter, our year-to-date open market repurchases totaled approximately $54 million, or about 816,000 shares. We have approximately $267 million remaining under our Board authorizations.

In the third quarter, we also paid our second ever quarterly dividend of $0.16 per share, a distribution of approximately $10 million. Year-to-date dividend distributions have totaled $19 million.

Between funds committed for share repurchase and dividends, we expect to return well over $400 million to our shareholders in 2013.

Q3 year-to-date cash flow from operations was approximately $64 million reflecting increased working capital related to inventory and receivables compared to the prior year period. This largely reflects expected growth in the business as well as receivables for tenant allowances related to our new Atlanta headquarters.

CapEx for the first nine months was $130 million compared to $60 million over the same period last year. Significant growth investments this year include our new multichannel distribution center, retail stores in the US and in Canada, information technology infrastructure to support our larger and increasingly complex business, and the buildout of our new global headquarters here in Atlanta.

Page 10 is a good summary of our business segment performance for the third quarter. At a high level, the growth in adjusted operating income was driven by improved profitability in the US of both our Carter's and OshKosh businesses. These contributions were offset by a slight decline in profitability in international and higher unallocated expense driven by higher legal, administrative and benefits expenses.

I'll spend a few minutes on our business segment results starting with Carter's wholesale on page 11. Carter's wholesale third-quarter sales grew about 16% compared to last year. We had planned for solid growth in this business in the third quarter and we exceeded that forecast. The upside was driven by about $4 million of net sales which we had planned to fall in the fourth quarter but which moved into the third quarter at the request of our customers.

We also saw strong replenishment demand and lower than planned order cancellations.

Season to date Fall 2013 over-the-counter selling at our major national customers is up in the low single-digit range with prices up slightly to last year.

Third quarter Carter's wholesale segment income grew 6%. The decline in operating margin reflects higher product costs, increased air freight expense due to the late delivery of product, the timing shift of the Count on Carter's marketing expense, and start-up expenses related with our new distribution center.

Looking ahead, our Spring 2014 seasonal bookings are up in the mid single-digit range and by our next earnings call in February, we should have good line of sight to Fall 2014 bookings.

This year we have continued our successful program of investing with our wholesale customers to make sure we have great presentation of the Carter's brand on the sales floor. Pages 12 and 13 contain views of recently refreshed Carter's shops at Kohl's and Macy's. We think these particular shops turned out great and really highlight what is possible in presenting the breadth and beauty of the Carter's brand.

Moving on to page 14 and Carter's retail, we had strong overall sales growth of 16% driven by the addition of 57 net new stores versus a year ago as well as eCommerce sales growth of 53%. Carter's retail store comp sales increased modestly in the quarter but were below our plans. As Mike said earlier, store traffic and sales were weak from about mid-September through the end of the quarter and September is traditionally one of the biggest months of the year.

We opened 17 new stores in the third quarter and our new Carter's stores continue to perform well and are in line with our models.

Carter's retail segment profit grew 11% in the third quarter driven by the segment's strong top-line growth as well is the continued growth of our high margin eCommerce business. Retail store gross margins were the highest in recent memory reflecting the strength of our product offerings and successful promotional strategies.

The decline in the Carter's retail segment operating margin was driven by some of the same factors affecting the Carter's wholesale segment namely the timing shift of brand advertising and higher distribution costs related to the startup of our new facility.

Moving to OshKosh retail on page 15, third-quarter net sales for the OshKosh retail segment grew 5% driven by eCommerce growth of 39%. Retail store comp sales increased 1%. At retail, the strongest parts of the assortment in the quarter were boys and girls play clothes and accessories.

We opened six stores on a net basis in the third quarter bringing our US OshKosh store count to 170.

In the third quarter, we continued to make very good progress against our goal of improving OshKosh profitability. Retail segment income improved by $2 million compared to last year with profit improvement in both the retail store and eCommerce components of the business. Segment operating margin improved over 200 basis points reflecting meaningfully better gross margins and a higher eCommerce contribution.

Moving to page 16 and OshKosh wholesale, third-quarter sales declined 13% reflecting lower demand. We are expecting that full-year net sales in 2013 will be down in the high single digits to around $73 million. The story here though is improved profitability which you will know it went from $2.4 million a year ago to $4.4 million in this year's third quarter.

One of the things we're excited about in the wholesale portion of the OshKosh business is our Genuine Kids from OshKosh brand which is an exclusive offering at Target. This is a licensed business for us and Target is in the process of relaunching this brand in a meaningful way on its sales floor. We think the product and presentation look great and hope to see good continued growth in this important channel of distribution for OshKosh.

Turning to our international segment on page 17, segment sales grew 21% in the third quarter driven by wholesale channel sales, continued growth of our Canadian retail store business, and the contribution of net sales from Japan. Canadian retail stores comped down approximately 4% in total. The cobranded Carter's and OshKosh stores comped down 1% and the legacy Bonnie Togs format stores comped down 6%.

Sales in Canada were below our expectations in the third quarter and we attribute this to a couple of factors. First, as we have continued to migrate away from the legacy private label product within the Bonnie Togs stores, we haven't yet seen those sales fully replaced with sales of Carter's and OshKosh product. Canadian retail sales in the quarter were also affected by the late delivery of some product.

As that late product has arrived in stores and weather has turned more consistently colder, we have seen stronger performance in Canada.

Through the third quarter this year, we have opened 15 new stores in Canada. Our new store performance in Canada particularly in Quebec continues to exceed our targets. We have also recently passed a milestone in Canada with the opening of our 100th retail store.

We are making plans to convert the legacy 33 Bonnie Togs stores to the Carter's and OshKosh B'Gosh nameplate in 2014 which we believe will further strengthen our market position particularly in Ontario where the Bonnie Togs stores are located.

Our Japanese retail business contributed approximately $4 million in net sales in the quarter with an operating loss of approximately $2 million, both in line with our expectations.

Third-quarter net sales in international wholesale grew 19% driven by growth from US-based multinational retailers. Our Canadian wholesale business continues to perform well overall and we are pleased with the initial results of our rollout with Target. We expect to begin shipments to Walmart Canada in the fourth quarter as we further develop our multichannel strategy in Canada.

Third-quarter international segment adjusted operating income declined 9% compared to last year principally due to the operating loss from our Japanese operations.

Now turning to our outlook on page 18, despite a slow start to October, we're expecting a good fourth quarter. We are projecting net sales to increase approximately 9% to 10% with our Carter's US retail and international business contributing the most to this growth. We expect adjusted earnings per share to increase 10% to 15% versus last year's adjusted $0.89 per share.

This fourth-quarter outlook takes into consideration the $0.03 to $0.04 per share timing benefit reflected in our third-quarter results.

For the full year, we are forecasting net sales to grow approximately 10% which is at the high-end of our previous guidance of 8% to 10%. Consistent with our previous outlook, we expect full-year earnings per share growth in the range of 15% to 17%.

We've made good progress with our investment agenda this year. We are projecting that full-year CapEx will be in the range of $180 million to $200 million. Looking ahead to 2014, we expect capital spending as a percent of net sales to normalize to more historical levels. Lastly, we continue to expect good operating cash flow for the year.

With those comments about our third-quarter performance and our outlook, we are ready to take questions.

(Operator Instructions). Scott Krasik, BB&T Capital Markets.

Hey, good morning everyone. Congratulations.

Thanks, Scott. Good morning.

Richard, can you just update us on where you are in terms of using third parties to facilitate any of your eCommerce business and you referenced that the operating margins have been running about 20%. Where do you think that goes once you are fully in-housed and you get the sales growth you expect next year?

Well, the most significant components of supporting the eCommerce business that were outsourced have now been in-sourced and that includes the fulfillment function and now the order management system. That was a big transition that we affected in the third quarter.

We have taken direct control of some of the other relationships, the website platform and such and while that is still a third-party, we are managing it directly which we think brings some efficiencies and some cost savings.

I think the outlook for margins in eCommerce are good. I won't be precise about where they are going to go but we expect them to go higher certainly as the business continues to ramp in its topline. The next step function of opportunity in terms of the cost structure is the more automated solution in our distribution center. Right now it is a fairly manual approach to the fulfillment activities for eCommerce and once all of the great automation and conveyor equipment, sortation equipment and such comes online in the new distribution center, that should meaningfully lower the fulfillment costs even further.

So we are bullish on the outlook for the margin structure of the eCommerce business.

What is the timeframe then in terms of automating the system within the distribution center?

I would say the middle part of next year.

Okay. And then in terms of the OshKosh margin improvement, I mean is this something that even though you are modeling especially wholesale sales negative in the first half of next year we should see similar margin improvement next year as well?

I think it is too early to comment on specifics on 2014, Scott. We are still working through those plans. I think OshKosh and Carter's both have some headwinds as it relates to product cost. As Mike said in his comments, we are cautious on the outlook for labor inflation in Asia and working through what the net effect of that will be on our results for 2014.

Okay, and then Richard, you just left out -- you mentioned performance comp would be down in Q4. Was it up or down in Q3 year over year?

We had a slight benefit in Q3.

Okay, all right, thanks very much guys. Good luck.

Thanks, Scott.

Thank you.

Taposh Bari, Goldman Sachs.

Hey, good morning. Nice quarter. I had a question about the revenue guidance. So you are taking up your revenue guidance for the fourth quarter yet it seems like you are reiterating the Carter's and OshKosh wholesale estimates for the fourth quarter. I know you spoke to a choppy start to the quarter on the retail front. Just trying to get a better sense of what is driving that revised revenue guide for the fourth quarter?

Well we do have some timing issues as we referenced, Taposh. There is some volume that shifted into Q3 from the fourth quarter. On balance though, I think we are bullish still despite the kind of soft start to October, we are bullish on the contribution that will come from our direct to consumer businesses, eCommerce, retail, international, though should contribute nicely. And so just more confidence I would say that we will be at the higher end of that full-year range that we talked about.

Okay, and then, Richard, this $0.03 to $0.04 timing shift, can you help me better understand that? I was trying to get -- trying to do the earnings math run at $4 million wholesale shift doesn't seem like -- seems like it is maybe $0.01 if that. So what else contributed to that timing?

Sure. It was some expense favorability in timing as well, Taposh. So that will move forward fourth quarter as well. So some expenses that we had planned to happen in Q3 will now from a timing perspective fall into the fourth quarter. That is the balance of the $0.03 to $0.04.

Okay. And then I wanted to ask you just in terms of the way you guys disclosed your store or your same-store sales. I think you are one of the last companies in retail to actually not include eCommerce. I think if you had actually included eCommerce, your comps would've been closer to I think 7% if you can correct me on that figure. And just curious to see where you guys stand in terms of how you are going to I guess provide that disclosure going forward?

Well, we track both metrics and certainly to the extent investors find that helpful, we are happy to share it. We give you the component so that it is possible to put the pieces together. I think you are right in your math. The direct to consumer comp if you will for Carter's would be something on the order of 7% and 5%-ish or so for the OshKosh.

So both brands continue to gain a lot of traction in the direct channels with consumers and we are happy to see it.

Okay. And just one more for you, Richard. Is just the fourth quarter guidance, if you could help me reconcile if I take the midpoint of your revenue guidance I guess A, what kind of share count assumption are you using for the fourth quarter? I am assuming I think 54.5 but it looks like you are embedding roughly a 50 basis point -- 50 basis points of compression to operating margin. Just trying to get a better handle on the components there.

I know there was a lot of noise in the third quarter in terms of the marketing shift and also the airfreight. If you can help us kind of parse out those line items, that would be helpful.

Well, I am not sure how much parsing I will do. We expect good growth in net sales. I think gross margin, we are starting to see a bit more of the headwinds from product costs being a bit higher so that is a bit of a change between Q3 and Q4. So we start to ship that Spring 2014 product so expect a little bit of pressure there.

You do have the timing issues that I referenced which are pressuring the previous forecast on spending in particular in the fourth quarter. So on balance, we are expecting good revenue growth, good earnings growth for the fourth quarter. I wouldn't say it is meaningfully different than our previous outlook. There are some timing shifts between the quarters but on balance, we expect it to be a good quarter.

Share count will be somewhat of a benefit. There is probably $0.01 or $0.02 net benefit from the capital structure work in the fourth quarter that is embedded in our guidance as well.

In the fourth quarter, we are starting to see a little bit of the Spring impact of higher Spring product costs. I think the last forecast I saw I think the product costs were going up a little over 4% and our pricing is going up some portion of 4%. So I think there is a spread between pricing and unit cost in the fourth quarter.

Okay, thanks a lot, guys. Good luck.

Thank you.

Susan Anderson, FBR.

Good morning guys and congrats on a great quarter.

Thank you.

So I guess I just wanted to touch a bit on OshKosh. Good job on the profitability there. But maybe you could give a little bit more color on kind of how the malls are performing and the dual format that you have any numbers around that yet? And just kind of any thoughts on for the brand going forward; it seems like wholesale is declining so is it going to be more of a retail or online format? Just any thoughts you have there.

It is mostly a retail business. I think we are making good progress. The outlet stores showed good progress in the third quarter. This new side-by-side store initiative is showing promise so a much more productive model, store model than we saw with the mall store test. So you will see us moving forward with the side-by-side store initiative as we roll into next year.

I think by the end of this year, we will have some portion of 24 of those new stores. If we hit the performance metrics on the first 24, it is likely we will open up some portion of another 24 next year.

I think we have had an opportunity to see the Spring 2014 product. We are selling that in -- shipping that out now in the fourth quarter. We have signed off on the Fall 2014 creative concepts within the last week or so and so the thing that is driving the performance is better product. We have got a talented merchandising and design team on it and so we are optimistic about the future of OshKosh.

I think we have made good progress this year. Our focus was improving profitability. I think we have achieved the objectives that we have had for improving profitability. So the arrow is pointing up on OshKosh. We are encouraged by the progress that we are making with it.

Okay, great. And then on the comps, so I think you said that October started off negative but it sounds like over the past week it has improved. Is it now trending positive? I guess I am just trying to get a sense because you are up against a tougher compare in the fourth quarter -- your expectations for the quarter given the environment out there is pretty tough.

The outlook for the quarter we are expecting positive comps for both brands. We typically model to be low single-digit comp store growth. I think as of this morning, I haven't seen this morning's results I think as of yesterday we were just still slightly negative for both brands, slightly negative.

Great, thanks. And then just one housekeeping item. Is the accelerated share repo in the guidance or is that like something that is additional?

That is included in the guidance, Susan.

Okay, great. Thanks, guys.

Thank you.

Stephanie Wissink, Piper Jaffray.

Great, thanks. This is actually Maria Vizuete on for Stephanie Wissink. We are just wondering if you can provide a little bit of color maybe on the OshKosh brand at Target and how that is trending?

Good question. We were out with Target within the past month. They are very pleased with the Genuine Kids brand, its performance. It looks great on the floor and we structured a new arrangement with them this past year and I think they are seeing better performance with the brand, we are seeing higher profitability from that new model.

Great, thank you. And then if you could just talk a little bit about the inventory from a perspective at retail and how that reconciles with your current quarter end inventory levels?

Hey, Maria, it's Brian. A couple of things. In our stores in our direct channel, our inventories are in good shape. At the end of the quarter we were down low single digits in inventory. So we feel like we are in good shape going into Q4.

Out there in wholesale, I would say the accounts are pleased with our performance thus far in Fall. There is modestly slower over-the-counter selling based on some of the traffic slowdowns in September, early October with the macro factors that we mentioned before. I wouldn't say inventories are a concern at this point. However, there is a good amount of selling still to come for holiday so that is always a risk out there.

But we are monitoring it closely. We feel good about the opportunities for holiday and we have accounted for any order movement or discount needs within our guidance in Q4.

Great, thank you. Best of luck.

Thank you.

Anna Andreeva, Oppenheimer.

Great, thanks so much. Good morning guys.

Good morning.

I had a follow-up on the fourth-quarter guidance. I guess are you expecting gross margins to be up for the quarter just given some of the comments on higher sourcing costs? And then just looking out to 2014, obviously we have had two very strong gross margin years for you guys. Maybe talk about some of the puts and takes on the gross margin line. I guess do you think the magnitude of the eCommerce and supply chain initiatives offset some of the higher sourcing next year?

And then also maybe also talk about some of the initiatives in the retail looking into the fourth quarter just to ensure positive comps in obviously a difficult landscape out there. And how should we think about your promotional activity in the fourth quarter?

Okay, Anna. Fourth quarter margins, at gross margins, typically we see a step up sequentially from the third quarter to the fourth quarter. We expect that will occur again this year. That is largely the benefit of the mix shift occurring in the fourth quarter. The direct to consumer businesses are a bigger piece of the pie than they are in the third quarter. So sequentially I do see some improvement.

In terms of year-over-year performance in the fourth quarter, I would say gross margins are expected to be flattish to down slightly and the difference would be the effect of the higher product costs that we are starting to see for the Spring 2014 product.

I think for 2014, we have already sourced the Spring assortment where product costs are up. Fall 2014, we are still in the process of sourcing those products. I think we have an indication that we are seeing a continuation of the trend towards product cost inflation but we don't know with precision yet what those costs are going to be.

So for full year, I think probably too early to comment in a lot of detail around 2014 gross margins but we are concerned a bit around the trends towards product cost inflation. We will do what we can in terms of pricing and other margin initiatives. We have a lot of good things underway to manage the supply chain, to drive improved productivity.

This distribution center that we are standing up here in Georgia is an enormous investment for us but we think it is worth it given the efficiency opportunities that will come with it. So that along with other inventory management opportunities, pricing initiatives, promotional strategies, we feel pretty good about what the long-term outlook will be. But short term, we are facing some headwinds on the product cost front.

In terms of the holiday marketing plans for our stores, I would start with first of all, I think we are in a great inventory position going into the season particularly in OshKosh a better inventory position than last year. We have got strong promotions for Q4 to drive traffic and communicate that we have got the best value in young children's apparel. I would say the promotional activity will be comparable to last year.

We have got beautiful holiday catazines OshKosh's hitting homes this week. Carter's is going to hit the homes next week. We have all been out as a management team and have seen the holiday store sets. They are beautiful. I think the stores are going to look spectacular for holiday.

We are going to continue some of the things we have lapped here are successful holiday rewards program and leveraging our database to target consumers with the great offers that we do have. We are going to be also looking at some local marketing where we have stores clustered in certain regions so we are going to do some targeted local marketing to make sure that we can drive traffic. But we feel good about the holiday season and our chances to do well.

Okay, great. No, that's very helpful. And just a quick follow-up. On Carter's wholesale, I think excluding the shipments pull forward, sales were still up 14%. Obviously a very robust number. I think you guys guided for high single digits previously. Just anything to call out there?

Just that the third quarter was up about 16%. If you recall in the first half, the growth was much less than that and we are expecting about 5% growth for the year. Year-to-date, the third quarter performance takes us up 6%. We are expecting about 5% growth for the year which is fully in line with what our growth objectives. We expect the wholesale business to grow for us some portion of 3% to 5% a year on average. And so our performance this year is fully in line with what our growth objectives are.

Okay, terrific. Well best of luck for the holiday.

Thanks very much.

(Operator Instructions). Carla Casella, JPMorgan.

Hi, my question relates to the side-by-side stores. How many stores ultimately do you see -- you could get to the side-by-side format?

We are taking it a step at a time. We have got some portion of about a dozen of them open right now and we are not in a sweat to open up stores that don't provide good returns to our shareholders. So we are pleased with the early progress, the response the consumers are having to the stores. I would encourage you all to go out and see these stores. We are happy to give you the locations.

But we have been out in the stores and we have spoken with the store associates, with the consumers and we are seeing a good response. Typically the response that you hear when the consumer comes into the Carter's store is they say geez, we didn't know OshKosh even had stores because most of the stores we have for OshKosh are in outlet center locations and only about 5% of young children's apparel is bought in outlet centers.

So the whole objective is to bring the brand closer to the consumer in a beautiful format, attach it to Carter's. Carter's has natural traffic to its stores and enables us to offer them an assortment for the older child. So Carter's has a beautiful product offering for very young children. OshKosh product offering skews to the older child.

So the side-by-side store initiative enables us to support what the original investment rationale was for OshKosh to acquire a wonderful complementary brand to Carter's and now we are making that product offering more convenient for the consumer.

So we will do 24 this year and as I said if we are happy with that performance, our guess is that we would do some portion of 24 stores next year. And then we will walk it up for them.

What the ultimate potential is -- too early to say. We will see how they perform and we will keep you posted on our progress but we are very pleased with the store economics, much more profitable store format than we had been seeing with prior models.

And then maybe are you having -- are there good opportunities in the real estate side or is the real estate market getting any tighter in terms of finding good locations?

Good question. There is plenty of real estate. It has actually become a significant point of interest with the property owners. They see it as a traffic driver to the centers. They see it as something that is unique, it is different. The consumer can come into one store and easily cross over to the other store and then have one convenient checkout. So they think it is a traffic driver for the centers and we are seeing a lot of interest from the property owners.

Okay. What percentage of your stores now are mall versus strip versus outlet?

I think it's probably best to think we have outlet stores and the lion's share of our stores are outlet stores. Of the 170 stores we have, probably some portion of maybe 25 to 30 are outside the outlet. So think of it as outlet stores versus brand stores. We probably have half a dozen stores in malls but there is not a significant difference between that format for the typical brand stores we will open up in strip centers.

Okay. And then I just have one question on the promotional environment in the department stores and with JCPenney returning to promotions, can you just comment on what you are seeing there?

I would say that the retail environment continues to be highly promotional. Many of the retailers particularly in the specialty markets are offering strong deals to work through their inventory based on those macro factors we said before, warmer fall, traffic declines during the situation in Washington. Q3, we were comparable with the exception of I would say in Carter's in late September. We did take some additional steps to make sure that we would go into Q4 cleaner than the past.

Consumer spending is always a point of risk and I think consumers confidence was clearly impacted during the shutdown. If you look at shopper, the traffic has improved recently but overall the promotional activity I think is going to be at least as impactful as last year given what folks have gone through. We do feel good about our plans for the balance of the year and we are moving forward.

Okay, great. Thanks for taking all the questions.

A pleasure. Thank you.

Steven Marotta, CL King & Associates.

Good morning, everybody. Regarding the slippage in on-time deliveries in Q3 and that spilling a bit into Q4, can you quantify the differential there? Can you quantify the improvement in Q4? And also comment on preventative measures for the first half of next year and beyond? And a quick follow-up to that is interest expense expectations in the fourth quarter. Thank you.

Sure. On the last question, Steve, interest expense is probably going to be something around $6.5 million. So we have the additional financing that is driving that.

On air freight, we had previously called out that we expected to spend $4 million to $5 million on air freight in the third quarter. We came in at the lower end of that range for the third quarter but I would say our performance from the factories continues to be less than what we would like it to be. We have seen a trend toward some improvement. So likely to still have some additional air freight expense that comes through the fourth quarter.

There has been a lot of very good work on the part of the supply chain to work with our vendors, work with our factories in Asia. Our head of sourcing just returned from a fairly comprehensive summit meeting with those folks and it is all about how can we take complexity out of our business. We do have a very complex business model with the channels and the wholesale business and retail growing, direct to consumer business, all of that factors into how we efficiently get product from the factories back over here to the US.

And there certainly have been some issues with some of the newer factories that we have added in terms of their ability to keep up with our demand.

So it is a comprehensive effort. Continues to be underway and we are on top of it.

Would you expect that headwind to slip into next year as well?

Well, we are certainly hoping for improved performance going into 2014.

Great, thank you very much.

Sure.

Taposh Bari, Goldman Sachs.

Hey, thanks for taking my follow-ups. Just had a couple kind of housekeeping items. The first is, as we anniversary I guess Hurricane Sandy in November, if you could just give us some context or if you could just address what your comparisons look like through the rest of the quarter given that you are implying an acceleration.

Two is, I thought I heard a lot of -- obviously a lot of commentary around inflation but I thought I heard Mike, you say that price and costs are going to be up 4%. So wouldn't those neutralize each other? If you can just direct that?

I would say costs in the fourth quarter were expected -- unit costs in the fourth quarter are projected to be up more than the average prices.

Okay. And then the last question, so I guess the Sandy question and then the other question I had was just kind a philosophically, the composition of your operating margins has changed meaningfully over the past couple of years, the past I would say two years really driven by cotton deflation and somewhat I would say masked by a period of overinvestment.

So as the cotton tailwinds go away, help us understand how you are approaching operating margin. I am not looking for a guide for 2014 but just trying to get a better handle on how you are approaching that line item?

Brian, why don't you comment on Sandy and then I will --?

In terms of Sandy, last year we would calculate that was worth about 1 point of comp loss last year. I would say we are hoping for no big storms this year so that would be helpful.

They are rare around Halloween.

Exactly. But our comps last year in Q4, we were down 6% in OshKosh. We were up 5% in Carter's but we think that Sandy was worth about a point.

Okay, thanks.

And with respect to cotton inflation, cotton I would say has stabilized. Cotton prices are still higher than last year but we feel as though at $0.80 a pound, the cotton market is fairly stable.

I shared with you that earlier this year we met with our largest suppliers and they told us not to expect much impact based on what they saw at the time to see much inflationary pressure because of cotton. At that price, the farmers are planting plenty of it and there would be adequate supply.

The focus is on rising labor costs. So if you have read plenty of the articles in terms of demand for higher wages, living wages and our view is we actually think those things are good because it will provide a more stable workforce and more people will come back after Chinese New Year and you won't see as much turnover and there will be more consistency in execution. But it does put some pressure on product costs.

So it is largely driven by labor. We are keeping an eye on it. We feel as though to Richard's point, we feel as though we have plenty of good margin driving initiatives. We are focused on great product and the best margins on product that is selling well. We have got direct sourcing capabilities and the analysis that we have seen would suggest that that has been a net benefit to us relative to sourcing everything through agents.

We will start to see more of a benefit we believe from the new multichannel distribution center that will go fully online, full automation some time middle part of next year. We will get the full benefit of that we hope in 2015.

We are seeing progress with OshKosh profitability which has weighed on our earnings in recent years. So there is no shortages of ways to improve our margin structure. We are committed to margin expansion. This year we are on track to have a 12% operating margin. We are working hard to make sure that we can make improvement on that.

We just don't know enough about what the Fall costs will be. Fall 2014, the second half of our year, is the more significant portion of our year. We have got -- we just finished developing the line. We have got the teams in Asia now starting to negotiate prices. So we will see how that comes back. Just don't have enough visibility on the second half.

But we are hopeful that on a net basis we have enough initiatives to offset the rising input costs.

Okay, thank you very much.

You're welcome.

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

Okay, well thank you all very much for joining us this morning. We appreciate your thoughtful questions. We hope this call has been helpful to you and we look forward to updating you again on our progress in February. Goodbye.

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