Carter's Inc (CRI) 2015 Q1 法說會逐字稿

Good day, everyone, and welcome to Carter's first-quarter 2015 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 and Treasurer.

(Operator Instructions)

Carter's issued its first-quarter 2015 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. 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 annual report filed with the Security and Exchange Commission, and the presentation materials posted on the Company's website.

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. 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 our website, I'd like to share some thoughts on our business with you. As you can see by the results this morning, we announced very good performance for the first quarter. We saw a good demand for our spring product offerings, and exceeded the sales and earnings goals we shared with you in February. Despite the highly promotional retail market, we improved price realization, and offset higher product costs.

Our supply chain performance improved, and we saw less disruption from the west coast port delays than expected. Currency devaluation and winter storms worked against us, but we controlled spending where possible, leveraged SG&A, and achieved record first-quarter profits. Given our first-quarter performance, together with our latest forecasts, we believe we're on track to have another good year of growth in sales and earnings, and we are reaffirming the guidance provided earlier this year.

As we shared with you on our last call, we got off to a good start in January, and then business slowed in February, with sales impacted by winter storms. In March, we saw a surge in demand for our brands in the weeks leading up to Easter. As expected, we're giving some of that growth back in April, given the shift in the timing of Easter. April traffic has been more sluggish than we expected. As more spring-like weather is arriving in many parts of the country, we are seeing traffic improve. Given the strength of our product offerings and marketing initiatives, we're forecasting good direct to consumer comps for May, June, and the second quarter.

To further strengthen our business, our top priorities this year include creating a more compelling direct to consumer experience with our brands, providing better performance for our wholesale customers, launching eCommerce in China, improving our supply chain capabilities and performance, and enabling our long-term growth objectives with better systems. With respect to improving the direct to consumer experience, we plan to launch our new customer loyalty program called Rewarding Moments later this year. It's a beautifully-branded cross-channel, cross-branded rewards program, which we believe will increase the frequency of visits and customer retention.

In our eCommerce business, we believe we're creating a more engaging online experience for consumers, especially millennial moms, with a refresh of our Carter's brand marketing, easier site navigation, an expanded scope of beautiful outfits, and an easier check-out process.

Beginning this fall, we're expanding the size range of our Carter's product offering in all stores and online. Consumers often expressed their desire to see our product offerings extend beyond size 7. If you recall, we tested sizes 8 to 12 last year with success. The full size range worked best online, and size 8 was the most productive in our stores. We believe this initiative will help us to extend our relationship with consumers and drive higher sales.

With respect to providing better performance for our wholesale customers, we're off to a good start this year, with better over the counter selling of our spring product offerings, and favorable trends in our replenishment business. Since our last call with you, three of our larger customers have honored Carter's with their Supplier of the Year awards. This is a special recognition of the good work many people do throughout our Company every day to support our wholesale partners.

In May, we're scheduled to launch our new Little Layette product offering. This is a high margin replenishment program for the national retailers, beautifully fixtured, and supported at a high level by our supply chain. This fall, we plan to expand and improve the presentation of our playwear product offering with one of our larger customers, during the back-to-school shopping season. We'll have more to share with you about this initiative on our next call.

With respect to China, we expect to launch the Carter's brand on Tmall, that's Alibaba's consumer website, in the second half this year. Over 70% of China's eCommerce is done on Tmall. We've selected Li & Fung as our eCommerce partner for this initiative. They will help us manage our Tmall website, logistics, order processing, and customer service functions. Our initial focus is to offer a subset of the total Carter's product offering, and we hope to expand the product choices over time, based on the consumer's response to this new business.

We're encouraged by our recent consumer research in China. The research suggests a higher awareness and interest in purchasing our Carter's brand than we had previously thought, given our limited presence in that market. Our international team is also exploring future phases of building our presence in China. We'll share more with you when those plans take shape.

With respect to improving our supply chain performance, we continue to see excellent performance from our suppliers in the first quarter. Richard and I met with some of our top suppliers and employees in Asia recently. Based on our discussions, we're expecting favorable product cost trends to continue through at least spring 2016.

There's currently an abundance of cotton in the market, keeping prices low. Oil prices have risen, but they're still lower than last year, and there appears to be adequate manufacturing capacity at our cost objectives, given the weakness in global demand for apparel. These favorable inputs may help offset the effects of rising labor costs in Asia.

We believe our distribution team did an exceptional job navigating the challenges of the west coast port delays. Our first quarter sales were negatively impacted by the late arrival of spring goods. Given the shorter than planned selling period, we promoted more aggressively to ensure we entered the second quarter in a good inventory position. That said, the port congestion charges and other costs related to expediting and rerouting shipments were lower than expected, given the excellent work by our distribution team. Our Braselton distribution facility had another solid quarter of performance. We leveraged our distribution expenses in the first quarter and expect to do so for the year.

Finally, we're investing nearly $50 million this year to strengthen our information systems. The focus of these investments include improving our omnichannel experience, improving our information systems in Canada, and replacing our core financial systems. These investments are being supported by good internal and external resources and are needed to support our long-term growth objectives.

That's a brief overview of our top five priorities for 2015. As the year evolves, we'll update you on our progress with each of these initiatives.

In summary, we're off to a good start this year. Given the strength of our growth initiatives and latest forecasts, we believe we're on track to achieve our growth objectives this year. More importantly, we believe we'll make good progress this year toward our longer term objectives of achieving over $4 billion in sales by 2019, with continued margin expansion and distribution of excess capital to our shareholders.

I want to thank our employees throughout the company, who helped us achieve the strong results we're reporting this morning. I'm grateful for their passion for our brands and their commitment to help us execute our growth plans. Richard will now walk you through the presentation on our website.

Thank you, Mike. Good morning, everyone. A reminder to begin that my remarks this morning and the discussion materials posted on our website present our business results on an as-adjusted basis, which excludes items which we believe are not indicative of underlying business performance. Reconciliations of this adjusted view of results to GAAP are provided in the appendix of today's presentation.

I'll begin on page 2 with some highlights of the first quarter. We delivered a strong quarter to begin the year, and our performance exceeded our expectations. At a high level, I would point to three factors which drove the outperformance to our previous forecast. First, net sales grew 5% higher than we had forecasted and included some additional wholesale volume, as well as meaningful improvement in consumer traffic and net sales in our direct businesses in March, particularly toward the end of the month.

Second, gross margin was stronger than we had planned. We saw good demand in the wholesale channel throughout much of the quarter, as many of our customers were chasing product. Costs and delays related to congestion at the west coast ports were less than expected, and we had lower inventory-related charges, reflecting our very clean inventory position heading into the second quarter. And finally, the organization did a good job managing spending in response to softer demand earlier in the quarter. We expect to give back some of this expense favorability over the balance of the year, as various strategic initiatives and investments in the business go forward.

All of this translated to very good profitability for the quarter. Our consolidated adjusted operating income grew 24% to $87 million, while our consolidated operating margin expanded by nearly 200 basis points to 12.7%. Our growth in adjusted earnings per share was even stronger at 33%, resulting in EPS for the quarter of $0.97.

Moving to page 3, with some details on our sales performance in the first quarter, our consolidated sales growth in the first quarter was driven by a balance of higher unit sales and improved average pricing across the business. The largest contributors to growth were our direct to consumer businesses here in the US.

Total Carter's brand sales in the US grew 5%, driven by higher retail store and eCommerce sales. Net sales in the Carter's wholesale segment declined about 1%, in part, we believe, due to delays in receiving product through the west coast. We continued to see strength in our OshKosh business in the first quarter, with total OshKosh sales growing 13% in the US. OshKosh posted a strong direct to consumer comp of 5%, with strong growth in eCommerce and a 1.5% comp in the stores.

There were a lot of moving pieces within the international segment this quarter, which I will cover in more detail shortly. Our reported international segment net sales were down about 3% year-over-year in the quarter. The weaker Canadian dollar negatively affected sales by about $6 million. On a constant currency basis the international segment net sales increased just over 5%.

Moving to page 4 in our first quarter P&L, building on our 5% growth in net sales was solid expansion of gross margin of 150 basis points over the prior year to 41.5%. This improvement reflects the growth of our higher margin direct to consumer businesses, lower inventory related costs, lower freight, and lower other costs in our supply chain. Adjusted SG&A levered 40 basis points in the first quarter to 30.4%, and I'll provide some more detail on SG&A in a moment.

As I mentioned, we saw good growth in adjusted operating income and meaningful expansion of our adjusted operating margin. Our weighted average share count declined approximately 2% versus a year ago, reflecting our share repurchase activity. We have estimated that share repurchase added approximately $0.02 to this year's first-quarter EPS. So again, on the bottom, first quarter adjusted EPS was $0.97, up 33% over last year.

On page 5, we have included some additional detail on spending in the first quarter. Consistent with recent quarters, higher operational expenses related to our fast-growing direct to consumer businesses drove the overall increase in SG&A in the quarter. Over the past year, we've added over 100 new stores in the US and Canada, and achieved significant growth in our eCommerce business.

In the first quarter, we continued to make investments to support our growth agenda, namely strengthening our information technology capabilities across the Company, as well as spending on marketing initiatives and on business development related activities in our international business. Favorable items year-over-year in the first quarter included the absence of expenses related to Japan, as we exited those operations in 2014, and lower professional fees.

A definite bright spot in the quarter was our overall control of spending throughout the Company, given the uneven demand we saw throughout much of the quarter. We do expect to give back a portion of this favorability over the balance of the year, with the ongoing growth rate of spending being higher than the 4% achieved in the first quarter, as we continue to invest in the business.

Now turning to page 6 for a recap of a few notable balance sheet and cash flow items. Our balance sheet and liquidity remain strong. We ended the first quarter with approximately $380 million in cash, and roughly $180 million of availability on our revolving credit facility.

Quarter-end inventories were comparable to a year ago in both dollars and units. We believe our inventories are in good shape and are of high quality heading into the second quarter. We're forecasting 2015 year-end inventories to increase in the mid single-digit range, driven by planned growth across the business.

In the first quarter, we repurchased approximately 160,000 of our shares for a total of $14 million. We also paid $12 million in dividends. As noted on this page, we have made very good progress in returning excess capital to shareholders over the past several years, and it's our intention to continue to do so going forward.

Our operating cash flow for the first quarter was $87 million, up from $31 million in 2014. This improvement reflects higher earnings and favorable movements in net working capital. First-quarter capital expenditures were $21 million, down from $32 million in last year's first quarter, reflecting nonrecurring spending last year on our Braselton distribution center and Atlanta corporate offices.

Free cash flow improved substantially to $66 million compared to a negative $2 million in the first quarter of last year, driven by the improved operating cash flow and lower CapEx that I just noted. We believe we'll generate good free cash flow again this year. It's our expectation that we will continue to deploy some portion of our excess cash to share repurchases over the balance of 2015

Moving to page 8 for a summary of our business segment results. As noted earlier, our consolidated operating margin was 12.7% in the first quarter, a solid increase over last year. Nearly every segment contributed to this operating margin expansion.

At a high level, I would cite a handful of factors as the main drivers of the overall improvement in our profitability versus a year ago. First, we're in a better inventory position than last year, resulting in generally lower inventory-related costs. Our supply chain is performing well and we're seeing increased efficiencies there, including in the distribution functions. And finally we had favorability and leverage across a number of spending categories, including professional fees and bad debt expense.

I'll cover our individual business segments in more detail beginning with Carter's Wholesale on page 9. Net sales in the Carter's wholesale segment declined 1% in the first quarter. Absent the impact of product which we believe arrived late due to the disruptions on the west coast, we believe the business would have delivered modest growth in the first quarter. Despite slightly lower sales, the profitability of this part of the business was up year-over-year, with a substantial improvement in this segment's operating margin. The improvement in profitability was driven by some of the factors which I just mentioned, including better product margins, improved inventory performance, favorable distribution cost, and lower bad debt expense.

As Mike noted, consumer demand for our products has been solid in the wholesale channel. Over the counter selling of spring seasonal product at our top accounts increased in the mid-single digits compared to last year. Fall bookings remain up in the mid single-digit range, and we anticipate good replenishment demand.

In Carter's wholesale, we expect good sales growth in the second quarter, with improved visibility on the balance of 2015. Full-year segment sales are now planned up modestly. As we mentioned on our last call, our reported growth in this segment will be affected by the comparison to the 53rd week in 2014.

Turning to page 10 and the Carter's retail segment, total Carter's US retail segment sales in the first quarter increased 12% versus last year. This strong growth was driven by the addition of 58 net new stores, and an increase in direct to consumer comparable sales of about 1%. Retail store comparable sales declined by 1%. While sales were helped by the earlier Easter holiday and an increase in conversion in the stores, lower consumer traffic throughout much of the quarter and lower inventory levels due to the issues on the west coast were significant net negatives on our sales performance.

Our brand stores, which comprise over half of our Carter's retail store base, comped positively in the first quarter. We opened 20 new stores in the first quarter, and closed 2. New stores continued to perform well, and consistent with our expectations. In 2015, we expect to open a total of approximately 65 new Carter's stores in the US.

Carter's eCommerce sales grew 14% over last year, and represented 20% of total Carter's retail segment sales. While demand from US customer remains strong in the quarter, demand from international customers on our US website was lower, including from places like Russia and the Ukraine. Despite these challenges, we continue to forecast good growth this year for Carter's eCommerce.

Carter's retail segment profits grew 4%. Segment operating margin declined by 140 basis points, principally due to higher product costs and higher levels of promotional activity, given the shorter selling periods in connection with the west coast port delays.

Pages 11 and 12 include selections from a recent Carter's direct mail piece. Consistent warmer weather is bound to arrive sooner or later, although that's tough to believe across big portions of the country this morning. These couple of pages show just a few of the many Carter's summer product offerings available to help mom get ready for the warmer weather.

Moving to page 13 and OshKosh retail, OshKosh retail continues to demonstrate good momentum and was our fastest-growing segment again in the first quarter. Segment sales increased 15% versus last year, driven by the addition of 22 net new stores in the US, strong eCommerce sales growth and positive store comps. OshKosh direct to consumer comps were up nicely, as summarized on this chart.

We're pleased with the performance of the side by side stores, which comped in the high single digits in the quarter. We continued to learn about the side by side format, and are encouraged by the positive changes in consumer behavior that we believe the format is driving. In past years, only about 10% of customers purchased both of our brands where Carter's and OshKosh stores were located within the same center. This metric has increased to nearly 50% with the side by side format, indicating much more significant cross-brand purchasing is taking place today.

Our OshKosh store portfolio included 60 side by side stores at the end of the first quarter. We expect to open approximately 45 new OshKosh side by side stores in 2015. The operating loss for the OshKosh retail segment improved by $4 million compared to last year, and segment operating margin improved by nearly 600 basis points, reflecting store and field support expense leverage.

Pages 14 and 15 are also from a recent OshKosh direct mail piece, and feature girls and boys playwear for summer. We've continued to upgrade our photography and messaging in marketing pieces such as this to better convey the style and value of OshKosh. Page 16 is a photo of a relatively new side by side store in El Paso, Texas. This store opened this past December.

Turning to OshKosh wholesale on page 17, first-quarter net sales grew 3%, compared to last year. Spring seasonal over the counter selling at our top accounts has been strong, reflecting in part earlier product deliveries compared to the prior year. OshKosh wholesale segment operating income improved nicely to $3 million compared to $2 million in the prior year. Improvement in segment margin was driven by improved gross margin, distribution expense leverage, and higher royalty income. Fall 2015 seasonal bookings are planned down in the low single-digit range, and as we told you last time, full-year OshKosh wholesale segment sales are forecasted to decline approximately 10%.

Moving on to our international segment on page 18, our reported first-quarter international segment net sales declined 3% compared to last year. In the table at the top right of page 18 we provided some additional analysis, hopefully some additional insight into the underlying sales performance of this part of our business. The table adjusts $7 million of revenue from exited businesses out of the prior year and states 2015's net sales on a constant currency basis. With these pro forma adjustments, first-quarter international net sales increased 18% year-over-year.

We had a strong quarter in Canada. Reported net sales of our retail stores increased 15% versus last year, which was plus 30% on a constant currency basis. We posted a 7% comp in our Canadian retail stores, with both Carter's and OshKosh branded product performing well. We opened three new stores in Canada in the first quarter, bringing our total store count to 127. We expect to open a total of 20 new stores in Canada in 2015.

Despite our concerns about foreign currency exchange rates, which are not unique to Carter's, our team in Canada has made great progress over the past several years. In the last year we gained significant market share, and our Carter's and OshKosh brands on a combined basis now hold the number one position among young children's apparel brands in Canada.

International segment adjusting operating income increased to $7 million in the first quarter compared to $4 million in the prior year. Segment operating margin improved by 450 basis points to 10.2%, reflecting improved gross margin and expense leverage in Canada, and the elimination of the operating loss in Japan.

One of the parts of the international business that we're particularly excited about is what we refer to internally as our partners business. We have 26 partners who operate in approximately 60 markets around the world. These partners represented over $50 million of our net sales in FY14.

Pages 19 through 21 highlight some recent store openings from several of our partners. Page 19 is a picture of a new Carter's store in Riyadh, Saudi Arabia. Page 20 is a new co-branded Carter's and OshKosh store in Lebanon.

And finally, on page 21, we've included a screen shot of the co-branded website that was launched by our partner in Turkey in the first quarter. This partner operates a multi-channel business model in Turkey, with retail stores and a wholesale business, in addition now to eCommerce. We're encouraged by our international partners' results and are planning for good growth in this part of our business over the coming years.

Now turning to page 22 for our outlook for the fiscal year and second quarter. Our full-year outlook is consistent with what we shared on our last call in February. We're expecting net sales to grow approximately 5%, driven by our US direct to consumer and international businesses.

Unfavorable exchange rate movements, the 53rd week comparison to 2014, and the impact of the west coast port delays are collectively estimated to reduce our expected 2015 revenue growth rate by about 3 percentage points. We continue to expect full-year adjusted earnings per share growth will be in the range of 10% to 14% compared to 2014, adjusted $3.93 per share, driven by top line growth and operating margin expansion. Projections of capital spending of about $130 million, and strong operating cash flow of $275 million to $300 million remain consistent with our prior view.

For the second quarter, we expect net sales to increase approximately 6%, driven by growth in our US direct to consumer and wholesale businesses. We expect second-quarter adjusted diluted earnings per share to be approximately comparable to a year ago. If we're successful with our second-quarter plans, we would achieve first-half sales growth of approximately 6%, and adjusted EPS growth of about 17%.

Meaningful risks that we continue to monitor include the weakening of the Canadian dollar relative to the US dollar, inconsistency in consumer demand, and the overall level of promotional activity in the marketplace. And with these remarks, we're ready to take your questions.

(Operator Instructions)

And for our first question, we go to Taposh Bari with Goldman Sachs.

Good morning. Nice job in the quarter.

Good morning Taposh.

Richard, starting with you on the guidance for the full year, Last quarter, you had guided EPS growth to be pretty -- just to follow a pretty sharp acceleration path into the back half of the year on favorable product costs. Aside from SG&A timing, has anything changed to that original view, as you see it now?

I would say that there is some demand shift from the first quarter into the second quarter. We are still planning very good earnings growth in the second half of the year, driven by gross margin expansion. Certainly some element of SG&A, as I mentioned. We are planning to spend to our full-year plans. We have a number of initiatives that are really kicking off at this point, and so that some of that SG&A favorability that's occurred in the first quarter, we will give back over the balance of the year.

I'd say we're also cautious on the outlook for foreign currency rates for much of the quarter after we held the fourth-quarter call in February, rates deteriorated fairly substantially. They've come back more recently, but I think we have a very cautious eye towards the impact that that exchange rate may have on our business. So on balance, still a very solid earnings growth plan for the second half of the year.

Great. And maybe Mike, for you, on the segment margin performance, it seems like every channel did very well in terms of margin performance, with the sole exception of Carter's DTC.

Right.

I know the port delays obviously had an impact there, but I was surprised that didn't affect the rest of the business. I was hoping you could speak to why that would be.

Well, I think retail, our retail stores were probably the most impacted by the west coast port delays. They had a certain plan to have a certain mix, particularly in the month of March. I think I shared with you on the last call, March is one of the most significant months of the year, both in sales and profit contribution, and we had less than an ideal mix of spring products, particularly getting ready for Easter.

And so the retail team had to deal with the mix that they had. In some cases, we had tops without bottoms, bottoms without tops, and so they had to be more promotional in the month of March to clear through what they had, and enter the second quarter in a better inventory position. If you look at the spread between what the margins would have otherwise been, what they were last year, and what we're reporting this morning, it's some portion of about $4 million lower, and that is equal to the amount of discounting we had to do to deal with less than an ideal inventory mix. So we would attribute most of that margin erosion to the west coast port delays.

Great and last one for you, and I'll pass it along. Just your philosophy, I know you're asked this question frequently, but just an update on your philosophy towards retail store growth at the Carter's brand. I guess a multi-part question here.

First, it feels like the retail base is a tale of two halves. You've got outlet, which continues to comp negatively, it seems, and strip malls, where the growth lies. New store productivity looks good. The comps are positive.

Can you speak to the tale of two channels, there? And then separately, which metrics are you most focused on, as you evaluate your new store growth strategy? Thanks.

Thanks. So we're expecting very good growth with our retail store segment. We're planning growth over the next five years of about, at least 8% a year. Most of that growth will be driven by new store growth. The new stores are achieving our performance objectives. We're reaching more consumers.

I think the thing that's unique about our business, we're still evolving from outlets to brand store locations, and to your point, the brand stores had positive comps in the first quarter. The outlet stores had negative comps. And I think that's a natural consequence of the evolution of our business.

I think it's important to know the brick and mortar market for specialty retail is flat. Flat to down. More consumers are shifting to eCommerce, we're gaining market share through store growth. There is some cannibalization.

We think it's an expected consequence of our door growth. We're bringing our brands closer to the consumer. Our view, it's a good trade. Given the new store economics, we're extending the reach of our brands, and seeing higher frequency of visits from consumers, and we're seeing higher retention. So, I think we look at it as a total package, and when you put it all together, we're expecting good growth in both sales and profitability.

And the metrics that you're most focused on?

Total sales growth and profitability.

Great. Thank you, and best of luck throughout the rest of the year.

Thanks Taposh.

And for our next question, we go to Susan Anderson with Friedman, Billings, Ramsey.

Good morning, congrats on a really good quarter.

Thank you.

Just to follow up on that, just looking at the EBIT margins by segment. It looks like Carter's retail was the only one that was down in the quarter. Was this driven just by the ports and maybe a little bit more promotions because of that? Or is this something we should continue to expect as you continue to open more stores?

As it relates to the first quarter, I would say it was entirely related to the higher promotions needed to clear through the goods that arrived late, because of the west coast port delays.

Okay. And on the OshKosh EBIT margin, that one continues to be very strong, continues to expand. What are your thoughts now going forward for the OshKosh segment? Like where could the EBIT margin go for this one?

I think we're really encouraged by the progress being made in the strong team at OshKosh. We had a margin in the mid-single digits in the last few years, and with all the work that folks are doing, side by sides are improving the business, and focusing on value for the consumer. Making sure that we've got compelling price points, making sure that we've got convenience nailed for her, in terms of compelling websites and door growth, and making sure the product is relevant and the experience is relevant, we think we're going to have good performance.

So the possibilities for that brand, we had about a $500 million business globally with about a 6% operating margin. And if we're successful with our efforts and door growth, which we believe we will be, that's a potential over five years for about an $800 million brand, with a high single digit operating margin. So the possibilities are very positive for OshKosh.

Great, that sounds good. And then last one on the product cost, so it sounds like from what you said on the call that you're maybe seeing extra capacity out there. So does that mean labor is getting a little bit more favorable, so should we think about product costs maybe being a little bit more favorable as we go throughout the year this year?

I would say labor rates are still moving up. I think the things that are working in our favor, cotton prices continue to be low, oil prices are low, there's sufficient capacity in Asia. We see our suppliers are hungry for our business.

The beauty of our business, we've grown every year for the past 26 years. We're a manufacturer's dream. They can count on us for good orders for them, year after year.

And so those will largely, or I hope at least near-term, the positive inputs, cotton, oil, excess capacity, will serve to offset the rising labor cost. But labor is still working against us.

Got it. Okay, thanks a lot. Good luck next quarter.

Thanks very much.

And for our next question, we go to Kate McShane with Citi Research.

Hello, this is Geoff Small on behalf of Kate McShane. Congratulations on a strong start to the year.

Thanks Geoff.

We were hoping you could elaborate on the performance of your Canadian operations, both the brick and mortar segment, which appears to have rebounded in the first quarter, as well as the trends you're seeing on the new Canadian eCommerce site?

The Canadian eCommerce site is achieving our expectations. We launched it in the second half of last year. We're reaching new consumers with the site.

I think the performance of Canada, the retail portion, was up about 30% in local currency, so they had a strong quarter. New stores are meeting our performance objectives. We'll open up about 20 stores this year. And the things that are working against us, the things that are impacting the results that you see in the press release this morning are largely FX.

The currency is working against us, but there's reasons to be optimistic with that as well. Recently the exchange rate was around $1.28. I think today it's closer to $1.20. So it's something -- it's a risk for the balance of the year. And but if we look at the Canadian business and local currency, we're seeing good performance from that team.

Geoff, the only other thing I would add is that we're through the period over the last year or so, so we've been in the process of exiting that business's legacy private label brands, and so now the assortment is entirely based around Carter's and OshKosh, which we think is obviously the right strategy going forward. But the last number of quarters have been burdened by the comparisons to the previous sales of those private label brands, and we've now anniversaried that, so second quarter and beyond, it's purely our brands.

Thank you. That's very helpful. Congratulations on a strong start to the year.

Thank you.

And for our next question, we go to Steph Wissink with Piper Jaffray.

Thanks. Good morning everyone. I'll add my congrats as well. Just a quick question for you, Richard, on the Li & Fung partnership. Can you just help us understand how that's going to be reported in your P&L? Is that going to be a wholesale arrangement or is that Carters.com additive?

Mike, I was intrigued by what you talked about with your loyalty program, and I think you have been capturing e-mails and mailing addresses at POS for several years. Can you give us an update on how big that customer file is today, and how you're planning to port that existing customer file over to the new loyalty program? And what the timing is of that through the back half? Thanks.

The Chinese eCommerce sales, as I understand it, will be reported within our international segment as eCommerce sales. So very similar to how we launched the business here in the US. Steph, as we got started, we have a series of third parties that are helping us with the infrastructure and the fulfillment. For instance, customer service, order management; the same model, just in China. We'll report that within our international segment.

And with respect to the loyalty program, we expect to have that launched in the second half of this year. It will be cross-brand, cross-channel. So that if the consumer shopping for OshKosh, she earns points for Carter's, and vice versa. And it's beautiful branded, referred to as Rewarding Moments. I won't comment specifically on the size of our customer file, but our first-quarter performance, all of the key customer metrics are improving. The number of customers, retention, new customers added to the file. So this is going to be another tool that we believe will help us improve the performance of both our retail stores and online businesses.

Okay, thanks for the information. Best of luck.

Thank you.

And we go next to Robert Ohmes with Bank of America Merrill Lynch.

Good morning. This is Dan O'Hare on for Robby Ohmes. So can you talk about the decision to increase from -- or increase to size 8, and how incremental can that be over time? Thank you.

Dan, we did a test in our stores last year of taking the sizes up to 8 to 12 in Carter's. We've had a lot of moms and consumer feedback that they're interested in extending the brand up. So we did a test in a limited number of stores, with a limited number of our playwear collections, and the consumers responded very favorably.

The highest productive size was size 8. And given the space of our stores and how we merchandise things, we decided to move forward with adding size 8. It's a logical move for us to extend her up. Size 8, is actually a child which is usually younger than eight years of age.

So we decided to extend that to all of our playwear and sleepwear product starting this fall, so we're excited about that. We think it can be a boost for all of our channels, actually. Even some of our wholesale customers have picked it up. I won't comment specifically on the incrementality of that, but we do think it's one of the many tools that we're using to drive growth in comp store sales.

Got it. And then just one more, if I may. Footwear is a licensed category for you. How has that been performing? And how do you benefit from a sale that's done online, or in one of your own stores? Thanks.

Okay, footwear, our shoe business has been very strong in both brands, Carter's and OshKosh. We work very closely with a licensee. We actually we do a good bit of the design of that shoe business in-house, and we work with them as footwear experts, and us with our brand knowledge and consumer insights to make sure we have a compelling assortment.

So both businesses have been growing. I would say, mom wants to come in and do shopping at a one-stop shop, and with our side by side store, she's got what we believe to be the two best brands in children's apparel. She can dress that child now, head to toe.

In terms of how the economics work, it is a license arrangement, but the product, we buy that from a licensee for our direct channels. So when we sell that product through our direct channels, it's recognized as a sale, and we recognize the margin on that. In addition, there is a royalty component, so when the licensee sells that product to our wholesale customers, we recognize the royalty on that product as well.

Got it, thanks so much.

And we go next to Tom Nikic with Sterne Agee CRT.

Hey guys and thanks for taking my call and congratulations on a nice quarter. I apologize if this has been asked already, I got disconnected from the call before, but can we talk a bit about the deceleration of the eCommerce business? Specifically for the Carter's brand?

I think you touched on it a little bit with the international demand sort of tapering. Do you think that's a function of the strong dollar, or do you think that there's something else at play? Also, you mentioned that the comp growth was 8%, but the total growth was 14%? What's that non-comp portion of the eCommerce sales?

So with respect to the US eCommerce business, we have seen a demand fall off from international markets in the fourth quarter last year, and again in the first quarter of this year. And I'd say in the top five markets outside the United States, where the demand came from, China continues to be number one. China was followed by Russia and Ukraine, and you can imagine for the reasons for things that are going on in that part of the world, demand has fallen off. And from memory, I think the demand from Russia and Ukraine was down about 40% in the fourth quarter, down about 70% in the first quarter. And it has been impacted by the conflicts going on in that part of the world, and also the stronger dollar.

That said, we're actually looking at better growth in the second quarter this year from international markets. So we're encouraged by that. So the demand on our US website from US customers was up about 30%, so the demand on the US side, very strong.

We never expected big demand outside the United States. That was an unexpected benefit of launching the eCommerce business years ago, that we'd see that amount of demand outside the United States, on our US website. And we've seen some pullback in that demand, given the stronger dollar, but we think that hopefully will improve over time. we're starting to see improvement in the second quarter.

And Tom on your question as it relates to the difference between total eCommerce sales and the comp, it's entirely, I would say, a quirk of the calendars. The fact that we had the 53rd week last year. So the total eCommerce sales for Carter's were up something like 14%, the comp was around 8%. For OshKosh, it's 27% going down to a comp of 20%.

So the fiscal period in this year's first quarter was from January 4 through April 4. That is the comp store sales period that we are using year over year. That's slightly different than the prior year fiscal first quarter, which ran from December 29, 2013 to March 29. So it's just entirely a feature of a quirk of the calendars.

Okay, that makes sense. Thanks very much. And just a quick piece of housekeeping, did you provide guidance for year-end inventory levels?

I believe I did. We're expecting year-end inventories to be up in the mid single digit range.

All right, great. Thanks, and good luck for the rest of the year.

Thank you.

And for our next question, we go to Rick Patel with Stephens Incorporated.

Good morning everyone and I'll add my congrats on the strong performance.

Thank you.

Just a question on the China eCommerce launch, it looks like your research points to good demand. But can you talk about how you're going to approach marketing in that market, and to what extent you're relying on partners, and how we should be thinking about the expenses related to that?

I don't think the expenses are going to be significant. We're assuming some portion of about $2 million of operating losses this year from this initiative. And over time, I think the marketing will largely be digital marketing, and getting the word out through developing a customer database, based on the order file.

So we view this as, it's going to ramp up at least initially slowly. We view it as a wonderful opportunity to enter the market, to tap into the demand we're seeing on our US website. It occurred to us, it's about a $2 billion eCommerce market in China. And last year on our US website, we had about $16 million of demand, but very little effort in the United States. We have gained almost a point of market share on the China market.

So the marketing efforts will be focused largely on those folks who are tapping into our website on Tmall. I'm sure we'll be tag-teaming some good efforts with Tmall and leveraging their expertise, in terms of how to best reach consumers, and we'll share more with you later this year. I'm not quite sure there'll be much to share with you in July when we update you next, but certainly later this year, we'll let you know how this good initiative is underway.

And then also a question on the execution of your OshKosh side by side strategy. So how difficult is it to execute openings for this brand over the long run, just given that these are side by side locations? I'm curious, do you have to pay your Carter's neighbors to relocate? Do you have to wait for leases to come due? Just some help on that strategy and perhaps the limitations as you try to add 200 stores over the long run?

We don't see much limitations. I actually think to the contrary, I think the property owners view this as a point of differentiation in their shopping center. So when a new center is being built, we actually get prime space in the center of the wing allocated to kids apparel.

And this is a traffic driver for the shopping centers, having the two best brands in young children's apparel sitting side by side. So we haven't seen any difficulty finding the space available for these stores. I think today, all of our sites for 2015 have been locked down, and a good portion of our 2016 sites have been locked down. So we don't see any challenges finding space available for these two stores.

Thanks very much, and all the best this year.

Thanks very much.

For our next question, we go to Steve Marotta with CL King & Associates.

Just a couple of quick questions. Has the domestic competitive environment changed, the promotional environment at all, either from a direct to retail standpoint or on the wholesale channel in the first quarter, and in particularly April?

No, I don't think so. It continues to be very promotional. It always has been promotional. I think the only thing that probably worked against retailers in the first quarter, similar to the experience we had, was the difficulties, challenges related to the west coast port delays.

Weather is never ideal in the first quarter. So it depends on when the winter storms hit. We had winter storms hit us over the important President's Day weekend. So what product you didn't sell over those important shopping periods, you got to ultimately move through. I would say our promotions year over year, I'd say are comparable to maybe up a bit, and largely because of the west coast port delays.

Okay, that's helpful. And Richard, as it pertains to the tax rate expected this year, can you talk -- is there a drift down for any particular reason, or due to maybe a little bit more international income than previously expected? And maybe even comment a little bit on next year, if you can.

Sure, Steve. For the full year, we're expecting an effective tax rate somewhere in the neighborhood of 36%. The rate was a bit lower in the first quarter. We had a couple of outstanding audit issues that were settled, and so there were some reserve releases that benefited the first-quarter rate. So it was a bit unusually low in the quarter. It will tick back up.

I'd say, on balance, the opportunity is over the coming years, as our international operations become more significant to hopefully have that effective rate move down over time. That would be a function of the commerce that we hope to do outside the US, and then also the benefit we get from our Hong Kong sourcing office. Those opportunities, I would say, are still to come. So that rate will be somewhere around 36% I would say for the next year or so.

Very helpful, thank you.

We go next to Anna Andreeva with Oppenheimer.

Great, thanks. Good morning and congratulations on very solid results.

Thanks.

We had a question on gross margin performance. Maybe talk about some of the buckets of strength there in the first quarter. I'm not sure if we missed it, but what was the AUC versus AUR relationship, and what is embedded in the gross margin for the second quarter? And for the year, should we expect even bigger expansion in the back half, like you guided previously?

I would say in the first quarter, the drivers of gross margin were solid demand in the wholesale channel. I'd say bookings were modest in the first part of the year, and so demand for whatever reason has been consistently very strong, perhaps stronger in that channel than it has been during the quarter in our own stores.

Those folks were looking for inventory, the product that we have for that channel was perhaps less affected by the port strikes than the product that was bound for our own retail stores. So very good demand, very good sell through, good product performance. The fact we were able to sell through a lot of fall inventory, probably at a better clip than we would have otherwise, because the spring product was late arriving, allowed us to be in a very good position year over year. And so there was less of those incumbent inventory quality charges that you sometimes take at the end of a period.

As Mike indicated, the overall charges that we had expected for the congestion on the west coast, with moving products through those ports, were less than we had planned, so that was certainly a benefit and a source of some of the upside in gross margin. We expected gross margin performance, I'd say, consistent with what we told you last time. In the second half, product costs are expected to be down year over year, that's a feature of cotton being lower, fuel, some things that Mike mentioned.

I think the outlook for gross margins in the second half of the year continues to be very, very good. In terms of the first quarter, unit costs were up slightly, and pricing was, as well, for the Company. So there was a bit of a positive gap between pricing and costs in the first quarter.

Okay, that's terrific. And with the west coast port delays, should we, Richard, expect those are behind us now, and you're in a clean state exiting the second quarter?

I think that's right, Anna. It was mostly a first quarter effect, we did originally anticipate that would extend over into the second quarter. I would say what we're tracking right now is very modest impact on the second quarter, and we're largely caught up at this point.

So briefly, we received yesterday, just something we will keep an eye on, apparently there are truckers are striking out on the west coast. So we haven't seen any impact of that yet, but it's something to keep an eye on. That's kind of late breaking news for us yesterday, as we prepared for this call.

Got you. Okay, best of luck. Thanks.

Thanks very much.

And with a follow-up question, we return to Taposh Bari with Goldman Sachs.

Thank you. A couple quick follow-ups. On the e-com question, surprised, I guess the question is, what do you make of OshKosh e-com growth holding up, actually accelerating? I think both OshKosh and Carter's have tracked similarly in years past, but it seems like they're diverging, so hopefully you can comment on that. And then quickly, on FX, Richard, can you quantify the EPS impact to FX for the quarter? And then last one, and I'll stop, is if you can quantify the amount of price that you realized in the quarter, versus the amount that costs were up? Thank you.

Let me just comment on OshKosh, one, OshKosh, I think we're making great progress with the brand. There's good leadership over the brand, there's a very talented team, that team has been together now for several years. We're seeing good feedback from consumers on the brand. I think it's fair to say OshKosh has an easier comparison to prior years than Carter's has online.

That said, the marketing is terrific. The experience online in the stores, the benefit of these side by sides, they all serve to strengthen the relationship with consumers. If you've not been in the side by side stores recently, it's worth a visit just to see the progress that we've made with the OshKosh brand, and we're seeing a good response.

The Net Promoter scores on the OshKosh brand continue to improve. So I think we're making good progress. I share Brian's view on this, I think we've got good growth in both sales and profitability ahead with OshKosh. The more successful these stores are, and the better we do online, the more scale we're creating with that business, and able to lever some of the overhead associated with the brand.

Taposh, on FX in the first quarter, as I mentioned, it cost us about $6 million on the top line, probably $4 million-ish or so in earnings. That translates probably to $0.05 or so within the quarter, negatively. In terms of pricing costs, I would say that unit costs were up in the low single digit range, and our pricing was up similarly. So that was the result of the first quarter.

Thanks again.

Sure.

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.

Well, thanks very much. Thank you all for joining us this morning. We appreciate your questions and your interest in our business.

We look forward to updating you again on our progress in July. Thank you all very much. Bye-bye.

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