Carter's Inc (CRI) 2016 Q3 法說會逐字稿

Welcome to Carter's Third-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 third-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. 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. Please go ahead, sir.

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

We're heading into the final weeks of what we expect will be another good year for our Company. Earlier today, we reported a record level of sales in earnings in our third-quarter. We outperformed the market and continue to gain share. We achieved good growth in our retail, wholesale and international businesses. We saw very strong demand for our brands online, including improvement in demand from international consumers shopping with us again in the United States. And with the help of our new wholesale partner, our first Carter's store was opened in China recently.

All-in-all, good progress in growth in the third quarter, though at the lower end of what we thought was possible. Our biggest challenge in the quarter was sluggish domestic demand for our fall transitional products in late summer, which caused promotions to be higher than planned. We had good growth in July and September, but saw an unusual decline in demand in August. It was our toughest month in terms of comparable sales and profitability.

Less seasonal products, like shoes and socks, comped positively. Fall playwear and sleepwear did not. The west region, historically a bell weather in seasonal transitions, had a solid mid-single digit comp, however the other regions comped negatively, the weakest comp in the southeast.

In recent years, we've improved the Wear Now mix of our product offerings during the seasonal transition periods, but our performance in August suggests more progress is needed. With cooler weather arriving in more parts of the country, we've seen an improvement in sales. We continue to see very strong demand over the holiday shopping periods. We had double digit comp increases in retail sales over the week-long Labor Day and Columbus Day holiday promotions at better margins than last year.

We believe we have strong product offerings and marketing events planned for the upcoming holidays. We're hopeful we'll see a strong finish to the year similar to our experience last year.

Some of our best performing stores in the quarter were our side-by-side stores. We continue to believe that having our two brands together provides a better experience for consumers. Since starting this initiative three years ago, we have seen an improvement in consumer feedback on key brand attributes for both Carter's and OshKosh.

We've also seen a meaningful lift in e-commerce sales for both brands driven in part, we believe, by the convenience of shopping online and in our stores which are increasingly located closer to consumers. Over the past year, we have tested what we expect will be the next generation of our store model which replicates the successful co-branded store model in Canada.

Given the evolution of online shopping, we believe a smaller store and more focused product offering, will provide an even better and more convenient shopping experience for consumers. This new store model has an edited assortment of the most productive styles for Carter's and OshKosh B'gosh in a 5,000 square foot location, about 30% smaller than our side-by-side store model. This is a proven store model in Canada and will be tested in 20 US locations this year.

Our test this year included converting some of our stand alone Carter's stores to a co-branded format with the best of Carter's product up front and the best of OshKosh in the back of the store. Year-to-date, the comp sales for these co-branded stores are meaningfully better after conversion, and better than the total chain comp.

We believe the economics of this new store model are more attractive than the side-by-side store model, with lower CapEx, higher productivity, and a higher return on investment. We also believe this smaller, more productive store model will open up more and better real estate opportunities for our brands.

Given the success we've seen this past year with this initiative, we've planned to shift the mix of future store openings from side-by-side stores to co-branded stores beginning next year. We plan to open 200 or more of these stores over the next four years.

With respect to our wholesale business, we expect sales for the year to be comparable to last year. In July, we briefed you on our outlook for Spring 2017 bookings, which at the time, we expected would be lower than Spring 2016 with certain mall-based retailers planning more conservatively next year. Our current outlook for Spring 2017 demand is consistent with our update in July.

To pursue new opportunities for growth, we have made progress this past year developing plans to establish a direct relationship with Amazon. As you may know, the best-selling brand in newborn apparel on Amazon has been Carter's. We find this interesting, especially because we don't sell to Amazon directly.

Over the past year, we've been working with Amazon to develop a product offering that provides a better experience for their customers. We'll make our initial shipments to Amazon this fall and expect this new relationship to build to a more meaningful level in the years to come.

With respect to our international business, we had double digit percentage growth in each of our retail and wholesale businesses. We saw good growth in Canada in the third quarter, which represented two-thirds of our total international sales.

Our latest market share data suggests we have strengthened our number one market share position in Canada this year. We expect Canada will continue to provide a good source of growth for us.

We believe the next largest source of growth in international sales will be from China. The annual births in China are four times that of the United States. In recent years, we evaluated several potential partners to help us extend the reach of our brands in China. Alibaba's Tmall website was a logical choice for us given its strength in the market. We launched with Tmall last year and our Carter's brand has been consistently ranked among the top ten selling brands in young children's apparel.

Our market research indicated the importance of a physical store presence to complement our e-commerce capabilities. We're announcing today a new wholesale partnership with Pou Sheng, $2 billion publicly traded retailer of popular brands in China, including Nike, Skechers, and Levi's.

This past year we've been working with Pou Sheng to explore the potential of store openings in China. The first Carter's store was opened in September in Nanjing. The second store was opened last week in Xiamen. Both stores have been beautifully executed.

Our plan is to support Pou Sheng in its efforts to open 10 or more stores in the balance of this year, 40 or more next year, and 200 or more stores over the next five years. We believe this relationship with Pou Sheng, together with Tmall, will enable us to extend the reach of our brands to more consumers in China and may support our objective of $100 million in sales in China by 2020.

This initiative is an important component of our plan to double our international business to over $600 million, or 15% of our total company sales, by 2020.

With respect to our supply chain, we continue to make good progress with our direct sourcing initiative, with nearly 47% of our products now sourced directly from suppliers. We believe this initiative has created a more competitive sourcing model for us. We plan to increase the mix of direct sourcing to 70% by 2021.

To support this initiative, we are shifting more of our sourcing leadership and decision-making authority to Asia. We believe this next phase of our direct sourcing initiative will improve the efficiency of our sourcing process and contribute to our earnings growth objectives.

We now have a bit more visibility to Fall 2017 product costs. We're still in the negotiation process, but are receiving indications from our suppliers that they can support our objectives for cost reduction next year.

Cotton prices have increased since last year and labor rates are rising, but the rate of growth has moderated. Thankfully, global capacity at our cost objectives continues to be plentiful. We'll have a good update on 2017 product cost to share with you in February.

In summary, we believe our multichannel, global business model will enable us to outperform the market and continue to gain share. Despite the challenging retail market, we believe we're on track to achieve a record level of sales and profitability this year, which would be our 28th consecutive year of sales growth.

More importantly, we believe there are many opportunities to strengthen our business and achieve our long-term growth objective of $4 billion in sales by 2020.

The children's apparel market is stable and forecasted to grow in the years to come, driven by favorable demographics, and an improving trend in annual births. No other company has our market presence in young children's apparel and we believe we're well-positioned to benefit from these improving trends.

I want to thank all of our employees in North America and in Asia who are committed to helping our company provide the best value and experience in young children's apparel.

In 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.

Thanks, Mike. Good morning, everyone. I'll begin my comments on Page 2 of our presentation materials with some highlights for the third quarter.

Third-quarter is an important quarter for us and we posted good growth in sales and earnings. Our results were towards the lower end of our previous guidance.

Consolidated net sales grew 6% and virtually all components of our business posted year-over-year growth. Overall, higher promotional activity in our US retail businesses negatively affected our gross margin in the quarter. Our spending was lower than we had forecasted, but this upside wasn't enough to offset the top line in margin pressure.

We believe consumer demand, broadly speaking, was weak in the marketplace, likely influenced by unusually warm weather across the nation in the quarter.

Adjusted operating income was comparable to last year at $131 million. Adjusted operating margin declined by 80 basis points, reflecting gross margin improvements that was more than offset by planned spending against several key growth initiatives. Adjusted earnings per share grew 6% to $1.61.

Moving to Page 3, with a recap of our sales performance in the third quarter. Our Carter's businesses in the US grew 5%, driven by good growth in both of our retail and wholesale segments. Carter's retail segment comparable sales grew 2%.

Our OshKosh business in the US also grew nicely at 6%, driven by strong growth of 9% in the retail segment. OshKosh retail comparable sales grew 4%.

International posted the highest growth in the third quarter at 12% on a reported and constant currency basis. Our Canadian stores and e-commerce businesses, sales to wholesale partners and overseas markets, and our e-commerce business in China all contributed to growth in this segment. And for the first time in a number of quarters, movements in foreign currency exchange rates were not a drag on our reported revenue.

I'll speak to our business segment results in more detail in a moment.

Turning to our third-quarter P&L on Page 4, building on the 6% growth in net sales was an expansion in consolidated gross margin of 80 basis points to 41.7%. This performance reflects favorable product mix and product costs versus a year ago, partially offset by higher promotional activity in our retail businesses.

Adjusted SG&A grew 11% in the third quarter. I'll provide additional color on SG&A in a moment.

Royalty income declined by $2 million, reflecting, in part, the insourcing of certain product categories that were formerly licensed and lower international royalties as we've continued to convert international licensees to wholesale relationships.

Our weighted average share count declined approximately 4% compared to last year, reflecting our share repurchase activity. So, on the bottom line, third-quarter adjusted EPS was $1.61 up from $1.52 last year.

Moving to Page 5 and SG&A, we planned SG&A to be higher in the third quarter and the 11% growth versus last year was well below our forecast. Our retail team did a good job in pulling back on spending in response to the uneven demand trends during the quarter. As in past quarters, growth in our store portfolio in the US and Canada and the significant growth in global e-commerce volume, drove the majority of the increase in consolidated SG&A.

Planned initiative spending in the quarter included technology investments in omnichannel capabilities, implementation of a new corporate financial system, and investments in our business in China. We expect the year-over-year growth rate in spending in the fourth quarter to be lower than in the third quarter.

Pages 6 and 7 summarize our year-to-date performance. Through the first three quarters of the year, we delivered top and bottom line growth of 5%. Coming in to 2016, we had planned for higher earnings growth in the second half of the year, given the anticipated impact of lower international consumer demand in our US retail businesses in the first half of the year. We've seen some stabilization in international consumer demand in the US and hope this trend continues into the fourth quarter.

Now turning to Page 8 with several balance sheet and cash flow highlights. Quarter-end inventories grew in line with our forecast at plus 8%, this growth aligns with our higher store count and e-commerce volume versus a year ago and our near-term sales forecasts. We believe inventories are in good shape as we enter the fourth quarter.

Operating cash flow for the first three quarters was $117 million compared to $146 million last year. Movements in working capital, principally related to the timing of inventory payments, drove this decline. Consistent with past years, we expect to generate a good amount of our annual operating and free cash flow in the fourth quarter.

Year-to-date capital expenditures were $71 million, down somewhat compared to last year of $77 million. Notable areas of investments this year include new stores in the US and Canada, as well as various retail and enterprise information technology projects.

In the third quarter, we continued to return capital to shareholders. During Q3, we returned a total of $75 million in share repurchases and dividends. Through the first three quarters of 2016, we've returned a total of $289 million to shareholders, comprised of $239 million in share repurchases and $50 million in dividends. As of 2013, we've now returned over $1 billion to shareholders.

Page 10 summarizes our business segment results in the third quarter. Our US wholesale businesses delivered stronger operating margins. Profitability in our US retail businesses declined, in part due to expense deleverage due to lower store comparable sales, lower gross margin due to higher promotional activity, and higher spending on new stores and technology projects.

International segment operating income increased on strong top line growth, but operating margin declined versus last year, in part due to retail store expense deleverage and China start-up costs.

So, in total, third-quarter consolidated adjusted operating income was comparable to the prior year at $131 million and adjusted operating margin was 14.6% compared to 15.4% last year.

Moving on to our individual business segments in more detail, beginning with Carter's wholesale on Page 12. Net sales for Carter's wholesale in the third quarter grew 4%. These results were somewhat better than forecasted, due to some earlier than planned customer demand. Carter's wholesale segment operating profit was $82 million compared to $74 million last year. Segment margin improved by 130 basis points to 22.9%, reflecting a higher gross margin driven by a more favorable product mix than a year ago, as well as supply chain efficiencies.

Through the first three quarters of the year, net sales in our Carter's wholesale business have grown 2%. For the full year, net sales in this segment are forecasted to be comparable to up slightly over last year.

As noted on our last call, we anticipate Spring 2017 bookings will be down year-over-year, principally due to lower demand from mall-based retailers. These lower bookings are expected to negatively affect net sales in the fourth quarter, as we being shipping Spring 2017 product in December.

Turning to Page 13 and the Carter's retail segment. Total Carter's US retail segment sales increased 7% versus last year. Carter's retail segment same store sales grew 2% over last year. Store comps declined 4%, reflecting lower consumer demand which we believe was driven by unseasonably warm weather across much of the country.

As Mike said, we saw better performance in regions where temperatures were more seasonal, such as the west, which comped positively.

E-commerce demand was strong in the quarter with a comp increase of 25%. It's notable that e-commerce represented almost 25% of Carter's retail segment sales in the quarter.

Store comps continued to be pressured by lower demand from international consumers, but to a lesser extent than in previous quarters. In the third quarter, we opened 13 new Carter's stores and closed one. Over the last year, we've added 59 net new Carter's stores in the US.

Carter's retail segment profits in the third quarter were $48 million compared to last year's $52 million. Segment operating margin declined by 220 basis points, principally driven by store expense deleverage, higher promotional activity, and higher distribution expenses.

On Page 14, we've updated our analysis of comp trends in our US retail businesses. As discussed on our last several calls, we believe the strength of the US dollar against many other currencies has adversely affected demand from international consumers shopping in our US stores and on our website.

During the third quarter, we saw demand from international customers stabilize as year-over-year exchange rate comparisons became more favorable. We estimate that third-quarter retail comparable sales from international consumers grew modestly, in contrast to the significant comp declines that we've experienced over the past four quarters.

International demand trends improved in both stores and online, with more meaningful improvement occurring in our e-commerce business.

While we saw the trend in international consumer demand improve, we saw weaker demand from domestic consumers in our stores in the quarter, driven in part by lower demand for fall product which we believe was the result of unusually warm weather around the country. We are forecasting continued improvement in international demand in the fourth quarter.

Pages 15 and 16 contain portions of the latest Carter's direct mail piece, featuring our latest baby collections and sleepwear for the winter season.

Now moving to page 17 and OshKosh retail segment results. OshKosh total retail segment net sales grew 9%, driven by strong performance in e-commerce and the contribution from new store openings.

OshKosh retail comparable sales grew 4%, comprised of an e-commerce comp growth of 35% and a decline in store comps of 3%. Drivers of the OshKosh store comp decline were similar, we believe, to that in Carter's, namely lower consumer traffic due to unseasonably warm weather and softer demand from international consumers in our stores.

In Q3, we opened seven new stores and closed two. Over the last 12 months, we've opened 35 net new OshKosh stores. We ended the third quarter with 127 side-by-side format stores, which now represent nearly 50% of the OshKosh store portfolio. These stores comped positively in the third quarter.

OshKosh retail segment income in the third quarter was $3 million, compared to last year's $6 million. Segment operating margin declined by 380 basis points, due to the same factors affecting Carter's retail, store expense deleverage, higher promotional activity, and higher distribution expenses.

Pages 18 and 19 are selections from a recent OshKosh direct mail piece, which highlight our newest products for fall.

On Pages 20 and 21, as Mike mentioned, we've been testing a new co-branded store format inspired by the success of our stores in Canada. As the photo on Page 20 indicates, the external store signage features both the Carter's and OshKosh brands. On the inside, on Page 21, the front of the store features Carter's product while OshKosh is presented in the back of the store. We continue to test and refine this concept and initial results are encouraging. We have approximately 10 stores in this format currently and plan to have approximately 20 open by the end of 2016.

Moving to our international segment on Page 22. Our international segment achieved solid growth in the third quarter. Net sales grew approximately 12% on a reported and constant currency basis. Canadian retail comps increased approximately 2%, driven by very strong e-commerce comp growth of 37%. Store comps were roughly consistent with the prior year and were adversely affected by lighter consumer traffic, which we attribute to warmer than usual weather. Comps so far in October have been strong, particularly as weather has turned colder across Canada.

Our international e-commerce business grew 18% in the third quarter, driven by the strong growth in Canada that I noted, with additional contributions from our Tmall business in China. Third-quarter net sales in the wholesale component of our international segment grew 15%, reflecting higher demand across multiple markets.

International segment operating income in the third quarter grew 8% to approximately $20 million. Segment operating margin declined by approximately 80 basis points to 18.5%, principally due to store expense deleverage in Canada, growth investments in China, expenses related to the relocation of our Canadian office, offset, in part, by stronger gross margins.

We're excited about the opening of the first Carter's retail stores in China as Mike mentioned. Pages 23 and 24 include pictures of the new stores in Nanjing and Xiamen. These stores are approximately 1,000 square feet and are located in enclosed shopping malls. Initial results have been good. We expect to have 10 or more stores open in China by year-end and are developing plans with our partner Pou Sheng for 2017 store openings.

Now turning to Page 25 for our outlook for the fourth quarter and fiscal 2016. For the fourth quarter, we expect net sales to grow approximately 5% to 6%, principally driven by growth in our U.S. retail and international businesses. We are forecasting fourth-quarter adjusted diluted earnings per share in the range of $1.65 to $1.70. This represents growth of approximately 18% to 21% compared to an adjusted EPS of $1.40 in the fourth quarter of 2015.

This forecasted earnings growth for the fourth quarter contemplates gross margin expansion, a lower growth rate in spending than we've posted earlier in the year, and the cumulative benefit of share repurchase activity.

For full-year fiscal 2016, we continue to expect net sales to grow approximately 5% to 6%. We are forecasting good growth in profitability in 2016. We've refined our adjusted EPS outlook to a projection of growth of approximately 9% to 10% compared to 2015's adjusted $4.61 per share.

We expect 2016 will finish as another good year of operating cash flow generation and our forecast for CapEx is now around $105 million, roughly comparable with last year's level. Risks that we continue to monitor include inconsistent trends in consumer demand, the level of promotional activity in the marketplace, foreign exchange rates, and consumer sentiment as the presidential election cycle concludes.

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

(Operator Instructions).

Susan Anderson, FBR Capital Markets.

Good quarter in a tough environment. I was wondering if you could talk about just your expectation for wholesale in the fourth quarter. It looks like I think maybe you said it got pulled forward a little bit. But yet, we're still seeing you maintain your top line guidance. Maybe if you could just give some color around what you're expecting. And then if you have any early thoughts also on Fall 2017?

Fourth-quarter we will be down slightly. What's going to happen is the spring bookings which Richard talked about are down I'd say mid-single digits. And some of that gets pre-shipped at the end of this year. So, that will impact fourth-quarter.

All in, we're still projecting sales for the year of flattish to up 1%. We feel good about that given the environment. And as we've shared before on prior calls, the primary softness we're seeing there is mall-based department store bookings which is going to result in about 15% of our wholesale business.

The non-mall-based bookings are up. But we still feel like demand is strong for our brands. Going forward, we see opportunities for growth in the wholesale business and continue to help our key accounts with their store business and their really strong and growing e-commerce businesses as well as starting a closer relationship with Amazon as Mike shared.

And then is there any early color on Fall 2017 at all?

I would say too early to tell. We just finished up design. We think it's beautiful. The samples will be coming in and we'll be costing that product, but we haven't taken that to the market yet.

But there's obviously learnings that we've had from this year. We've done a lot of things well. We've got some other learnings in terms of Wear Now product and some other things that we want to continue to improve upon for the customers. So, we're optimistic about it, but too early to comment on it.

And then just one follow up on Amazon, so obviously exciting to hear that you're now going to be officially be selling on Amazon. Maybe if you could just give any thoughts around how big you think this could be. Or is there an impact on the first shipments for fall to the numbers? And then if you have any color around the dollar amount maybe that they're currently selling through third party?

I'd say too early to comment on volume going forward. I think you know, there's thousands of products on their site today. Most of them are third party sellers. We don't have data on exactly what that amount is. But Carter's is the best-selling brand on the site.

So, we've got a good relationship with them. Our licensees sell to them today. Given the strength of our brands, we do think it's an opportunity to work with them actively and we want to distribute our product where Mom is shopping for young children's apparel. And she's clearly shopping at Amazon.

So, we'll have more to share on our upcoming calls, but safe to say that we're working on an assortment strategy and products which we think will differentiate the experience for Mom on Amazon.

Anna Andreeva, Oppenheimer Capital.

A couple of questions from us. Guidance for the fourth quarter, you're guiding a little bit above The Street. I guess what are you seeing in the business quarter-to-date to give you that confidence? Should we expect bigger gross margin expansion in the fourth quarter compared to 3Q? And has store comps turned positive with cooler weather across all the banners? I think you just mentioned Canada improving.

And also, I know you're not giving guidance for 2017, but you've grown earnings now double digits for a number of years. Maybe talk about the levers you have in place to continue growing in that low double digit range looking out. Should we expect to start seeing maybe some SG&A favorability as some of the investments roll off?

On the subject of gross margin, we are expecting gross margin expansion will be year-over-year above what we posted in the third quarter. There's a few things that contribute to that. We continue to benefit from lower product costs. FX is a bit less of a drag than it has been, particularly in Canada.

We're up against comparisons last year where we were heavily discounting to clear inventory that had been procured for those international consumers who weren't in our stores. So, we're certainly hoping that our level of promotional activity is going to be below a year ago.

And then serially, the mix of our retail business is a combination of stores and e-commerce. It is much more significant in the fourth quarter. So, clearly for third-quarter that's a benefit in fourth quarter margins.

As it relates to earnings expectations, we certainly pride ourselves on delivering those double digit earnings results. That would be our objective going forward. So, we'll share more on our next call as it relates to 2017 guidance.

What about comp quarter-to-date? Is that across all banners?

The comps quarter-to-date? Is that the question, Anna?

Have comps turned positive?

They have. Actually, the store comps quarter-to-date are flat and we've seen at least a point of comp improvement since the third quarter. And when you take in consideration the impact of the hurricane that rolled through Florida and the east coast and some of the disruptions from the Hanjin bankruptcy. But the comps in the fourth quarter are meaningfully better than the third quarter.

[Robert Ohmes],BofA Merrill Lynch.

This is Dan O'Hare on behalf of Robby Ohmes.

Can you give us an update on how the Rewarding Moments sign-ups are going and then how buy online pick up in store is doing? And any plans to promote those during the holidays. And then also do you have any plans to implement ship from store?

Rewarding Moments we feel good about. We just anniversaried the first full year of that program. We've got about 10.5 million folks signed up. We're really happy about that. About 90% of the transactions are associated with Rewarding Moments. So, we feel like we're doing the right thing for our customers. Add we've got a rich database and have gotten to know them well, so we feel good about that.

You asked about buy online ship to store, that has been a good program for us. We think we've got about 10% of the folks taking part in that buy online ship to store. When they do come into the store, we feel good about that because they like the experience and about a third of them are actually buying additional products when they come in.

And then the other thing that we're working on which we're actually just starting to roll out now is a save the sale program. So, we've upgraded our point of sales systems. We've invested in technology in the stores. And one of the things the guests gave us feedback on is when they're in the store and she can't find her size or color in a beautiful product that she likes, she's frustrated. So we reacted to that with a new point of sales system. The software we've put in, we're able to go ahead and order that out of the distribution center as part of a transaction and go ahead and ship that to her home.

So, that's something that we're rolling out across the country as we speak.

My next question is on China. How did you come up with 200 as being the right number of stores to build over the next five years? Just given how big the market is, I'm just wondering why 200 is the right number?

I'd say it's a starting point. We've been working with Pou Shang for the past year. The important thing is to get the first group of stores off to a good start. And if those stores perform well, we should expect 40 or more stores opened next year. If those meet our expectations and Pou Shang's expectations, we would expect 200 or more stores opened over the next five years. So, it's early.

A lot of people have rushed in to China. And not had a good experience. Our plan is to have a good experience in China. But we're going to do it thoughtfully and over time. Those stores, together with our e-commerce capabilities, should be a good source of growth for us over the next five years.

And then my final question is, can you just remind us where e-commerce sales are with Tmall?

We're expecting e-commerce sales this year with Tmall to be somewhere around $13 million.

Jim Chartier, Monness, Crespi, & Hardt.

First, can you just talk about how bookings translate into sales? So, for spring of 2016, I believe bookings were at mid-single digits the first half. Wholesale sales for Carter's were only at 1%. So, can you just talk about how the replenishment factors into that and what you're expecting from replenishment in the first half of next year?

There's a lot of different variables. You've got spring bookings. You've got fall bookings and you've got replenishment. Replenishment is not pre-booked. The orders go out to service the demand. So, that's about 25% of the business, wholesale. So, you've got different variables.

You asked about when the revenue is recognized. Obviously the revenue is recognized when we ship it. But from a spring standpoint, for instance, we've got a good portion of the spring product that actually pre-ships out in November and December of the prior year. So, that component is out there.

And then you've got your replenishment piece, that's a good part of business and the fall piece. So, several moving parts to it. But again, we talked about the wholesale business before. We feel good about it overall. Although the spring bookings were down, mid-single digits, just to keep that in perspective, about $20 million reduction of a $1.1 billion wholesale business.

So, we would like it to be better. But in the near term, we'll weather that and we think we'll be stronger over time.

Would you expect, I guess replenishment was probably softer this year given the strong bookings. Would you expect a better replenishment business in the first half of 2017?

It's too early to tell on that. Replenishment trends have been mixed across our Carter's brands. We had strong trends on our mass business. I would say we're somewhat below our expectations in the other accounts. The largest program we have out there for replenishment is the Little Baby Basics program which we launched in May. Online business for that program has been very good, in our channel and for our accounts, but the store business has not met our expectations.

So, we've got fall updates that we've launched. They're performing better than the styles that we launched in May. And we've got a meaningful update with Creative Refreshes that go out late November which will last until next April. We'll be optimistic, but too early to tell what the rate of replenishment will be for next spring.

And then on the co-branded stores, it's great to hear they're still out-comping the chain total. How are the earliest store openings performing, are they still comping strongly or has that tapered off?

They are. The side-by-side stores, I would say, are our best performing stores. We've tested something this past year replicating the successful model up in Canada. A co-branded store, it's a smaller store. It's an edited assortment. It's got the most productive styles for both Carter's and OshKosh in the store.

The things that we've edited out of the smaller box are fully available online. But it's a promising store model. We've always admired the good work done by our Canadian team with the smaller box. And we've studied that over the years and we've decided to test it this past year. The test results have been encouraging. It's a limited sample, but I'd say that we see a meaningful difference in terms of the comps for the chain in total and we think it's even a better model than the side-by-side store model.

We believe everything smaller is more productive. We think it's responsive to how the consumer is shopping. She likes to shop in the stores. She likes to shop online. Our consumer who shops in both the stores and online is the fastest growing segment of our customer database.

Today about 77% of our customers shop only in our stores. Some portion, about 13%, shop only online. And then the balance, about 10%, shop in both stores and online. They like the convenience of shopping online and then picking the product up in the store.

So, we think going smaller opens up, provides a better experience for the consumer and opens up more real estate opportunities for us. We've seen some very positive feedback from the mall owners on the smaller box. So, we think that potentially, if the test results in the balance of this year continue to be as good as they've been earlier in the year that might be a new model for us going forward.

We'll talk a little bit more about it in February. But based on what we've seen so far, we think we've got a new store model that we can start rolling out next year.

Kate McShane, Citi [Research].

Just with regards to your commentary on Wear Now. How much of your fall offering as a percentage do you think is Wear Now and where do you think it needs to go?

I hesitate to give an exact percentage. I would say these transitional periods have continued to evolve in the entire retail industry. You've got people buying closer to need. You've got weather that continues to change and be warmer. And at the end of the season, customers want a deal.

There's a lot of clearance product out there and as a retail environment, it's been tougher. There's a lot of clearance product out there. So, where the pressure comes on this Wear Now thing, most cases is in fall when you transition, then July August time period. We had a tough August. And then when you go into spring, January and February.

Depending on which way the weather turns, and all of us as retailers used to ship in that forward-looking product to get the fresh stuff in the store and everybody used to do well with it. And I think the market has changed. People generally buy closer to need.

So, it is a case where the last two years we have meaningfully changed our transitional programs to be more aware now with some layering pieces, Wear Forward for instance, as we go into fall. As Mike commented up front, particularly in August I would say, we've got some more work to do.

I think we had probably more collections than key items. And in those key items we want to make sure that they are transitional in nature. That they're not necessarily just cotton, they're not necessarily fleece, but maybe French terry or other items that can be layering in nature. So, we've got some more work to do, I would say. Just hesitate to give an exact percent.

And then my follow up question, you mentioned during your prepared comments, that you saw a good degree of success during the Labor Day week and the Columbus Day week, because of your marketing promotion. Can you walk us through with some more details about what was done for those two holidays? Maybe how it differed year-over-year?

The major holidays, the market tends to be more promotional and those two holidays we tend to run full store promotions. So, that would be something like 50% off entire stores. There are exceptions.

We have door busters which are really sharp price point items that don't have a percent off. And there are certain things that are excluded. But by and large, those are 50% off entire store events. The customer likes that. It's easy to do the math. And it's very competitive in the marketplace during those events.

You've got traffic that's coming out. And the outlet stores, people want to see a good deal and we tend to do well with those events. But those promotions, my recollection, is that they were comp promotions for the prior year and 50% off entire stores.

Better margins year-over-year, but it was double digit comp increases in our retail business. And that's been a consistent experience for us all year. The consumer demand is strong for the brands. It's just she comes out during the big events. And the peaks are higher. The troughs are deeper and a little bit longer than, what we've seen in years past.

But when we have the big holiday events, and typically these things don't last the weekend, they last typically for a week, but I think it's the clarity of the promotion. It's the strength of the product offering. I think our marketing capabilities have gotten better. I don't think our marketing has ever been better for each of the brands.

Our marketing team has built the capabilities to more personalize the marketing messages. So, I think that, together with the success of this Rewarding Moments loyalty program, I think we're doing a much better job getting the message out to the consumers, stimulating demand and getting them in to shop with us.

Ike Boruchow, Wells Fargo Securities.

Just two clarifications. On wholesale, I just wanted clarify, is a mid-single digit decline in spring orders what you were thinking when you last spoke to us in July? Or is that expectation come down at all over the last three months?

It's consistent with our belief in July.

And then just on the retail business, the shift to co-branded from side-by-side to some extent is, does that impact your footage growth profile at all? Should we continue to expect double digit footage growth next year and then how does that change maybe some of the retail margin declines we've been seeing for the last couple quarters?

It would change the square footage growth assumptions we would have had a year ago. But what we like about this model is the square footage is about 30% smaller. But the profitability, the return on investment, the CapEx investment, the gross margin profile is more attractive.

So, we think it's a better model going forward. We think it will likely open up more real estate opportunities for us. We'll have more to share with you in February. This is still in a test phase. But we continue to believe that we will have good growth in our store business. We'll open up 200 or more of these stores, more likely there'll be more co-branded stores than the side-by-side stores.

But we think this is a better model. A better experience for the consumer, more convenient for her to shop both brands, and if we can replicate the success that our Canadian team has had with this model, then I think it's a better way forward for us.

Stephanie Wissink, Piper Jaffray.

Just a couple of questions on your online, both wholesale and direct retail. Mike, if you could talk a little bit about some of your customer acquisition costs, your traffic metrics, anything to just give us insight into the composition of that 20% plus growth rate.

And then on Amazon, I think you talked about going direct, but I just wanted to clarify, are you going to be delivering inventory to Amazon or are they taking possession of it? Or are you going to be fulfilling those orders out of your own distribution centers?

The product will be shipped to Amazon. They'll fulfill the orders. And then in terms of the growth, I would say traffic to the stores has been down. I would say it's meaningfully better than the traffic data we've seen from Shopper Track.

But the demand online, the traffic to our website, the demand and the significant increases, particularly on mobile, we've been increasing some of our investments in the mobile experience. It is the number one way the consumer is interacting with our brand. She starts the transaction on her mobile device and that transaction either takes her to a transaction on the mobile device or drives her to the stores.

But we saw a significant increase in demand in e-commerce in the third quarter. The thing that's given a lift in our business, we started to see it a bit in the second quarter, we saw it more in the third quarter, was the return of the international customer shopping with us in the United States.

So, we have outperformed the expectations we had online. I think the international demand online on our e-commerce business was up about 12% in the third quarter. I think you know that's the best performance we've had in five quarters. It was down about 15%, the online demand was down about 15% in the first half. I think it was down probably closer to 20% in the second half of last year.

But was up 12% in the third quarter and up over 20%, if you exclude consumers from China. So, we're seeing that international consumer come back. If that performance is sustained in the balance of the year, I think we've got a good fourth quarter ahead of us.

We haven't seen the return as much in our stores as we had seen online, but meaningfully better. First half, traffic from transactions with international guests in our stores in the first half of this year, down 20%. And in the third quarter, it was down less than 7%.

So, the trend is up. That had a meaningful impact in our business starting in the second half of last year, we believe because of the stronger dollar, had a meaningful impact on our performance the first half of this year. But that is giving us a lift in our business in the second half of this year.

John Kernan, Cowen & Company.

Congrats on the Amazon announcement. I think some of the cloud of work that we've done here at Cowen suggests that they'll be the biggest apparel retailer in North America, will surpass Macy's next year in terms of total dollar volume.

Can you help us understand the economics of the wholesale relationship with them? From what we've heard from some of the other first party brands that are selling to them, the economics are even a little bit better than traditional wholesale because there's no markdown allowances and they don't cancel orders. So, just help us understand the economics as you ramp your first part of your relationship with Amazon.

I would say, I don't think Amazon would want us commenting on it, but I will tell you what you've heard, we've heard over the past year. People that we know who do business with Amazon, it has been a good relationship. It has been a profitable relationship. And so, our point of view is this is where the consumer is shopping.

I would encourage you, if you were to look on the Amazon website today and look under newborn apparel, you'll probably see some portion, about 50 brands, represented in newborn apparel. And parenthetically they show the number of choices on any one day that they're offering.

And when I looked at it recently, there were probably 12,000 choices listed for the Carter's brand. You have to add up the other 49 brands represented to come up to the total number of choices offered by Amazon for the Carter's brand. And we find it interesting because we don't sell to them directly.

So, we see an opportunity there. Amazon has been a good partner to work with over the past year exploring what's possible, working more directly together. Brian and his team are putting together some unique assortments that will provide a better experience for the Amazon customer.

But we are adding this to our wholesale business because this is where the consumer is shopping. And we expect it to be a good profitable relationship for us going forward.

One more question, when I looked at Street estimate for next year, there's a fair bit of margin expansion expected based on your guide. This year operating margins roughly flat. So, I'm trying to understand what could be the drivers of consolidated margin expansion next year? Is there lower SG&A growth? Is there better gross margin from some of the wholesale businesses in terms of product costs mix? What could drive margin improvement in your business as we look into next year?

I always focus on the operating margin. But operating margin expansion is still part of our plan. Just a few things I would share with you, and some of the initiatives we talked about this morning. But we will have, going forward, a higher mix of e-commerce sales. There's no doubt about it. That's been the trend in the business.

I think we've shared with you e-commerce is our fastest growing, highest margin business. So, we will have a higher mix of e-commerce going forward.

This co-branded store model we think is a much more profitable store model for us than the current store models. We'll have a higher mix of direct sourcing. That's created a much more competitive sourcing model for us. And we expect, based on what we know today, that we'll still be in a fairly favorable cost environment.

So, I'm hopeful that in February when we update you on our 2017 plan and longer term opportunities that will continue to show margin expansion.

Rick Patel, CLSA.

A question on your Amazon relationship. When you talk about your Spring 2017 bookings being down, are you including Amazon in that bucket or are you talking about like for like accounts?

And then also, do you expect to create differentiated assortments for Amazon? Or will it be a continuation of your best-selling lines, just how to think about the assortment there.

We're still working with Amazon on the spring component of the business. Keep in mind, this is a launch. This is a new relationship and a new opportunity. So, there will be a starting point and a growth path that we expect.

As far as assortments, going to kind of hold off to give a lot more color on that until the spring when we're comfortable in announcing that with our Amazon partners. But I would just say, safe to say it would be a differentiated assortment. We are broadly distributed. We think this is the right decision. But we will have a more differentiated product assortment on Amazon than we do for other customers.

Can you provide some more color on the wholesale channel in 3Q in terms of the benefit you got from product mix? Did you sell more products for older kids? Was it just more expensive items on like for like categories? And as we think about your outlook for Spring 2017, can this product mix benefit continue to offset some of the pressure you might be seeing from the order bookings?

A couple of different things. We had a benefit from product orders that moved in from Q4 to Q3. We had a benefit of lower costs which we projected we would have for fall. And we've got some of that for spring.

And in terms of product mix, we continue to have a good relationship with Kohl's. Kohl's playwear strategy has been a winning strategy for their company as well as ours. We're on our third season of good growth with them. So, we did have some higher UR playwear shipments go out in the quarter to support that strategy as well.

And we would hope that that strategy goes forward. We expect good growth with Kohl's. And we're bullish on our playwear business. It's an opportunity that we have in other accounts over time. They do tend to focus more on their private label playwear business, so it's a strategy we'll continue to pursue with other accounts.

I'm sorry if I missed this, but did you provide [terminal] store target updates for Carter's and OshKosh now that you have this co-branded store format that you're looking to scale.

We have not. We'll provide updated guidance, but we think we have still a number of years ahead of rolling out retail stores. Our hypothesis is that they'll be slightly smaller than the model we have been rolling out the last couple of years.

Janet Kloppenberg, JJK Research.

To clarify in the wholesale business, I think you're looking for to perhaps be down mid-single digits in the spring. If the mid-tier department store component is such a small part of wholesale, is there, are there other pressures going on there? Maybe I just don't understand the math of it. Maybe you could help me a little bit with that.

And I was also wondering about feedback from the mid-tier department stores. Are they just attempting to carry lower inventories to increase their returns? Or were there some merchandising issues there that maybe you can address and capitalize on for improved orders in the back half of 2017?

And just lastly, does the international consumer business pick up indicate that the outlet business is starting to improve?

The mid-tier department store business was down. It was down disproportionately. When you think about that, a couple causal factors. Their businesses collectively, I won't comment on any one retailer, but their businesses collectively have been challenged.

And so they are reducing inventories as they go into the holiday season and trying to make sure that they increase the returns and that they have the appropriate inventory level. So, I think I would say that in the market, as a collective group, they've been more cautious.

So, that's one factor. The second factor is there are some that change strategies. And there's some folks that I think feel that disproportionately growing a private label business as the strategy shifts may be the right thing for them as they try to drive traffic to their stores and differentiate from their competitors.

So, you've got a couple factors working in their business and then mall traffic, as we all know, has been down. So, there was a good clip in bookings from those folks. But to reiterate, our non-mall-based retailers as a group were up.

Overall, we'd love to see higher. But they're up, we felt good about that. And overall we feel good about our business. The biggest challenge that a lot of these folks have is their brick and mortar stores are down and they continue to go down based on traffic. Their e-commerce businesses are growing rapidly and we're supporting them and they're growing double digits. But that is a challenge out there.

And some of them are even closing stores. So, there's a lot of factors at play in the wholesale business, particularly in the department store channel.

I would just say, from my perspective, it's a right sizing of some of the book of business we had with them. If you recall last year, some retailers did not have a particularly good holiday season last year, so they rolled into this year with more fall and holiday product than they would have otherwise liked to have had. And that impacted spring selling.

So, with these mall-based department stores, my perspective is it's a bit of right sizing. They've got to correct the inventory levels so that they have better sell-throughs, better margins. We support that. We don't think that's a downward trend of the business that will continue. I think it's just a bit of a right sizing for their business.

You had asked about the return of the international customer. We are seeing a meaningful change in trends, particularly in our largest stores in Florida. So, the international consumer is coming back to those big, very profitable stores we have in the tourist locations in Florida. We hope that continues into the balance of this year.

Steve Marotta, CL King and Associates.

I just have one this morning. Could you amplify your comments a little bit on royalty income in the third quarter? What categories are now being insourced and what can we expect from that line item going forward? Because of that insourcing can we expect year-over-year declines for the next three or four quarters?

I would say there's some noise in the royalty line item this year on the P&L. Several factors, one, to your point, we have brought some categories in-house. Most recently, that's been blankets and cold weather accessories. That's been a good trade for us and improved margin opportunity. We think a better way of servicing our own retail stores and wholesale customers if we manage those ourselves.

So, that's been a good trade. We do give up some of the royalty income on that line of P&L, but we do pick it up elsewhere. There is, in effect, also that line item reports both domestic royalties and international royalties. We've continued to convert historically licensed relationships around the globe to wholesale relationships. That's also similarly profitable, but we give up income on the royalty line.

I think for the full year, we're planning to be down 4% or 5%, that's a couple million dollars. I would expect we'll see growth going forward next year in royalties.

Ladies and gentlemen, this will conclude our question and answer session for today. And I would like to turn the conference back over to Mr. Casey for any closing remarks.

Thanks very much. Thank you all for joining us this morning. We appreciate your questions and your interest in our business and we look forward to updating you again with our fourth-quarter performance in February. Good-bye everybody.

Ladies and gentleman, this will conclude today's conference. Thank you for your participation. You may now disconnect.