Carter's Inc (CRI) 2015 Q3 法說會逐字稿

Good day, everyone, and welcome to Carter's Third 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 third 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 Securities and Exchange Commission, and the presentation materials posted on the Company's website.

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.

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.

We're in the home stretch of what we expect will be another good year for our Company. Earlier today, we reported a record level of sales and earnings in our third quarter. Our sales growth outperformed the market, and we continued to gain market share.

We exceeded our earnings plan with gross margin expansion and SG&A leverage. And stronger cash flow this year enabled us to distribute over $100 million of capital to our shareholders. Given better visibility to demand, we have tempered our annual sales forecast, and we are reaffirming our previous earnings guidance.

In terms of business trends, we had good sales growth in July, August and September relative to last year. Relative to our plan, however, the third quarter got off to a slow start. Sales trends improved as we moved into September with cooler, more seasonal fall weather arriving throughout the country. Those favorable trends continued through mid-October and then slowed again in recent weeks.

The challenge in our business this year has been the decline in demand from international consumers shopping in the United States. We believe this is a macro issue, certainly not unique to Carter's. As you may know, we've benefited from strong international demand on our US websites in years past, exceeding over 40% of total demand in each of the past four years.

In the third quarter, international demand on our US websites decreased over 20%, and represented only 30% of US eCommerce demand, compared to over 40% last year. Based on our analysis of credit card data, the biggest decline in eCommerce demand came from China, Russia and Brazil.

During our third quarter, our stores in the United States also experienced lower demand from international tourists. We estimate that sales to international customers dropped over 20% in the third quarter. The largest decreases were from Canada, Brazil and Mexico. We believe the decline in international demand is related to meaningful changes in currency exchange rates. It is possible that we'll continue to see decreases in international demand well into next year, until exchange rates normalize year-over-year.

By comparison, we had very good performance in our international business, which we believe reflects our efforts to expand the reach of our brands to global markets.

We were more promotional in the third quarter than planned. We had planned pricing to be comparable year-over-year. But prices were down about 2%. Thankfully, product cost reductions more than offset lower prices and we improved our gross profit margin. All in all, we're pleased with our third-quarter results and believe we can achieve our earnings growth objectives this year on slightly lower sales than previously planned.

With nine weeks left in the year, I'd say we've made good progress with our top priorities for 2015, which include creating a more compelling direct-to-consumer experience with our brands, providing better performance for our wholesale customers, launching eCommerce in China, and improving our supply chain performance.

With respect to improving our direct-to-consumer experience, we completed the piloting phase of our new Rewarding Moments loyalty program in the third quarter, and rolled it out early October. Within the first 10 days of launching Rewarding Moments, over 1 million consumers signed up for the new program. Consumers can now track their rewards on their mobile phones, and use the rewards for either Carter's or OshKosh in our stores and online. These benefits were not previously available to them.

We believe this new loyalty program will attract more consumers to our brands, retain them longer, increase the frequency of their visits, and provide a better shopping experience for them. We expect this initiative may drive over $30 million in incremental sales next year.

This year we also believe we've strengthened the store and online experience by extending our Carter's product offering to include size 8. Given the strong demand for size 8 this fall, we've increased our buy for spring 2016. This one initiative is also expected generate over $30 million in total sales for us in its first full year in 2016.

We believe one of the most impactful ways to improve our direct-to-consumer experience is through our stores. We continue to get good consumer feedback on our side-by-side stores, which provide the best of our Carter's and OshKosh product offerings in one convenient location. This relatively new store format has received the highest Net Promoter scores from consumers relative to our other store formats. Prior to this new format, we typically only saw about 10% cross-shopping between our brands. We're now seeing nearly 50% of consumers checking out with both brands in our side-by-side stores.

We currently have 86 side-by-side stores, and plan to open 250 stores in this format over the next five years. On average, these stores generate about $2 million a year on a combined basis. We view this as a good $500 million growth opportunity for us.

Our new stores are achieving our performance goals. Consumers enjoy the convenience of shopping in our stores and online. The annual spend per customer is the highest for our multi-channel customer, more than double our eCommerce-only customer. Given the compelling returns on our store investments and significant contribution to our sales and earnings, we believe store growth will continue to be a meaningful component of our Company's growth strategy.

With respect to providing better performance for our wholesale customers, we're pleased with the results of our expanded playwear offering for Kohl's launched during the back-to-school season. This initiative builds on a successful expansion of our baby product offering for them last year. We expect this initiative, together with the support of our brands from the other major retailers, will enable us to exceed our wholesale sales plan this year.

As you may know, baby is a growth category for many of the larger national retailers. Our brands have been viewed as traffic drivers, given the need to change wardrobes frequently in the early years of a child's life, and we provide a compelling alternative to the retailer's private-label brands. A good portion of our baby business is on automatic replenishment. Replenishment trends were significantly better in the third quarter, and first nine months of this year.

With respect to China, in June we launched our Carter's brand on Tmall, Alibaba's consumer website. We're very pleased with our performance to date. It's early, but the demand so far has been better than expected. Our initial focus was to offer a small subset of the total Carter's product offering. With better visibility to the level and scope of demand, we've expanded the product offering, and have increased our forecasts for this year and next.

As I shared with you on our last call, we believe China represents a significant opportunity for us. Children's apparel is the fastest-growing segment of the apparel market in China. Consumers seek brands that have a reputation for safety, quality and value. We believe these are the attributes that have defined our brands for generations of consumers.

We've previously estimated the China eCommerce opportunity to be about $60 million by 2019. Given the early read on the consumer response to this new initiative, we believe the opportunity may be greater. We'll have more to share with you as this initiative and our other business development activities in China evolve.

With respect to our supply chain performance, we continue to see excellent results from our supply chain in the third quarter in terms of on-time deliveries from Asia, and shipments to our customers. We've negotiated lower product costs through spring 2016, which takes us through most of the first half of next year. We've taken advantage of this favorable cost environment, and negotiated lower product costs for about one third of our product offerings through fall 2016.

Labor costs are rising, but other input costs continue to be favorable, resulting in net product cost reductions. By the time we brief you again in February, we'll have better visibility on fall 2016 product costs. Currently, we expect them to be lower year-over-year.

We continue to make good progress with our direct-sourcing initiative, which is expected to exceed 40% of total units sourced in 2016. We believe this initiative has created a more competitive sourcing model for us. In the third quarter we also continued to leverage our distribution expenses, the second-largest component of our SG&A, driven by improved efficiencies in our distribution network.

In summary, we believe we've 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 improving our profitability. We believe we're on track to achieve a record level of sales and profitability this year, which would be our 27th consecutive year of sales growth. I'm grateful for the support provided by all of our employees this year. Their passion for our brands and their commitment to strengthen our business are reflected in the strong performance we're reporting this morning. With their help, we've built a multi-channel business model that has enabled us to weather a challenging retail environment.

Within the next few months we'll refresh our growth plans based on our progress this year. Based on our preliminary estimates, we're expecting good growth in sales and earnings next year. Richard will now walk you through the presentation on our website.

Thank you, Mike. Good morning, everyone. I will begin my comments on page 2 with some highlights of our performance in the third quarter. As Mike has said, we've posted strong overall results for the quarter in what's turned out to be a challenging environment.

Consolidated net sales increased 6%. I'll go through our revenue results by business segment in a moment. Like most companies with international operations, the strong US dollar continues to weigh on our results. Negative movements in foreign currency exchange rates reduced our consolidated net sales growth in the third quarter. On a constant currency basis, our net sales grew closer to 8% versus the 6% reflected in our P&L this morning.

We posted strong growth in earnings in the third quarter. Adjusted operating income grew 16%, and adjusted EPS grew 20%. We outperformed our previous earnings forecast, as we were able to offset softer-than-planned demand in our US direct-to-consumer businesses with strong control of spending, and good demand in our wholesale and international businesses.

Turning to page 3 where we summarize details of our sales performance in the third quarter. Sales of our Carter's brand in the US drove our overall sales growth in the quarter, with growth of 8% over last year. We had an excellent quarter in Carter's wholesale, in part due to the earlier demand from several customers, as well as improved shipping performance. The Carter's retail segment, which includes both our retail stores and eCommerce businesses, grew 5%.

Total OshKosh sales in the US were comparable to last year, as solid growth in the OshKosh retail segment of 8% was offset by planned lower sales in the OshKosh wholesale segment.

International segment net sales grew 3% in the third quarter. When viewed on a constant-currency basis, international segment net sales grew 17%, led by particularly strong growth in our Canadian business.

Moving to page 4 and our third quarter P&L. Building on our 6% top-line growth, consolidated gross margin improved by 70 basis points over last year, to 40.9%, reflecting lower product costs, which were somewhat offset by a decline in average unit pricing. In general, our promotional activity was higher than we had planned in the quarter. Adjusted SG&A improved by 40 basis points to 27%. And I'll provide more detail on SG&A in a moment.

Our gross margin improvement and expense leverage resulted in solid expansion in our consolidated adjusted operating margin to 15.4%, an increase of 120 basis points. As noted on our second quarter call, earlier this year we reinitiated some hedging activity to help manage a portion of the exposure we have in Canada related to currency exchange rates. In the third quarter, we recorded income of approximately $1.5 million related to settlement and revaluation of foreign currency forward contracts. This is reported in the interest and other line on the P&L on page 4.

Our weighted average share count declined approximately 1% in the third quarter, reflecting our share repurchase activity. So again on the bottom line, adjusted EPS for the third quarter grew 20% to $1.52 per share.

On page 5 we've included some additional detail on spending in the third quarter. We managed overall spending to growth of about 5%, and achieved leverage of 40 basis points compared to last year. SG&A increased by $10 million compared to last year's third quarter, principally driven by higher spending in our US direct-to-consumer businesses. Over the last year we've added 114 net new stores in the US and in Canada, and grown in our eCommerce businesses by 20%.

We increased our investment in marketing in the third quarter, as planned, specifically in areas such as email, direct mail, digital and social media. We have seen good returns on this spend, as we explore productive ways to drive increased consumer traffic and demand, particularly to our direct-to-consumer businesses.

Distribution expenses declined over $4 million versus last year, despite higher sales volumes. We achieved good efficiencies in our distribution network in the third quarter, particularly in comparison to last year, when we were spending additional amounts to ramp up our new Braselton DC facility.

Overall SG&A in the third quarter came in below our forecast, as we took steps to manage discretionary spending in response to weaker consumer traffic trends in the quarter. We plan to continue to closely manage spending over the balance of the year.

Pages 6 through 8 summarize our year-to-date results. To recap, 2015 has been a very strong year for Carter's. We've grown net sales by 6%, expanded gross margin, leveraged SG&A, grown operating margin by 120 basis points, and increased adjusted earnings per share by 23% versus last year.

Now turning to page 9 to cover a few balance sheet and cash flow highlights, we ended the third quarter with approximately $290 million in cash. During the quarter we finalized an amendment and extension of our revolving credit facility, which created a $500 million facility with a new five-year term. We have approximately $300 million available under this facility as of the end of the quarter.

Quarter-end inventories decreased 1.5% in dollars, compared to a year ago, with unit growth of 4%. We continue to make good progress on our return-of-capital agenda in the third quarter by repurchasing approximately 290,000 of our shares for a total of $29 million, and paying $11 million in dividends. Through the first three quarters of the year, we've returned a total of $113 million to shareholders through share repurchases and dividends.

Our operating cash flow for the first three quarters of the year was $146 million, compared to $25 million last year. This increase reflects higher earnings and favorable movements in working capital. Year-to-date capital expenditures were $77 million, down from $84 million last year. Meaningful areas of investment this year include new retail stores in the US and Canada, and several technology initiatives intended to enhance the customer experience in our stores and online. We are also making investments to improve our enterprise financial systems.

For the full year in 2015, we're forecasting capital expenditures of approximately $120 million. We continue to forecast solid operating cash flow for the year in the range of $275 million to $300 million. The business has historically generated the majority of its annual free cash flow in the fourth quarter, and we believe that will be the case this year as well.

Page 11 summarizes our third quarter results by business segment. As I mentioned, we achieved good expansion in our consolidated adjusted operating margin. We expanded operating margin in our US wholesale businesses, in our OshKosh retail segment, and in international. The operating margin in the Carter's retail segment declined versus last year, which I'll cover in more detail in a minute. And I'll review our individual business segments in more detail beginning with Carter's wholesale on page 12.

We had a good quarter in Carter's wholesale, with net sales up 11% over last year. This performance was somewhat better than we had forecasted, in part due to some earlier demand and better shipping performance. Demand for replenishment product in the quarter was very good. We've seen good demand for fall seasonal product. And the launch of a new playwear initiative with Kohl's has added to wholesale sales.

We've seen some unevenness in Carter's wholesale segment sales this year, as a result of differences between our calendar and the calendars of our wholesale customers. This was also a contributor to the unusually high double-digit revenue growth in this segment in Q3. Segment operating margin improved by 360 basis points, reflecting strong revenue growth, lower product costs and distribution efficiencies.

Given the calendar timing issue and the earlier demand from some customers which benefited third quarter sales, we expect fourth quarter Carter's wholesale revenue will be down in the low double-digits. For the full year, we expect to achieve a low single-digit increase in Carter's wholesale segment sales, which is above our original plan coming into the year. We are forecasting good demand into the first part of 2016, as we're currently planning spring 2016 bookings up in the mid-single-digit range.

Page 13 features a photo of one the new Carter's Playwear Shops at Kohl's. We strive for impactful brand presentations wherever consumers shop for the Carter's brand, whether in our stores, on our websites, or with our wholesale partners. This is a good example of how we partnered with one of our wholesale customers to create an elevated and differentiated shopping experience, one which centers on a meaningfully expanded Carter's playwear assortment.

Turning to page 14 and the Carter's retail segment, total Carter's US retail segment sales increased roughly 5% versus last year. Both components of this segment, retail stores and eCommerce, contributed to sales growth. We opened 15 new Carter's stores in the third quarter, and have opened 46 net new stores so far this year. New stores continue to perform in line with our expectations, and are providing good returns with an average ROI above 20%.

Our overall Carter's direct-to-consumer comp declined 3.2% in the third quarter. This consisted of a retail store comp decline of 5.6%, and a positive eCommerce comp of 6%. Carter's retail segment profits were $52 million in the third quarter, compared to $55 million last year. Segment operating margin declined by 170 basis points, reflecting higher promotions and marketing spend and the profit effect of down comps, which were partially offset by lower distribution and fulfillment expenses.

On page 15 we have provided some analysis to show how significantly we believe the stronger US dollar and lower international traffic have negatively affected our US direct-to-consumer businesses. The left side of the page shows how the US dollar has appreciated against foreign currencies at some of our key customer bases over the past year. These relative values worsened during the third quarter.

The strengthening of the US dollar has contributed, we believe, to declines in traffic from international customers to our US retail stores and website. On the right side of the page, we've estimated the comp sales performance by customer type. Our analysis of credit card transaction data and other information suggests a meaningful decline in demand from international customers in excess of 20% for both the Carter's and OshKosh brands. As Mike noted, we believe we could see continued pressure on our US direct-to-consumer businesses until exchange rates stabilize on a year-over-year basis.

Pages 16 and 17 include selections from a recent Carter's direct mail piece. As Mike mentioned, we've rolled out our new Rewarding Moments loyalty program, including integrating messaging about the program in our direct mail communications. Page 17 is a good example of how we are messaging our outfitting capabilities and focusing on how Carter's provides solutions to particularly time-stretched millennial moms.

Moving to page 18 and OshKosh retail, segment sales increased approximately 8% versus last year, driven by the addition of 37 net new stores in the US, and solid eCommerce sales growth. During the third quarter we opened 12 new OshKosh stores, all of which were in the side-by-side format, and closed one store. We have opened 32 net new stores so far this year. Returns of OshKosh stores also continue to be very good, with ROIs in the mid to upper teens.

Our OshKosh direct-to-consumer comp declined 2%, which reflects a store comp of down 5.4% and strong eCommerce comp, up 14%. As noted on page 15, our analysis estimates good growth in domestic demand for OshKosh at plus 5%, but again a significant decline in international demand of over 20%.

OshKosh retail segment profits improved by $1 million, with segment margin improving by 50 basis points, principally due to lower distribution and fulfillment costs that more than offset the effects of down comps and higher marketing investments.

Pages 19 and 20 include selections from a recent OshKosh direct mail piece. The holiday theme created here is intended to highlight fashion for girls, as well as functional style for boys, all representing great OshKosh value.

Pages 21 and 22 include photos of new side-by-side stores in Augusta, Georgia and Mobile, Alabama. These stores opened in September, and are off to a good start.

Moving to OshKosh wholesale on page 23, third quarter net sales were down about $6 million compared to last year, principally driven by lower shipments to the off-price channel and lower seasonal bookings. OshKosh wholesale segment operating income in the third quarter improved by $2 million, and segment operating margin improved meaningfully to nearly 24%, principally due to stronger product margins, in part due to less off-price channel clearance activity versus last year.

Full-year OshKosh wholesale segment sales are forecasted to decline approximately 12%, or about $9 million.

Moving on to our international segment on page 24, third quarter international segment net sales increased 3% on a reported basis, and grew 17% on a constant-currency basis. Our Canadian business was a particularly bright spot for us in the third quarter. Reported net sales of retail stores in Canada increased 4% versus last year, or growth of 25% on a constant-currency basis. Canadian same-store sales improved by nearly 5%, reflecting we believe the success and appeal of our product offerings, improved effectiveness of our marketing programs, and excellent in-store execution.

We opened seven new stores in Canada in the third quarter, bringing us to 140 stores in total. We expect to open a total of 23 new stores in Canada for the full year. Our international eCommerce business grew to $7 million in the third quarter, up from $2 million last year, driven by eCommerce sales in Canada, and the launch of our website in China earlier this year.

Net sales in the wholesale component of our international segment declined by $3 million to $39 million, largely reflecting lost sales related to the Target Canada bankruptcy earlier this year. International segment adjusted operating income in the third quarter improved by $2 million over last year to $18 million. Segment operating margin improved by 130 basis points to 19.3%, in part due to strong revenue growth with partners across multiple regions and direct-to-consumer growth and expense leverage in Canada. These factors were somewhat offset by new business investments and the unfavorable effects of foreign currency exchange rate movements.

On page 25 we've included a screenshot from our new website in China. As Mike mentioned, we're very pleased with the initial demand from our Chinese customers. We're forecasting that China eCommerce sales will contribute about $5 million in net sales this year, with significant growth planned for next year.

Page 26 includes a photo of a new wholesale shop concept in Canada featuring Child of Mine, our exclusive brand with Wal-Mart. This brand refresh elevates our baby presentation, and is intended to strengthen this important category. Overall our business with Wal-Mart in Canada has been very strong this year.

Pages 27 and 28 highlight some recent store openings from several of our international partners. Page 27 is a photo of a new co-branded Carter's and OshKosh store in Australia. Page 28 is a new co-branded Carter's and OshKosh store in Indonesia. Our international partners are expected to open over 100 net new stores globally in 2015, which would result in over 750 retail locations in more than 60 countries at year end.

Now turning to page 29 for our outlook for the fourth quarter and fiscal year. Recall that our full year and fourth quarter performance comparisons will be affected by differences in our fiscal calendars. Our fiscal 2014 contained 53 weeks. And 2015 consists of 52 weeks. We have estimated that the 53rd week last year contributed approximately $44 million in net sales and $0.05 in earnings.

For the fourth quarter we expect net sales to decline approximately 2%. This outlook contemplates a low single-digit US direct-to-consumer comparable sales assumption. Adjusting for the 53rd week, consolidated net sales growth in the fourth quarter is estimated to be approximately 3%.

We expect fourth quarter adjusted diluted earnings per share in the range of $1.22 to $1.30, compared to adjusted earnings per share of $1.32 in last year's fourth quarter. Based on our year-to-date performance and current expectations for the fourth quarter, we're reaffirming our earnings guidance for the full year.

For the year we expect net sales to grow approximately 4%, which compares to our prior view of growth of approximately 5%. This adjusted view incorporates our year-to-date results and contemplates our expectations for a more challenging US direct-to-consumer environment in the fourth quarter.

Recall that several factors, including unfavorable exchange rates, the 53rd week comparison to 2014, and the impact of the West Coast port delays earlier this year will collectively reduce our expected 2015 revenue growth rate. We expect full year adjusted earnings per share growth will be in the range of 13% to 15% compared to 2014's adjusted $3.93 per share, largely consistent with our prior view.

Meaningful risks that we're monitoring include the overall macroeconomic environment, inconsistency in consumer traffic and demand, the level of promotional activity in the marketplace, and possible further weakening of international consumer traffic to our stores and websites, and the related risk of further weakness in foreign currency exchange rates versus the US dollar.

With these remarks, we're now ready to take your questions.

(Operator Instructions) Susan Anderson, Friedman, Billings, Ramsey

Hi. Good morning, everyone. Thanks for taking my question.

Good morning Susan.

I was wondering, just go over a little bit on the guidance, the fourth quarter revenue guidance. Is the biggest change there just the wholesale being down double-digit due to the timing issues, and then the 53rd week? Or is it also-- is DTC, I guess, worsening kind of as we go into fourth quarter versus third quarter? Maybe if you could talk about October quarter-to-date.

Let's say Susan, our overall assumptions for the fourth quarter do have the double-digit decline that we're forecasting in Carter's wholesale. I'd say that's largely the result of these calendar alignment differences between us and our wholesale customers, as well as the 53rd week. And that's why looking at the year, I think, is the better indication of the performance of that business. We are forecasting for that low single-digit growth that I mentioned.

But for the quarter specifically, we are planning that to be a down item. We are planning growth in the Carter's retail segment, which again includes the stores business and the eCommerce business. We're planning for growth in the OshKosh retail segment, and for some modest growth in the international segment. Those are the building blocks to the revenue guidance.

We'd say in terms of trends, Susan, I would say October has been better than September. And September was better than August. So the trends have improved.

Got it. Okay. That's helpful. And then how should we think about cotton and the impact on your product costs in third quarter and then going into fourth quarter? Is it more significant?

Well it was-- the fall 2015 product line was locked down earlier this year. So we've had the benefit of lower product costs in the second half of this year. Best visibility we have is through spring of 2016. That takes us through most of the first half of next year. Those product costs will also be lower. We're currently working on fall 2016. We've got good people over in Asia right now negotiating those product costs. And based on what we know today, product costs potentially could be lower in the second half of next as well. So cotton has certainly helped.

I think probably the most significant thing that has helped us is global demand for apparel is down. So there has been plenty of capacity available at our cost objectives. So the outlook for costs is good, as best we can tell is good. It's expected to be good for most of 2016 as well.

Got it. Okay. And then last quick question on inventory. I believe it was up 15% at the end of the quarter. Can you maybe talk about the drivers there, and do you expect it to get down to a little bit more normalized levels by the end of the fourth quarter?

Yes. Actually inventory was down at 1.5% at the [end of] third quarter Susan. Our expectations for the end of the year are for some inventory build, probably in the low double-digit range. That's consistent with our plans for good revenue growth in the first quarter. It's also some earlier delivery of some programs.

Great. Good luck guys, next quarter.

Thank you.

Kate McShane, Citi Research

Thank you. Good morning. I wondered if you could give a little bit more detail on some of your commentary around tourism. Was it sequentially worse than what you saw during Q2? And do you have any sense of what the comps could have been if it was more normalized traffic?

Yes. I would say international tourism has been an issue for us for most of the year. I think it was more pronounced in the third quarter. So we've dug deeper, looked at credit card data, international IP addresses, and saw a meaningful change in the level of international tourism in our stores and our websites. So we've benefited from that demand over the years. The analysis that I think we've shared with you in this business presentation, other information we've looked at, there's been a meaningful change in exchange rates in countries that used to be a very good source of demand for us. And so it's something that's a new challenge for us. It was more pronounced in the third quarter than what we had expected.

That said, the beauty of our business is it's a multi-channel model. We've got a very healthy wholesale business, a very healthy international business. So we were able to work our way through it. But near term, it's something that we're going to have to keep a close eye on, and we will keep you informed about its impact on our business.

I think the domestic business was actually good. Domestic demand was good. The stores, the level of demand particularly on eCommerce was good. So we feel good about the domestic demand. But the international demand has weighed on the performance we would have otherwise liked to have achieved.

Okay. That's helpful. Thank you. And then my second question is just on some of your merchandising initiatives, with layout and the bigger sizes. It sounds like you called out that that translated well to wholesale. How about translating to retail and what could we expect to see over the next couple of quarters in terms of those new merchandising initiatives contributing to the top line?

Sure, Kate. Well, in terms of the sizing, that's been a good initiative for us. We really ramped that up in the second quarter this year. I think what Mike said, it's probably about $17 million of sales for us this year. We think next year that could be plus or minus double that. It's an initiative that we launched primarily in our stores. We did have some wholesale customers take it as well. So I think size 8 could be very meaningful for us next year.

And in addition, it's given us cause to look at OshKosh. And we're working through strategies to launch size 14 in OshKosh for fall 2016 as well. So if we can keep mom in our brands for one extra year that can have a meaningful impact on our ability to sell the product.

In terms of our layout in our basics business have been real good this year, actually. Replenishment trends have been good in wholesale. It's been a good performer for our retail stores, in our mass businesses with Child of Mine and Just One You, the brands of all businesses there have also been good. They are both set for this fall. We feel good about those businesses. So that's a high-margin business for us and the retailers. And if we can continue to keep that moving forward, which we expect to do, that should be a good indicator for us.

Thank you.

Taposh Bari, Goldman Sachs

Hey, everybody. Good morning.

Good morning, Taposh.

Richard, I just want to clarify on the DTC comps. Did you say you expect them to be positive low single-digits, including eCom in the fourth quarter?

Yes. Our forecast would be for a positive DTC comp in Q4.

Alright. So the question is, last quarter, Mike, you spoke to positive store comps in the back half. And that clearly hasn't materialized. You called out international tourism and currency headwinds to that. How comfortable are you with achieving that fourth quarter target, given what you're seeing so far?

Best information we have, Taposh. So that's all we can share with you. And so we feel as though those are reasonable assumptions for the balance of the year, based on what we've seen so far in the fourth quarter. We think it's achievable.

Sounds good. Okay. Higher-level question for you, Mike. So you've got a lot of things going against you this year, Target, currency, port delays. Yet your earnings year-to-date are still up 20%, in spite of store comps being negative at Carter's year-to-date. So I guess the question to you and Richard is, can you talk about the different P&L levers that you have at your disposal, whether it be on distribution or other SG&A as you try to work through this international demand correction?

I'll tell you, as a look at a high level, when we set the expectations for the year back in February, we were projecting the sales up about 5% and earnings up about 10% to 14%, as I recall. Latest view is that sales will be up about 4%, earnings will be up 13% to 15%.

So again, retail is a very important part of our business. The beauty of our business, there are a lot of levers to pull. Wherever moms are shopping for young children's apparel, it's likely our brands will have a strong presence on the floor. So, the wholesale business has had a good year. We expect to exceed the goals that we had for wholesale this year.

The US eCommerce business happens to be particularly strong, from a domestic demand standpoint, very strong. We're making very good progress up in Canada, despite the currency devaluation up there. Canada has had a very good year.

The international business that we have with several retailers throughout the world that business is particularly good, from a sales and an earnings contribution perspective. And then we're excited about the launch of Tmall.

So there are lots of ways to grow. And I think what we had to do in the third quarter when we saw some of the weakness in the international demand, we revisited some of our spending assumptions. And like any good company, we tightened our belt where we needed to. We are still funding the things that are important to us, some of the technology investments, some of the omni-channel initiatives.

So we are probably within the next couple few months, we'll put the finishing touches on our 2016 plan. Based on the information we have today, we'll have good growth in sales and earnings again next year. So we're not a mall-based retailer. I'm glad we're not. That's kind of a one-dimensional business. We have a multi-faceted business which enables us to grow, and we've demonstrated that for many years, in good economies, bad economies; we've been able to manage to grow the business.

I appreciate that, and if I could squeeze one more in for you guys on the wholesale business. So I think your orders were up mid-single-digits for the back half of the year. Can you just talk about point of sale, and the nature of the timing shift from 4Q to 3Q, if you can quantify that? I'm just trying to get a better sense on how that business is actually performing on the ground. Because there's obviously a lot of choppiness at retail. It seems like your DTC channel issues are tourist-specific. But what are you seeing on the ground in terms of the wholesale business at Carter's?

Well, I'll start. And then Brian can offer his commentary as well. I'd say the calendar shift issue specifically was probably worth 3 or 4 percentage points of that, from memory, 11% growth in the wholesale segment. So it had a material effect. And again, some of the lumpiness across the year is something that we can see from time to time, as orders shift between quarters. That's why the full-year number, we think, is a better gauge as it relates to over-the-counter performance. The data that we've looked at suggests that fall seasonal product is more or less even year over year with over-the-counter sales.

And Taposh, I think our-- over-the-counter, we feel good about where we are. It's comparable to last year. I think inventories are up low single digits in that channel. The sales performance has been very good with the playwear initiative that we talked about at Kohl's. It's been a real highlight of the season. It did offset some softness in some categories, more fleece-related where we had some issues with wearing out earlier in the season. But we think we're in a good position for Q4.

Good relationships, we have a meeting with these folks multiple times throughout the year. I met with some major accounts last week, had some very positive meetings. So overall I'd say we're on track. We raised our sales number for this year. We've got booking up mid-singles for spring. We're excited about the playwear initiative and think that we can grow our business not only at Kohl's, but across other retailers. And that initiative alone, I think it's important to note that about 40% of the business in our stores is playwear. And in wholesale, playwear accounts for about 25% of the business. So we think that's an opportunity to grow our share in the wholesale business.

And we work with them on our eCommerce initiatives, supporting it with baby sales. And of course, great presentation, which Richard shared earlier. So we feel as retailers continue to turn toward baby and kids as a traffic driver for their stores that that sets up well for our Company.

That's good. Thanks a lot, guys. Best of luck.

Thanks Taposh.

Robby Ohmes, Bank of America Merrill Lynch.

Hey Mike, how are you?

Good morning, Robby.

Good morning. Hey, two questions. First can you give us a little more color on the promotional levels? You know, what happened in the third quarter competitively and then what are you sort of assuming is going to happen in your categories in the fourth quarter?

And then the other kind of related question is, can you talk about cannibalization of wholesale or retail and if that might be going on. You talked about how strong the replenishment was with your wholesale customers. And I'd also be curious if you can comment on your discount channel wholesale customers' replenishment momentum versus your department store channel?

By discount channel you would mean--

Meaning Target, Wal-Mart versus Macy's, Kohl's? You know, who's running stronger?

Good, Robby. So in terms of the promotional environment, it continues to be a promotional environment. I can't recall a time when it wasn't promotional. I would say as we looked at the July results, we felt as though we were out-promoted in July. We had launched our new fall product offerings, transitional product offerings. But the market in July was deeply, deeply discounting prior-season product. Our inventories were in good shape heading into the third quarter. So we did not have to be discounting new products. And as we moved through the quarter, when we started to get better visibility on the lower international demand, we had to move through those units.

So we were more promotional. The thing-- I like how the results came out. The pricing for our Company was down about 2%. We had planned the pricing to be comparable year-over-year, but we had to move through those units. We're in good shape with inventories going into the fourth quarter. But the product cost reductions in the third quarter more than offset the pricing reductions.

So I think we've managed through that reasonably well. Brian, do you want to talk about cannibalization?

I would say in cannibalization, there's always going to be some give and take across all the channels in the multi-channel distribution strategy we have. It's important to note that we feel good about our wholesale business. But it is a low-single-digit growth business. So we're putting 2% to 3% more units in that marketplace every year. That is approximately the growth rate that a lot of the largest retailers in the country aim for is low-single-digit growth.

So there's always going to be some tradeoff. But we actually don't think that's significant. We've managed to grow the wholesale business over the years, and our direct businesses at the same time. So I think having broad distribution, wherever mom wants to shop for children's apparel, is a strength. And when we can make sure that the presentation is elevated in the wholesale accounts, we believe that has a halo effect on our brands for all channels.

You asked about mass. We don't normally comment on specific accounts. I would just say that the replenishments trends and the basic layout businesses are strong across all three of our Carter's brands, Carter's, Just One You, and Child of Mine.

And just a quick follow-up on that. It seems like the mass channel though is sort of beefing up in the baby category in general, not just in apparel, but across the board. And is that-- are you seeing relative strength in shelf or floor positioning within the mass channel? Do you see that channel growing faster? Do you think the mass is taking share in the baby apparel category at a faster rate than it had, say the last few years?

I think too early to tell on that. It's clearly a focus for the mass retailers. It is also a focus for several other retailers. They understand that getting that millennial mom into the store to buy apparel for her child and having her shop at other departments is a win for the retailer. So we're pleased to hear the focus on baby with Wal-Mart and Target in the mass accounts. It's a strategy a lot of other folks have. We've got a good relationship with them. We have leveraged that into even international markets.

I think Richard showed some beautiful photography of the shops that we put in in Canada for Wal-Mart. So baby items, apparel and consumables, they have a replenishment component. So they're going to be traffic drivers for those retailers. And I think that sets up well for us. I would say it's too early to say whether it's cannibalization between one retailer and another. It is a major focus for many retailers, mass retailers included.

Got it. Thanks very much, guys.

Thanks Robby.

Rick Patel, Stephens, Incorporated

Thanks. Good morning, everyone.

Good morning.

Just a question on pricing. So average pricing was down based on an increase in promotions. Can you talk about what your assumptions are for the competitive environment? I'm curious. With cotton cost down, companies have more wiggle room on the margin side. So do you think we're entering a deflationary pricing environment for kids' clothes as we think about the next few quarters? And if so, is there anything that you can do to help offset that, whether it's inventory management or sales mix?

A good question. I don't think we're in a deflationary environment. The cotton prices dropped significantly. In recent years we did not see a lot of the retailers dropping their prices meaningfully. So we're not anticipating that.

Year-to-date, for our company, our pricing is comparable year-over-year. The market data information we had for the third quarter would suggest pricing was down for the market about 2.5%. We were a bit better than that. But we don't have concerns that everyone's going to give away some of that margin benefit. Every competitor, most of our competitors are public companies. They're all focused on how to improve the profitability of their businesses.

Our approach has always been to take some of that benefit of cost reduction, and strengthen the product offering. So we don't have a concern that we're entering a deflationary period. It will continue to be a competitive period. But we don't have concerns about price deflation.

And do you have any initial thoughts on the change in the one-child policy in China, perhaps, what the opportunity could be from that, and does that change your thinking of taking a more direct and aggressive approach in China versus using Alibaba as a partner?

Well, we're excited about the China opportunity. I looked at some analysis this past week, which suggests that our currents views on China are more robust than what they previously were, based on our visibility to the new Tmall business.

The one-child policy, the best information I have would suggest that will take some time to be a meaningful benefit. I would not characterize the relaxing the one-child policy to be a near-term benefit. It will take some time for China to embrace that, and so we're not assuming that to be a meaningful benefit for us. The benefit for us is we have very little business there today. Children's apparel is the fastest-growing apparel segment in China.

And the response we had seen on our US website in terms of demand from China and now the demand on Tmall, suggests it will be a meaningful opportunity for us over time. So we're excited about China.

Thanks. Good luck this holiday.

Thanks Rick.

Anna Andreeva, Oppenheimer

Great. Thanks so much. Good morning. Thanks for taking our question.

Good morning.

I guess a follow-up on the fourth quarter comp guidance to be positive. Should we expect that October has turned positive or do you guys assume some acceleration in the business to get there?

And I guess looking at store growth, you've been adding new doors at a very robust double-digit pace, really for the past couple of years. Store comps have been negative for the past few quarters now. Does that change your thinking at all about the store growth going forward, and just opportunity down the road?

Yes, just briefly, the DTC performance has improved in October. And so performance is better than it was in September. And we're not assuming that it's going to accelerate. We've got-- the best information we have now with some more insight into international demand. So I think we've got reasonable assumptions on the DTC comps.

And in terms of the stores, we believe the stores will continue to be an important component of our growth strategy. Today about 80% of our customers shop in the stores. The market for young children's apparel today, my understanding is about 14% of young children's apparel is bought online. Five years from now some portion of about 20% of it is going to be bought online, meaning 80% of it will still be bought in stores.

So we're going to continue to open up some portion of 60 stores a year. Most of those will be the side-by-side stores, which are showing good returns and good traffic trends. Probably the best traffic trends have been to these side-by-side stores, where you have the very best of both brands in one convenient location for moms. We only have about 86 of those stores today. And we're going to open up about 250 of them over the next five years. That's the plan.

We're seeing good availability of real estate and good returns. If all of a sudden real estate availability changes or the returns change, we'll revisit the pace of growth. But for now, we think we've got some portion of five years or more of good growth ahead of us with these store openings.

Okay. That's great. That's helpful. Was there any variability during the quarter in your outlook versus brand store performance? And then just a follow-up on gross margins, as well. How should we model gross margin versus SG&A for the fourth quarter? And I guess as we get into 2016, do you think the AUC cushion and all the good work you're doing on inventories could offset some of that promotional environment?

Okay. Just so you know, brand stores are outperforming the outlets. Side-by-side stores are outperforming the brand stores. That's one way to think about it. That's been our experience so far this year. And then the gross margin, fourth quarter?

And for the fourth quarter, Anna, we're planning good expansion in gross margin. There's a bit of a mix benefit. Because the wholesale business is going to be down. We get a nice mix benefit from having the DTC businesses be a bigger portion of the pie. So we are planning for expansion there. We're not planning for SG&A leverage. Expenses do naturally tick up between the third quarter and the fourth quarter. And given that revenue is planned down, we're not planning for leverage on the SG&A line.

And beyond that, I think, too early to really be specific on 2016.

Thanks so much, guys.

Thank you.

Ike Boruchow, Wells Fargo

Hi. Good morning, everyone. Thanks for taking my question.

Good morning.

I think, on the Carter's wholesale business obviously there were timing shifts and calendar shifts you talked about for Q3. I guess my question is now that we're a month into Q4, have you actually seen that pull-forward play out, or is that just your assumption, given how strong the growth was in Q3?

Yeah, I would say we still feel good about the year overall. In Q4 again, we did have some timing. We had some pull-forwards. Our replenishment trends are still positive. So we feel good about that. But overall, again as Richard had mentioned before, we elevated our sales guidance for the year on wholesale. We had thought that the business would be comparable to last year, based on the 53 to 52-week comparison. But in fact, based on again replenishment, the Kohl's playwear initiatives and some strengthening we've had in that business, we think it's a low-single-digit growth this year.

So I think it's playing out as we expected thus far. It's still early in the quarter. Where we are now is that most of the fall product has shipped. And we will begin shipping pre-ships for next spring shortly.

Got it. And then just to stick with Carter's wholesale. I think your sell-throughs were up I think mid-singles in the first half, good growth in Q3, and mid-single-digit booking for spring. It's obviously a very choppy environment at retail right now. Can you just talk to the resiliency that you're seeing in that business? Because it seems pretty impressive right now.

I think it starts with the base in the core replenishment, which we've talked about. It's about 27% of the business is core basic. So if we continue to have that business and we do the things we need to do to keep that strong and competitive, that's been a blessing for us. It's-- mom grows-- she's got to go shopping. That child grows out of their product every three months in the first two years of that child's life. So that's a wonderful thing for our Company that she needs to go in and replenish those items.

So that continues to be a strong business for us. Again, highest margin product for us and the retailers. The playwear business has been strong. Where the challenge has been within that is more of a seasonality issue in more of our fleece businesses, which were slow out of the gate in July and August. And in early September, they picked up in September and they're strengthening as we go into the holiday season.

So we spend a lot of time on all of our channels. And wholesale, I think we have rededicated ourselves to making sure the presentation is awesome and that we support those retailers. And I think it's showing up in the results.

Great. Thanks. Good luck.

Thank you.

Stephanie Wissink, Piper Jaffray

Thanks. Good morning, everyone. I just wanted to follow up on the fourth quarter guidance. The EPS, even when you adjust for that 53rd week at about $0.05, came in a bit lower than we would have expected. So I'm curious, Richard, if you could maybe talk about the discretionary expenses that you may have differed in Q3 that maybe hit in Q4, if there's any timing there, or if that reflects just some lower margins overall on the business.

And then just secondly I had a clarification question regarding the international franchise and partner stores. Can you just give us an update on the store count there just remind us how the FX exposure plays out? Do you collect in US dollars or is that in foreign currency and you translate? Thank you.

As it relates to the spending question, there is a little bit of catch-up where some spending will likely move from the third quarter to the fourth quarter. And on balance, we've been behind in our hiring plans. It's taken longer to fill some key positions. And we certainly ask the organization to pull back a bit on hiring activity, given the unevenness of the consumer demand. So my guess is that hiring picks up a little bit.

We do have a number of technology initiatives as well that are pressing ahead. And some of that spend falls into the fourth quarter. We have increased marketing as well. So that's been a kind of a conscious decision all year long to invest additional amounts in marketing.

Certainly the 53rd week works against from an earnings contribution point of view, the overall effects of foreign currency. There is a net negative effect on earnings that hits the fourth quarter as well. I'd say those are the primary reasons why perhaps the earnings guidance isn't higher than it would be otherwise.

As it relates to the international business, our agreements are to sell products in US dollars. So we don't, per se, have an FX exposure there.

If I could just have one more guys. I think you mentioned potential for $500 million in incremental sales from the side-by-side initiative. Can you just help us appreciate what of that $500 million comes from cross-over or improvement in the overall volume, versus new units that you would add that layer on top of the existing base?

The assumption is, is that we'll be successful opening up 250 of these side-by-side stores over the next five years. Each of the side-by-sides on a combined basis do some portion of about $2 million a year with good returns. So that's the basis for the $500 million assumption.

Great. Thanks you, guys.

Thank you.

Jim Chartier, Monness, Crespi & Hardt

Hi. Thanks for taking my questions. I just wanted to talk a little bit more about the tourist business. Can you give us a sense of what percentage of your direct-to-consumer sales were done by international consumers in either 2012 and/or 2013?

Well here's directionally what we know, is probably with eCommerce in recent years, our US eCommerce business, over 40% of the demand on the US eCommerce business was coming from outside of the United States. That was an unexpected benefit. And then in our stores, I don't know about back to 2012, but we've always had a big international guest in our stores, particularly in the tourist locations. Both brands, it was a common experience to be shopping down in the Orlando or Dolphin Mall stores, Sawgrass Mills that you'd see customers from outside of the country. Our understanding, a lot of customers from Brazil queued up to check out with suitcases, loading up and bringing a lot of product back to their family.

And so in the stores, our best information is the level of international demand was probably in the stores, some portion of 15%. It's probably closer to 10%, based on our latest analysis. In this most recent quarter, third quarter, international demand on our US website went from over 40% closer to 30%. So it was significant. It was quite significant.

Okay. And then a lot of other retailers who have highlighted the impact of a declining tourist business saw the first impact in fourth quarter of last year. Did you guys see any impact and are you lapping that, and is that part of the reason you feel better about comps improving in fourth quarter this year?

I would say I'm certain we had felt some impact from it. I would say it was most significant in the third quarter this year. And as we looked at the change in exchange rates that we started to see it last year, but it didn't have a, I would say, a material effect on our business. I would say it did in the third quarter. And I think time will tell, depending on how the exchange rates move in the balance of the year. It's hard to predict. But so far in October, I think we're doing okay.

Okay. And then finally, can you talk about the propensity of tourists to use coupons and do they use coupons at a different rate than your domestic consumers, and therefore they are more profitable customer for you overall.

I would say on average the tourist, tourist use of coupons is less than domestic consumer. A lot of these folks are on vacation. Their spend is larger. They tend to come in and stock up. Some of them have counter-climates than we do. And they tend to come in and stock up. Because they come once a year or twice a year for the product.

But the coupon dilution is less with international tourists.

Okay. Thanks and best of luck.

Thank you Jim.

And ladies and gentlemen, this will conclude our question-and-answer session. Mr. Casey, I will turn the conference back over to you for any closing remarks.

Well thank you all for joining us this morning. We appreciate your questions and your interest in our business. We'll update you again with our progress in February. Good-bye.

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