Carter's Inc (CRI) 2016 Q2 法說會逐字稿

(Operator Instructions)

Welcome to Carter's second-quarter 2016 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. After today's prepared remarks we will take questions as time allows.

Carter's issued its second-quarter 2016 earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted on the Investor Relations Section of the company's website at www.carters.com.

Before we begin, let me remind you that statements made on this conference call, and in the Company's presentation materials about the Company's outlook, plans, and future performance are forward-looking statements. And actual results may differ materially from those projected. For a discussion of factors that could cause actual results to vary from those contained in the forward-looking statements. Please refer to the Company's most recent 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 are provided in the Company's earnings release and presentation materials.

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

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

We saw strong demand for our brands in our retail and international businesses in the second quarter. We achieved our first positive comp in two years, at our Carter's stores. And had strong demand online for both Carter's and OshKosh B'gosh. Demand from domestic consumers was particularly good. Thankfully, we are seeing some moderation in the negative effects of the stronger dollar. And some signs that international customers are coming back and shopping with us again in the United States.

Higher demand for our brands in Canada and China drove the growth in our international sales in the second quarter. And domestic wholesale sales were lower than last year, but in line with our plan.

In the second quarter, we continued to improve price realization. That improvement, together with lower product costs, drove a higher gross profit margin and funded greater investments in store expansion, technology, marketing, and China startup costs. And we're reporting good cash flow for the first half, which has enabled us to meaningfully increase the return of capital to our shareholders. All in all it was a good first half.

With nearly seven months into the year, we have better visibility to the second half. We have adjusted our annual sales and earnings plans to reflect our latest outlook on Spring 2017 bookings. And international demand for our brands.

Understandably, some of our wholesale customers are being more conservative with their inventory commitments given trends in their businesses. That said, we are expecting good growth for our Company this year. Our longer-term outlook has not changed. We believe that our multi-brand multi-channel business model will enable us to achieve $4 billion in sales by 2020.

With respect to business trends, sales ramped up in-line with our plan as we moved through the second quarter. If you recall, we saw our retail trends improve following the Easter Holiday with positive year-to-date comps through the end of April. Through yesterday, our year to date comps have improved on that level of performance.

We are expecting positive comps for the third quarter and second half, as we lap up against the volatility and exchange rates and drop in tourism last year. Our supply chain performance was exceptionally good in the second quarter in terms of on-time deliveries and distribution center efficiencies. And inventories are in good shape as we head into the balance of the year.

The stronger dollar continues to weigh on our results. Though less so than the previous three quarters. As you may recall, we began to see the dollar strengthen meaningfully in the second half of last year. As the dollar strengthened, we saw lower contribution from our Canadian operations and a significant decline in international customers shopping with us in the United States.

On a comparable basis, domestic demand in our US retail business grew over 8% in the second quarter. By comparison, international demand declined about 18% for a net comp increase of 3%. We've seen the biggest impact from lower international traffic in the southeast, in some of our largest most productive stores in Florida. These have historically been our best performing outlet stores that have benefited from international tourism.

Sales to international tourists dropped from 20% of our retail sales in the first half of 2015 to 15% in the first half of this year. This decrease impacted retail comps by about 3 percentage points.

As the volatility in exchange rates has begun to moderate, we are seeing a positive correlation in retail sales. There are reasons to be hopeful that these trends may continue. That said, we are also cautious knowing that they may not.

To achieve our growth objectives this year, we have initiatives focused on providing the best value and experience in young children's apparel, extending the reach of our brands and improving profitability. We believe one of our most impactful initiatives is our strategy to make shopping for our brands more convenient for consumers.

We plan to open 130 beautiful stores in North America this year. Most of these stores are located in high-value non-mall shopping centers. Our best performing stores this year are located outside of outlet centers. Closer to the consumer. Our best performing stores are the co-branded side-by-side stores, providing the best assortment of our Carter's and OshKosh B'gosh brand in one convenient location.

To encourage more frequent online shopping and store visits, we have recently rolled out technology that enables consumers to shop online and pick up their purchases in our stores. With more of our stores located closer to the consumer, we believe this option for free shipping has become more attractive. Since launching this initiative, about 10 percent of consumers choose to have the product shipped to our stores. And when they pick up their order, we have seen additional purchases made in the store.

We continue to see good performance from other initiatives this year which include our new loyalty program, extended sizes for both brands, and expanded shoe offerings. Our rewards program was launched in October last year. Prior to its launch, our loyalty program was not available to our e-commerce shoppers.

The consumer's response to this initiative has exceeded our expectations. Nearly 90% of transactions in our stores and online are with customers who have enrolled in the rewards program. This program captures important consumer information, which enables us to engage them more effectively. We are seeing higher redemption rates and higher spending upon redemption. We're also seeing higher sales per customer, and more frequent visits.

We believe we have improved the scope of our product offerings this year. In addition to Little Baby Basics launched in May, we now have extended sizes for both brands. If you recall, we launched a size 8 for Carter's last year and sold out earlier than expected. We have sourced more product for this fall and are seeing a nice lift in sales.

This fall, we've also launched size 14 for OshKosh B'gosh. It's early, but we believe this initiative will enable us to outfit more children for a longer period of time.

We've also expanded our shoe offering this year. Like apparel, we believe consumers want high-quality, high-value footwear for their children from brands that they trust. We are also reaching more consumers internationally through our global distribution capabilities. We saw strong demand in international sales which grew 8% in the second quarter, up 12% in constant currency and up 16% year to date.

Our business in Canada continued to strengthen its number one market share position in young children's apparel. We now own over 16% share of the Canadian young children's apparel market. Double the share of the next largest specialty retailer.

The next largest component of our international business is supported by retailers representing our brands in over 60 countries. Despite the turmoil in the world and effects of currency devaluation, we are expecting this part of our business to produce over $100 million in sales this year, which is comparable to last year.

China is the next largest international opportunity for us. The number of annual births is four times that of the United States. We continue to believe China sales could exceed $100 million by 2020.

With respect to improving profitability, we're focused on increasing our direct sourcing capabilities, improving distribution center efficiencies, strengthening inventory management capabilities, and improving Oshkosh profitability. Collectively, our profit improvement initiatives should enable us to achieve a 14% operating margin by 2018.

In summary, we made good progress improving our business in the first half of this year. Given the strength of our brands in the marketplace and multi channel model, we believe we are on track to have another good year of growth in sales and earnings.

Looking beyond 2016, we are encouraged by reports indicating an improved trend in the US birthrate for moms who are 25 years and older. Recent reports also suggest that the job market and the housing market are improving. And the presidential election will be behind us. And some of the uncertainties that way on consumer behavior may moderate.

I want to thank our employees throughout the Company who helped us achieve the results we are 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 and good morning everyone. We have a good quarter to tell you about today. And I will begin my comments on page 2 with some overall highlights.

Consolidated net sales grew 4% which was at the high-end of our prior guidance. Growth was driven by our US retail and international businesses. Adjusted operating income was roughly comparable to last year at $64 million, adjusted operating margin declined by 70 basis points reflecting gross margin improvement offset by increased investments to support our growth agenda.

Adjusted earnings per share were also about comparable to last year at $0.72. Which was better than our previous expectations, largely due to lower than planned spending in the quarter. Some portion of this spending favorability we believe is due to timing and does not represent upside for our full-year earnings outlook.

Negative movements in foreign exchange continue to be a headwind in the second quarter. Including continued lower demand from international consumer shopping in our US stores and on our website. We've estimated that the various effects of foreign exchange throughout the P&L cost us approximately $14 million in top line revenue, and approximately $0.15 to $0.20 in earnings in the second quarter.

Moving to page 3 with details of our sales performance in the second quarter. Our Carter's business in the US grew 5%, driven by strong growth of 11% in our Carter's retail segment. Carter's retail achieved a comp of plus 4% with both stores and e-commerce contributing to the positive comp.

Our Oshkosh business in the US grew 1%, with the Oshkosh retail segment contributing nearly $6 million to our sales growth. International delivered another solid quarter growing 8% compared to last year with growth of 12% on a constant currency basis. Our Canadian retail business and new e-commerce business in China drove the growth in this segment. I will cover our business segment results in more detail in a moment.

Turning to our second-quarter P&L on page 4. Consolidated gross margin improved by 120 basis points to 44.1%. This performance reflects a modest improvement in average unit pricing, largely due to the higher mix of retail sales and lower product cost.

Adjusted SG&A grew 11% in the second quarter. Consistent with recent quarters, the expense increase and higher SG&A rate were driven by growth in our retail businesses in the US and Canada, as well as investments in our e-commerce business in China. To a lesser degree, investment in marketing and higher technology spending also contributed to the increase.

As I noted a moment ago, second quarter SG&A was lower than forecasted. Some portion of this upside relates to the timing of spend, in such areas as consulting, HR, and marketing. We expect we will now incur these costs in the second half of the year.

Continuing down below operating income, the "Interest and Other Line" reflects a $300,000 loss in the quarter related to unfavorable settlements and revaluation of foreign currency forward contracts. This loss compares to a gain of nearly $2 million in last year's second quarter. Interest expense was comparable year-over-year.

Our effective tax rate was 35.5%, down somewhat compared to last year, primarily due to increased contributions from our international businesses. For the full year, we're forecasting an effective tax rate of approximately 35.5% consistent with 2015.

Our weighted average share count declined approximately 4% versus last year reflecting our share repurchase activity. The result of all of those items was bottom line adjusted earnings per share of $0.72 compared to $0.73 in last year's second quarter.

Pages 5 through 7 summarize our year to date performance. In the first half of the year, we have delivered good top line growth of 5%. Expanded gross margin and we've grown earnings. As expected, sales and margins in the first half were weighed down by lower sales to international consumers shopping in the US.

Our spending is higher, although less than we had planned as we continue to invest in our retail businesses and in critical infrastructure and omni channel initiatives.

Now turning to page 8 with a few balance sheet and cash flow highlights. Our liquidity at quarter end remains solid, with a cash position of over $200 million. And available capacity under our credit facility of over $300 million. Quarter-end inventories increased 8% versus last year, principally due to business growth. We believe our inventory quality was very good as we exited the second quarter.

Operating cash flow for the first half of the year was $86 million. Near a record high for us, compared to $27 million last year. Favorable movements in net working capital and higher earnings drove the improvement over last year.

First half capital expenditures were comparable to last year at $50 million. Significant areas of investment this year include new stores in the US and Canada, as well as various information technology projects. Free cash flow in the first half improved to $36 million driven by strong operating cash flow.

We have made good progress in returning capital to our shareholders and have now returned three times as much as we had at this time last year. Through the first two quarters of 2016 we repurchased $180 million of our stock and paid $34 million in dividends. For a total return to shareholders of $214 million.

With respect to our capital structure, we have concluded for now, that we are comfortable with our current leverage profile. Our adjusted leverage is about 2.3 times which we think is reasonable and consistent with our peer group. This leverage level, along with our substantial borrowing capacity, provides us with significant financial flexibility and strength.

We hope to continue to return excess capital to shareholders. This is a priority for us. Should we require liquidity to support this initiative, or the business, we have substantial capacity under our existing credit facility. We think this is a better approach at this time than pursuing more structured longer-term financing. Our review of our capital structure is an ongoing exercise for us. And something we discuss with our Board regularly.

Page 10 summarizes our business segment results in the second quarter. Consolidated adjusted operating income was roughly comparable to the prior-year at $64 million. And adjusted operating margin was 10%, compared to 10.7% last year. Our US wholesale, Oshkosh retail, and international businesses delivered stronger operating margins while our Carter's retail segment margin declined. Corporate expenses deleveraged 20 basis points compared to last year, principally due to spending on the upgrade of our core financial systems.

Moving to our individual business segments in more detail. Beginning with Carter's wholesale on page 11. As planned, net sales for Carter's wholesale in the second quarter declined year-over-year. Net sales were affected by the timing of customer demand both earlier demand from some customers which fell into the first-quarter. As well as some fall product shipments planned for the third quarter, as opposed to second quarter last year.

On a first half basis, net sales in our Carter's wholesale business grew 1% which was consistent with our plan. Net sales in this part of the business are now planned to be comparable to last year for the full-year.

Carter's wholesale segment operating profit was comparable to last year at $40 million. Segment margin improved by 40 basis points to 19.4%, reflecting favorable product mix and lower product cost. As Mike mentioned, we've moderated somewhat our sales forecast in our wholesale segment consistent with the challenges which many of our wholesale customers, particularly those with a high concentration of stores and in traditional storage in malls, have articulated regarding their businesses.

Page 12 shows a recent Carter's floor set at Babies 'R' Us one of our important wholesale partners. One of our key strategic priorities is to provide the best value and experience in young children's apparel. Wherever mom is shopping, including in the wholesale channel, it's important to us that she finds our brands in a way that emphasizes the strength of our value proposition and the beauty and quality of our products. This is a good example of where we have partnered with a significant wholesale customer to elevate the signage, fixturing, and branding surrounding the Carter's assortment carried at Babies 'R' Us.

Turning to page 13, and the Carter's retail segment. Total Carter's US retail segment sales increased 11% versus last year. Carter's retail segment same-store sales grew 4% over last year with store comps of 1% and e-commerce comp sales growing 17%.

We're pleased with our retail performance in light of such soft consumer traffic trends in the marketplace. Our analysis indicates our Carter's retail stores fairly significantly exceeded industry traffic benchmarks in the second quarter.

In Q2, we opened 15 new stores, and closed one. Over the last year we have added 62 net new Carter's stores in the US. New stores are delivering good returns with average after-tax return on investment in excess of 20%.

Carter's retail segment profits in the second quarter were comparable to last year at $38 million. Segment operating margin declined by 150 basis points, principally driven by store expense deleverage mostly from new store expenses, higher promotional activity due to lower international consumer demand, and increased marketing spend and investments in technology.

On page 14, we've updated the analysis we've shared previously which estimates the meaningful effects we believe of lower international traffic on our US retail businesses in the second quarter. Consistent with the last few quarters, we've seen good demand from domestic consumers. But a significant decline in demand from international consumers shopping in our US stores and on Carters.com.

Our forecast assumes that the declines in demand from international consumers will be less significant in the second half, in what we've seen over the past several quarters. We've already seen some meaningful improvements in international demand in e-commerce.

The stores however, continue to be under pressure. If the decline in US retail store sales to international consumers were to continue to decline at roughly the same year-over-year pace that we've been experiencing, it would represent an estimated additional $10 million in sales and profit risk to our current forecasts.

Pages 15 and 16 contain portions of the latest Carter's direct mail piece. These pages showcase our latest take on our iconic Carter's body suit, a must-have in every baby's wardrobe. As well as our updated sets which provide easy dressing options for parents, all at great prices.

Now moving to page 17 and Oshkosh retail results. Oshkosh total retail segment net sales grew 5% driven by new store openings and growth in e-commerce. Oshkosh's retail comp declined approximately 1% comprised of e-commerce comp growth of 18% and a store comp decline of 6%. We believe lower demand from international consumers disproportionately affected the Oshkosh store comp performance, given the concentration of international tourist outlets in the Oshkosh brand's store portfolio.

Nearly 2/3 of OshKosh stores are in outlet centers, compared to only 1/3 for Carter's. Non-outlet Oshkosh stores, principally side-by-side stores, comp'd positively in the second quarter.

In Q2 we opened 12 new stores and closed one. Over the past 12 months, we've opened 41 net new Oshkosh stores. We ended the second quarter with 119 side-by-side format stores which now represent 45% of the Oshkosh store portfolio. These new stores are delivering good returns with an average after-tax return on investment in excess of 15%.

Oshkosh retail segment income in the second quarter improved by about $300,000. Segment operating margin improved by 60 basis points, reflecting distribution efficiencies and lower product costs. These benefits were somewhat offset by store expense deleverage, increased marketing, and investments in technology.

Pages 18 and 19 feature selections from a recent Oshkosh direct-mail piece. These pages convey the value, quality, and relevance of the Oshkosh brand as we enter the important back-to-school shopping season. Page 20 is a photo of one or our newest side-by-side stores in the Minneapolis-St. Paul market. In this particular location, we had an opportunity to add a new Oshkosh store to an existing successful Carter's store in order to establish a side-by-side location and meaningfully increase the selection of our brands and products available to the consumer.

Moving to our international segment on page 21. Our international segment achieved very solid growth again this quarter. Second quarter reported net sales increased 8% and grew 12% on a constant currency basis.

Our Canadian store and e-commerce businesses continued to perform very well. Canada retail comps increased 8% with solid comps in both stores and e-commerce. Our international e-commerce business more than doubled in the second quarter, with net sales growing to $7 million compared to approximately $3 million last year. Our China Tmall business, launched at the end of Q2 last year, drove most of this growth.

Net sales in the wholesale component of our international segment were $22 million, compared to $26 million in last year's second quarter, largely reflecting lower shipments to Mexico. On a full year basis, we're forecasting 2016 net sales in this component of international to be comparable to 2015.

International segment adjusted operating income in the second quarter grew by 19% to $9 million. Segment operating margin improved by approximately 120 basis points to 12.7%, principally driven by the strong comp sales and improved profit contribution from Canada, partially offset by unfavorable foreign exchange effects.

Page 22 includes a photo of one of our newest stores in Canada. This Toronto area location opened in May and represents our second mall location in Canada. Results to date have been very encouraging.

Now turning to page 23 for our outlook for the third quarter in FY16. For the third quarter, we expect net sales to grow approximately 6% to 7%, principally driven by growth in our US retail and international businesses. We anticipate modest growth in our Carter's wholesale segment.

We are forecasting third quarter adjusted diluted earnings per share to grow approximately 6% to 10% compared to an adjusted EPS of $1.52 in the third quarter of 2015. This earnings forecast contemplates gross margin improvement on a year-over-year basis. And SG&A deleverage, in part due to planned spending that has shifted from second quarter to the third quarter.

For full-year 2016, we now expect net sales to grow approximately 5% to 6%, driven by our US retail and international businesses. This compares to our prior outlook of growth of 6% to 7%. As mentioned, this revised sales outlook reflects in part, more modest expectations for wholesale and international demand in the second half.

We continue to forecast good growth and profitability in 2016. We now expect adjusted EPS to grow approximately 10%, compared to 2015's adjusted $4.61 per share.

Risks that we're monitoring include: inconsistent trends in consumer demand and store traffic, both in our retail business and with our wholesale customers; foreign-exchange rates; the level of promotional activity in the marketplace; and consumer sentiment in light of the ongoing presidential election cycle; and the overall macroeconomic environment.

With these comments we are ready to take your questions.

(Operator Instructions)

Ike Boruchow, Wells Fargo.

Good morning everyone. Thanks for taking my question.

Good morning.

I think just about every vendor that's reported so far has talked about weaker Q3 orders. So, it makes some sense, what you're seeing in wholesale. My question is, is that due to a particular channel? Whether it be mid-tier department stores, or the mass channel? And how are your sell-throughs at POS within the wholesale channel? Any change there relative to the first half?

I would say couple things. We've got good initiatives out there in the wholesale. But the retail environment does continue to be challenging; especially we're finding the brick-and-mortar mall-based department stores. Our online businesses is very good and growing rapidly in virtually in all the accounts. Our latest view with our sales this year in wholesale like as Richard said, are going to be comparable to last year. As far as spring 2017, just to give you a little color on that. The bookings process is still ongoing. At this point we do believe they will come in lower than last year. That, primary softness we are seeing at mall-based department stores booking segment of the business. They're going to be down.

But they do represent a much smaller portion of our wholesale segment. At this point it's about 15% of our segment is the mall-based department store business. We are continuing to invest with our partners in presentation and driving sales to their websites and continue to support them in their efforts to drive the business. You asked about selling. I would say spring our overall, as we finished up, I'd say we had a really good play wear season. Sell-throughs were good. I would say some of the other categories of sell-throughs were not quite as high as we had hoped. Inventories are up just a little bit more than we would probably have anticipated in some of the accounts. But we think that will normalize quickly. If you remember, the fall bookings were comparable to last year.

Overall the channel, we think this year we can finish up comparable to last year. Maybe up slightly; we'd feel good about that. We still have the spring bookings under way. And we have a lot of good initiatives out there. We are driving online businesses, driving the play wear business, presentation. We have spoken about the Kohl's play wear strategy, which we are coming up on comping that from last year. They continue to see very good results with the expansion of our play wear business with that account, as well.

Got it. It sounds like there shouldn't be much variability Q3 and Q4 on your wholesale performance, is that fair?

I think Brian's comments, Ike are more directed towards the outlet for spring bookings. There's a portion of the spring shipments that go in the fourth quarter. I think that's the piece that we have moderated our expectations at this point. We're continuing to have a good outlook for the shipments of our fall product. But we're watching that as well.

Got it. Thanks so much.

Susan Anderson, FBR Capital Markets.

Good morning everyone, thanks for taking my question. I was wondering if I could dig in a little bit deeper on the wholesale orders for the fall. It sounds like basically, they came back to you guys and brought them down a little bit. I think they were supposed to be modestly up before?

I think we said before that they were comparable to last year. If not up modestly. So when you put it all together, you've got the fall bookings Susan. And you've also got Spring 2017 bookings. And some component of Spring 2017 bookings are pre-ships that go in the back half of this year late in the fourth quarter. That's the key reason we are moderating the outlook. Is that those, we do believe, will be down slightly to last year. When you put it all together with fall bookings and spring pre-ship bookings, that's how we arrived at that revision.

Got it. That's helpful. I think you also said that you expect international to slow a bit. Maybe if you could touch on that a little bit. Is that still the tourist impact? Or is that coming from Canada or other parts of the international business?

There's a few parts. The Spring 2017 bookings from our international customers are also expected to be lower than we previously expected, given issues in their different parts of the world and the continued effects of the stronger dollar. That's one component. The other component is the ramp up in our new China e-commerce business. That business will more than double this year. It just won't be at the same level of demand that we had previously forecast.

Probably the biggest challenge in our business I would say is the level of international demand from international tourists shopping with us in the United States, both in our stores and online. Thankfully, we are starting to see some recovery online. It appears as though they are coming back shopping online. Even though that business was down in the second quarter, if you'd exclude the big drop in China, online international demand was actually up online in the second quarter.

So we are starting to see some recovery. We haven't seen as much recovery yet in our stores. We're starting to see some recovery in some of the larger outlet stores in Florida, but that it hasn't been sustained.

So our biggest assumptions in the second half are, as exchange rates start to normalize year-over-year, the international guest is coming back. So we put reasonable assumptions on both our e-commerce business and the stores. We are seeing recovery online and not so much in the stores yet.

Got it. That's helpful. And one last question on the Oshkosh business. It seems like after several good quarters of comps it turned negative. Is that as you guys cycle more difficult compares? Or is there anything that you've seen in that business?

The arrow is pointing up in Oshkosh. Oshkosh is making good progress. Had positive comp in June, we expect positive comps in the second half. You've got to keep in mind, two thirds of Oshkosh stores are in outlet centers. And a good chunk of those outlet centers are in tourist locations. We saw a big drop off in tourist locations for Oshkosh and Carter's.

But having two thirds of the stores in outlet centers works against Oshkosh. Our plan is, to over the next five years, take that mix of outlet stores from what is two thirds, to less than one third. We are seeing very good performance from our side-by-side stores. The best traffic and the best comps are in our side-by-side stores. That is where have the best of Carter's and best of Oshkosh sitting side-by-side. The feedback from consumers on those stores have been good. The comps have been good. Every store we open, going forward for Oshkosh, will be in the co-branded format.

Great. That's really helpful. Thanks so much. Good luck next quarter.

Thanks very much.

Robert Ohmes, Bank of America Merrill Lynch.

Good morning. This is Dan O'Hare on behalf of Rob Ohmes. How is the Little Baby Basics launch perform post-launch? And is that primarily at retail or wholesale, as well?

The Little Baby Basics launches is all channels. We successfully launched that in May. I think we did a good job with strong marketing and brand presentation across the channels. The product is doing particularly well online in all channels. I would say a little less so in the stores.

The replenishment trends with our wholesale partners, we have moderated that forecast slightly based on initial out of the gate. There are some products that are doing really well and other ones that we are refreshing. We have about 15% of the business of the life cycle in so it's early. We are monitoring that sell-through as they finish clearing out their old program. We do have some refreshed creative for key components of that launch which arrive later in the year to support fall and holiday selling.

Got it. Could you remind us how many sign-ups that the Rewarding Moment loyalty program has?

It's my understanding right now is over 8 million. It continues to grow. We were surprised, as we dug into what percentage of the transactions both online and in stores are tied to the Rewarding Moments program. It nearly 90%. So, it's been a very successful program drawing more people back to the stores after their initial purchase. So it's been well received.

Got it. Has there been any increase in the transaction size with customers that have recently signed up?

Yes.

Thanks so much.

You're welcome.

Anna Andreeva, Oppenheimer.

Good morning guys, and congratulations on really strong Q2 results.

Thanks Anna.

I had a couple questions. First, remind us how much of your business is replenishment in the fourth quarter. And your ability to chase just in case better demand ends up realizing.

Secondly, Richard, gross margins very strong in the second quarter. Maybe talk about the dynamics between AUR and AUC. And how should we think about gross margins for the back half? And finally, you mentioned we should expect positive comps in retail for 3Q and Q4. What are you guys seeing so far in July? Thanks.

I will take the replenishment question. Replenishment, Anna, in our wholesale businesses is about 20% to 25% of the business. Overall, in the back half of the year. We position inventory on the shelf here. We give it a quick testing on things like Little Baby Basics in our stores. And we change our forecast based on that to make sure we try to keep the best articles in stock. So we do go a little bit long on some things. We do have the ability to, I'd say, ratchet that number up if it merits. Significant chase, no, because of lead times. But we do have the ability to service that, I think, at a good level.

On the gross margin. For the second quarter, I would say there are obviously multiple things at work there. You have the ongoing benefit of lower product costs. We do expect that will continue in the second half of this year. Pricing a less significant component. We did have a modest improvement in pricing. Some portion of that is mix related, both from growing the higher AUR businesses, including retail stores and e-commerce. I think those are the primary effects for the second quarter.

For second half, we have good continued gross margin reflected in our forecast. Actually the basis point expansion year-over-year would be, if we're successful with our forecast, above what we achieved in the first half. We're hoping we don't have the same measure of liquidation activity that we had a year ago. With all that inventory that we procured for international consumers. I think we were sharper in how we made our inventory commitments for the second half with the benefit of that analysis. Continuing to forecast the benefit of lower product costs, and hopefully less liquidation activity, continued growth of our high margin businesses, that's how I'd characterize the outlook for margin.

You asked about third quarter comps, both brands are comping positively third quarter to date. Had a strong start to the quarter with good demand for both brands over the Fourth of July Holiday. Saw a similarly good demand over the Memorial Day weekend. July got off to a strong start. The last couple weeks have been a little under what we had expected, but not materially. So, I would say third quarter to date, we are on track to have positive comps.

Awesome. Thanks guys. Good luck.

Kate McShane, Citi Research.

Good morning. Thanks for taking my question.

Just to drill down again at the wholesale accounts. Could you give us any insight into how promotional those accounts have been? Especially at the brick-and-mortar department stores? And how you see that playing out in the second half with regards to your gross margin guidance?

I think overall the retail environment continues to be promotional, Kate. I don't know that it backed off at all. Retailers are using different models to drive traffic to their sites as the customer pre-shops and they want conversion on their sites, as well as drive folks in their stores. There continues to be, I would say, significant promotional activities. Certainly not less. I would say it's at or above what it was in prior years. We were slightly more promotional in our retail channel, primarily due to our loyalty program and then the impact of international. But people are trying very different things. As we said, the department stores and the mall-based I think it's been well-chronicled in the media some of the challenges they are having. So they're trying different things to drive traffic to the stores.

Okay. Thank you.

My second question is on retail. Can you remind us at what comp you need to leverage both for Carter's and Oshkosh? And with Oshkosh shifting away from outlets over time, how does that impact some of the occupancy and the rent?

Our objective is to achieve a 3% comp. A retail comp for each of the brands at that level. Above that level, we leverage SG&A below. We deleverage. As we open up these Oshkosh stores, keep in mind, once we open up the Oshkosh stores they are attached to Carter's. And we're seeing a very good profit contribution from both brands. Because there is a sharing of the overhead, sharing of the real estate effort, build out effort. So the side-by-side model is much more profitable than standalone stores.

So we are seeing good performance with Oshkosh, seeing good comps. The closer the Oshkosh store is to the consumer, the better the performance. So we had positive comps for Oshkosh in the second quarter from the brand stores, from the side-by-side stores. We're not concerned that by opening up more Oshkosh stores it will put more pressure on our goals to achieve that 14% operating margin by 2018. It actually supports it.

Thank you.

You're welcome.

Steph Wissink, Piper Jaffray.

Thanks, good morning everyone.

Mike, I wanted to focus on your longer term guidance: the $4 billion in revenue and that 14% that you just mentioned. Can you help us understand what the complexion of the business might look like out a few years relative to the segment driver. It seems like wholesale may be stepping down a little bit. Retail stepping up, and then international contributing a bit more. Can you help us appreciate what the puts and takes are as we look forward in a few years?

Your understanding is correct. We are planning low single digit growth in wholesale. Our wholesale business. And that currently is under a bit of pressure. We're still hoping our wholesale sales this year are comparable year-over-year. Some of our wholesale partners are going through some changes in their business. We hope those changes work for them. And that we grow off of a different base of business. But we still believe there is some growth possible for wholesale. That was not the lion share of the growth. The biggest growth driver in our long-term plan is through these side-by-side stores.

Our objective is to open up 250 side-by-side stores. When you open those stores, they contribute some portion of about $2 million in the annual sales. It's a wonderful half-billion dollar growth opportunity. As we open these stores, we're seeing an interesting lift in e-commerce sales where those stores open up relative to the adjacent trade areas. So we are seeing the benefit in e-commerce. We've certainly seen that in our Oshkosh brand.

Oshkosh e-commerce comps were actually better than Carter's comps in the second quarter. And that's unusual. Usually nothing outperforms Carter's. But Oshkosh, at least online, did in the second quarter. And then international, we are expecting double digit growth in international. Lots of ways to grow. The two big growth drivers in international will be Canada. Because there is more room to grow in Canada. And China. But we also have well over 20 partners representing our brands in over 60 countries.

Good retailers working hard to grow their businesses and ours. And so, the two big growth drivers for international will be Canada and China. That's our expectation. This is the way I think of the business. Think of low single digit growth in wholesale, think of high single digit growth in store sales, think of double digit growth in e-commerce and international sales. Those are our growth objectives.

That's very helpful. Thanks.

And as a follow-up to that. Can you remind us what level the international or the China business specifically becomes accretive? I think you called it out as drag in the quarter. Can you help us appreciate where that curve starts to bend?

I'm trying to understand your question. International sales?

On the China specifically. I think that was what was called on.

China made money in the second quarter. It's modest. Keep in mind, China e-commerce, is, we hope is some portion of the $20 million business this year relative to the $3.2 billion. China is not a drag on earnings right now. It's a modest contribution.

Steph, we have some other startup costs, as well, in China that are coming through the P&L. There's distribution center expenses, building some of infrastructure capabilities that we will need long-term. So, in addition to China e-commerce -- Mike's correct, made a small amount of money. It is a smaller margin business today than more mature parts of the portfolio. But we're making good progress, but we are making some investments there.

All right. Thanks.

Jim Chartier, Monness, Crespi & Hardt.

Morning, thanks for taking my questions. First, it sounds like the larger size initiative maybe exceeded your expectations last year. Is that opportunity bigger now than you originally expected? And do you plan to go into higher sizes for Carter's going forward?

We are very pleased with how it's going. We did sell out last year. We sourced a bunch more, as Mike noted, of size 8 this year. I don't know that we're prepared to give an exact number in terms of revenue impact this year.

But we've also added size 14 for Oshkosh. That is on plan out of the gate as well. So, we will continue to role those out. I think we have an opportunity in our stores and online to grow that.

I'd like to think that could help us grow the business with our wholesale partners as well. Several of them have taken part in the size 8 in Carter's. Some have not, based on how their floors are laid out and organized. Let's hope that's the case. And we started to, take Carter's, we'd like to have the life of the consumer extended with us. So, we started with size 8 and we feel good about that. If that makes sense, maybe we go higher at some point.

Great. Richard, just wanted to get some more specificity on the impact that you're assuming for the international component of your comp sales. Do you expect that to still be down? And a drag on comp sales in the back half of the year? Or do you expect that to get to flat in the back half? Thanks.

We do expect that, in the stores component in particular, it will be down in the second half. Although at an improved position relative to what we've seen recently. But still pressure in the second half.

Great. Thanks. And best of luck.

You're welcome. Thank you.

John Kernan, Cowen.

Good morning everyone, and thanks for taking my question. Can you help us understand SG&A dollar growth or SG&A as a percent of sales in the back half? Obviously, there's still some square footage growth to come. It sounds like there's more investments in IT and China as well.

Sure John. We continue to shift the balance of the business to the higher SG&A format businesses that we have. Retail stores, e-commerce: they are much higher SG&A as business than wholesale. We have mentioned we have taken down our forecast for wholesale.

We would expect the SG&A rate will continue to increase. There are some discrete investments that we're making around some IT technology. Some infrastructure, and some discrete projects to help the retail business to build out our omni channel capabilities.

That funding will continue to some extent. Those projects are little bit behind where we thought they would be from a spending point of view at the first half of the year. So some of that spending shifts forward. We have a couple discrete consulting engagements that are also running here in the second half of the year. Those will both drive up the dollar amount of SG&A and the rate in the second half.

That's helpful. Thanks.

Can you help us also understand the durability of lower product costs as a benefit to your gross margin? For what it's worth we've seen cotton pick up a little bit in recent weeks.

You're right. Cotton has gone up at least a dime. And so we are keeping an eye on it. Oil continues to be favorable. Freight continues to be favorable. Probably the most single largest impact on our cost going forward will be global capacity, which is abundant, given the overall weak demand for apparel globally.

We are one of the few apparel companies growing. We are seeing hungry manufacturers eager to do business with us. And working with us to meet our cost objectives. So, we have visibility through Spring 2017 for product costs. And we are expecting those costs to be down. Working on fall 2017 probably by October, we will have some indication of how costs are trending in the second half of 2017. But our visibility into the first half of 2017 is good. We expect a lower product cost in the first half of next year.

That's helpful. Thanks.

And one final question. Congratulations on the big acceleration of Carter's same-store sales. Can you help us understand the drivers of the operating margin decline on the improved sales?

I would say the timing of stores openings. Keep in mind, second quarter is the lightest quarter of the year. So the store expenses are relatively the same from quarter to quarter. You will start to see improvement in the second half of the year. So, the deleverage you see in the second quarter segment profitability for retail you will see that improve. We expect that will improve meaningfully in the second-half. And still will be a bit of deleverage for the year. But not as significant as you are seeing in the second quarter.

Okay. Thank you. Best of luck.

Thanks very much.

Janet Kloppenburg, JJK Research.

Good morning everyone.

I was wondering if you could talk a little bit about your Spring 2017 wholesale outlook? I think you said it may be down year-over-year. I was wondering if you could help us understand if that's just ongoing conservatism by mid-tier department stores? Or something else? Or perhaps the international wholesale business? Or if you're seeing increased competition there, maybe from owned brands or other new competitors in the marketplace.

I think as we said a few minutes ago, we do plan to see the Spring 2017 bookings lower than last year. We've got a ways to go. A lot of our mass bookings are not even in yet. They book a little bit later. That is primarily a mall-based department store issue. We're optimistic with the sum total of the account base the rest of the account base. That we continue to have good performance. This represents somewhere around 15% to 16% of our wholesale business. And we would project that would be down.

As far as competition, you've got some of these folks at department stores particularly, that are trying to make a go of it. And drive traffic, and they have strategic shifts and they certainly do lean on the private label. They make different decisions on their business and trying to have unique products. In terms of new competitors we would say no, we don't see new competitors. There are always the ups and downs and shifts of folks growing and right sizing their private-label businesses. I would say it's fair to say that is going on in department stores.

Great. And just specifically on the outlet stores, I know the international-oriented traffic stores are down deeply. Are you seeing improvements in outlet store malls where it's primarily a domestic customer?

Domestic demand generally has been good. We track credit card data. And so we can see the domestic demand for the brands is good. But international is down. As I've shared with you, online we are starting to see improvement. In the stores, we are starting to see some improvement in some of the larger international tourist locations.

Time will tell. We expect it to improve in the second half. The unknown is timing. When will it start to moderate. We are assuming some moderation more so online than the stores based on our experience to date.

And one last question on the wholesale channel please. If that business continues to be under pressure, should we expect operating profitability in that channel to also be under pressure?

It may. Time will tell. We are not forecasting it for the year. We're forecasting margin expansion for wholesale this year.

But time will tell. Because we don't have all of the Spring bookings in yet. But in October we will have better visibility to it for you.

Also, I think you made some reference to inventories may be being a little bit higher in the channel. And I wondered if you to have some markdown reconciliations with the stores?

We have a different model with our wholesale partners. An upfront discount model. To answer the question is no. To reiterate, in inventory, yes there is some inventory that's elevated somewhat in some of the product categories. Play wear sold-through the best. Some of the other categories did not have the sell-through that folks plan for many different reasons.

There are some pockets out there. But we booked flattish to up modestly for fall. So, in totality we're not very concerned about it.

Okay. Thanks so much for your time.

Our pleasure.

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

Thanks very much. Thank you all for joining us on the call. We appreciate your interest in our business. We will update you again on our progress in October. Goodbye.

This does conclude today's conference. Thank you for your participation. You may now disconnect.