Welcome to the Carter's Second Quarter 2021 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer. [Operator Instructions] Carter's issued its second quarter 2021 earnings press release earlier this morning. A copy of the release and the presentation materials for today's call have been posted on the Investor Relations section of the company's website at ir.carters.com. Before we begin, let me remind you that statements made on this conference call and the company 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 and quarterly reports 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'd like to turn the call over to Mr. Casey.

Thanks very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I'd like to share some thoughts on our business with you. Earlier today, we reported record levels of sales and earnings in our second quarter. We continue to see a good recovery from the pandemic-related disruption last year, with strong double-digit growth in each of our Retail, Wholesale and International segments. Profitability is meaningfully higher than last year and significantly better than our pre-pandemic performance. Earnings in the second quarter were up over 70% compared to our second quarter 2019 earnings. Over the past year, we made structural changes in our business to help us weather the pandemic and emerge stronger from it. We focused our product offerings on fewer and better choices. We dropped low-margin styles and reduced product choices by over 20%. We then increased the mix of higher margin, longer life cycle product choices, including our new sustainable Little Planet brand and Bold Basics product offering. We ran leaner on inventories and reduced low-margin clearance and off-price sales. With a better mix of inventory, our marketing focused more on brand building and less on promotions. We strengthened our e-commerce capabilities during the pandemic last year to improve the experience for our high-margin online customers, including curbside pickup, same-day pickup and ship-from-store capabilities. We launched a new mobile app and invested in RFID capabilities that we believe will improve inventory accuracy, sell-throughs and margins. And we doubled our store closure plan to edit out lower-margin stores that have a low penetration of omni-channel sales. The collective benefit of fewer better product choices, fewer better higher-margin stores, a better mix of high-margin e-commerce customers, leaner inventories and fewer and better promotions drove a meaningful improvement…

Thank you, Mike. Good morning, everyone. I'll begin on Page 2 with our GAAP income statement for the second quarter. Net sales were $746 million, up 45% from last year. Reported operating income was $108 million compared to $21 million last year, and reported EPS was $1.62 compared to $0.19 a year ago. Last year's second quarter results were heavily affected in the early days of the pandemic by store closures, which began in mid-March and continued through the balance of the second quarter, and the suspension of shipments to many of our wholesale customers. Our second quarter results for 2021 and 2020 included unusual items, which are summarized on Page 3. We've treated these items as non-GAAP adjustments to our reported results to enable greater comparability and provide insight into the underlying performance of the business. My remarks today will speak to our results on an adjusted basis, which excludes these unusual items. On Page 4, we've summarized some highlights of our second quarter performance over the past 3 years. Given the significant disruption to our business and the broader marketplace in last year's second quarter, we expected to post good growth over 2020, which we delivered. As the chart indicates, we also delivered growth over our 2019 performance, especially in profitability. Certainly, the recovery from the pandemic has been a significant contributor to our performance, but we've also made some fundamental improvements to our business, many of which Mike just enumerated. We believe these factors will continue to drive our business going forward. Moving to Page 5 and our adjusted P&L for the second quarter. Building on the 45% increase in net sales, gross profit grew at an even greater rate 57%, to $369 million. Gross margin improved 370 basis points to 49.4%, a fifth consecutive quarterly record…

[Operator Instructions] Our first question comes from Susan Anderson with B. Riley.

Really nice job on the quarter. Good to see the rebound in the business there. I'm curious maybe if you can give a little bit more color on back-to-school this year. Everyone is talking about a record back-to-school. Are you expecting it to get back to normal in terms of timing, which maybe is why you're seeing the earlier wholesale demand? And then also, are there any early reads so far in July? Or any impact you've seen so far from the child tax credit?

Yes. We're expecting to see a very good back-to-school season to be comparable, if not better than 2019, and we're prepared for that. So -- and then as it relates to the child tax credit, we did see sales pick up mid-July relative to our plan. I would say it was a relatively short-lived and it was obviously a smaller benefit than stimulus check that was received earlier this year. But we saw business pick up, and it picked up for a week or so and then settled back down closer to our plan. So the nice thing about the enhanced child tax credit. Those are 6 monthly payments in the balance of this year. And then the second half of the annual benefit would be paid early part of next year. So we'll continue to see whether or not that continues to benefit us in each of the months in the balance of the year. But it's a meaningful benefit for families with young children. For children under the age of 6, I think the payment -- the tax credit improved by some portion of about 80% to about $3,600 a year for children under the age of 6. So it should be good for families with young children and might be a potentially good benefit for us.

Okay. Great. And if I could just add one more. I'm curious how you're thinking now about the longer-term operating margins with the performance in the quarter and your expectations for the year, are those -- I guess I'm curious how much of those margins are sustainable longer term? And does that change your longer-term outlook on the operating margins?

It does. What we shared with you earlier this year that we were targeting an operating margin of around 13% by 2025. We'll exceed that margin goal this year. So in the balance of the year, we'll revisit what our longer-term potential is based on the structural changes that we've made in the business. Our objective would be is to build on the strong margin performance that we're expecting this year.

Our next question comes from Jim Chartier with Monness.

I just wanted to touch on kind of the fourth quarter expectation. It looks like sales implied down on a 2-year basis, about 10% versus up 1% or 2% in second and third quarter. So any color you could give there would be great.

Jim, as I mentioned, there's a number of issues affecting comparability and it is a different business now comparing back to 2020, and it's a different business comparing back to 2019 as well. So you had in 2020, you had a 53rd week, which would have fallen in the fourth quarter, that was over $30 million of revenue. There were issues in the timing of wholesale, that's perhaps more of a Q3 issue. And then an issue for the entire second half is just -- we're operating less retail stores than we had a year ago. Those were largely marginally profitable or unprofitable stores. And so we're better off from a profit point of view, but we will be short of those sales and how we report revenue here for the second half.

Okay. And then any inventory constraints that impacted second quarter? And then does that situation get better for you over the balance of the year?

Wouldn't say meaningfully. So we probably would estimate there was some portion of about $15 million in sales that we would have otherwise had if the inventory position was better, and more than half of that will go in the third quarter.

Okay. And then lastly on share repurchases here, just curious what balance sheet metrics or other things you're waiting for to start repurchasing shares again?

Well, it's a topic that we continually discuss with our Board. I think as we have moved through this year, our confidence has increased regarding the sustainability of the business, the durability of the business, the resilience of our operations. We are in a very good liquidity position. But there's still a lot of uncertainties, and that's why we've been cautious to date, given that we're not through the pandemic 100%, yet. This more recent rebound of the virus around the country and around the world has some pause for thought for us. But we'd like to be more constructive than not. We feel good about our liquidity. We think this is a business that's going to generate substantial free cash flow going forward, and that would be our intent to revisit it shortly.

Our next question comes from Ike Boruchow with Wells Fargo.

This is Will on for Ike. Just a question on gross margin next quarter and in 4Q. Can you just talk a little bit about and frame up how we should think about gross margin for the back half of the year?

I'd say we're forecasting bottom line gross margin down a bit in both Q3 and Q4, and that's largely related to the transportation costs that I mentioned. We're -- we don't spend a lot of air freight typically in this business, and we're spending several years' worth of air freight based on our forecast, given the delays in production. So that will weigh on gross margin. I would say some of the more fundamental building blocks, though, continue to be a positive story. We expect to continue to make progress with price realization. Product costs are expected to be down largely through the second half of the year. So more on a product margin point of view, I think that will continue to show expansion. But we'll give some of that back in the form of these really higher-than-typical transportation costs.

So you're expecting -- are you expecting margins to kind of revert back to pre-pandemic levels? Or you think they'll be a little bit a bit higher than that, gross margin?

I think they're going to be down year-over-year, as I said, for Q3 and Q4. I think in terms of longer-term outlook, I think we feel good about the outlook for gross margin. We are intending to cover product cost inflation, which we see on the horizon. We mentioned on our last call, we're seeing some inflationary pressures in product costs for spring of 2022. That's what we have visibility to at this point. We're planning on covering those with pricing increases. I think the progress we've made over the last year has given us increasing confidence that we have the ability to do that. So we're not expecting deterioration from that front. I think in terms of transportation costs, what we'd like to be out of the business of spending a lot on airfreight, which we, obviously, are this year. Hopefully, that would go back to something at a more historical level. I think it has yet to be determined how other inflation and transportation costs may play out. I think the increases that we're seeing in oceangoing freight, those may persist with us for a while, certainly into 2022, whether additional capacity comes online. That's what's happened in the past is that we've seen spikes in oceangoing rates. And then additional ships are brought online, additional capacity comes into the marketplace and those rates come back down. But we'll have to see how that plays out over time.

And if I could just squeeze one more in. What are you guys seeing in terms of traffic to stores? I mean how -- are you seeing it recover to pre-pandemic levels? Where are we in terms of foot traffic and that you're seeing coming to brick-and-mortar stores?

Yes. It's -- again, it's not comparable to 2020 because we were closed. So if you look at versus 2019, our traffic is still lower than '19. It is recovering. It's getting better every month as we move forward, and we expect to have that continue to improve as we go through the balance of the year. But we're optimistic on what we're seeing. Again, it's getting better virtually every week, but it is not at 2019 levels yet.

I'd say largely, the weakest part is the international customers...correct just with travel. Our largest markets are in California, Texas, Florida, New York and New Jersey. Those are obviously big international tourist destinations. And then we have some of the largest outlets in those states. And so that's been the weakest part. To Brian's point, traffic every month seems to be improving both from more domestic shop stores, consumers and those international guests but International continues to weigh on the business.

[Operator Instructions] Our next question comes from Paul Lejuez with Citi.

This is Kelly Crago on for Paul. Just looking at 3Q guidance, it looks like you're expecting an EBIT margin around 11% to 12%, which means your EBIT margin would be down versus 2019 levels. While in 2Q, it was up pretty significantly, I think, over 600 basis points. That's a pretty big delta despite the top line looking pretty similar. So could you just help us understand the drivers of that delta? How much was the supply chain freight headwinds impacting your business in the second quarter? And what does that look like in the third and fourth? And then how much of that is coming from higher SG&A?

Well, it's substantial. The issue that you just went through, Kelly. As I mentioned, the transportation costs, which affect the gross margin line, that will affect Q3 and Q4. I would say some of the additional investment spending will weigh on the P&L as well. Now we think that's a good long-term trade for us. That's spending across a lot of different areas. It's technology, it's marketing, it's restoration of some of these compensation provisions, which were abnormally low a year ago. And I would say spending was abnormally low a year ago. And even in -- back to 2019, some of those provisions were not quite as fulsome as we would like them to have been. So those will all affect the comparisons and the operating margin. But we think they're good long-term trades. And I think that spending will serve us well over time. And again, I think given the comparability issues that I mentioned, it's important to look at the full year. The full year is going to be an extraordinary year for us.

Yes. Kelly, I would just add to that. I'm looking at the way you would. So in the second half, our operating margin will decrease to about 12% from the 13%, and let's call it, 13.5% we had in 2019, so 1.5 points on nearly $2 billion in second half revenues. That's $30 million of margin erosion. And the freight costs alone -- the increase in freight costs alone, including the air freight to support the demand we're seeing for the brands, to get the product here, to expedite deliveries from Asia, to overcome the pandemic-related production delays. The freight costs alone will be up about $50 million versus 2020.

Got it. And just secondly, I'm curious about your pricing strategy for spring '22. How much are the price increases that you're expecting to implement? And will that be on like-for-like product? And if so, what parts of the assortment do you see the most opportunity?

The cost increases for spring '22, largely driven by fabric prices, higher cotton, higher polyester input costs, will be mid-single digits. Keep in mind, mid-single-digit increases for us in product costs, unit costs are some portion of around $0.20. So our price increases will be mid-single-digit price increases. So it still offers significant value to the consumer. But in light of the -- what's going on with inflation, that we'll start to see product cost increase in the first half of next year.

Our next question comes from Steve Marotta with CL King.

Mike, I want to just ask a follow-up to that question, mid-single-digit product costs in the first half of '22. There'll be price increases that partially offset that. Do you think the promotional environment will be similar so that price realization ultimately will be similar to what we're seeing in the first half of next year versus the first half of '20 is similar to what we're seeing in the current environment?

Yes. I'll tell you, from our experience, Steve, every good retailer is focused on improving their margins, improving price realization, running leaner on inventories, chasing demand as opposed to backing up with excess inventory that sits on the clearance rack at lower prices and lower margins. So will it be a more promotional environment in the second half next year? All depends on the strength of the product offering in the market and how you bought the inventory. So we're going to continue to run leaner on inventories, be conservative on the buys, conservative on the forecast and be more in a chase mode. It's a much healthier business. And we see that with some of our better wholesale customers that they're leaner, they're seeing better sell-throughs, higher price realization, better margins. So I think good companies will do their best to have this -- make sure the pendulum does not swing back to backing up with inventory. So the promotional environment is largely driven by how you bought the inventories. So I just think that overall, I think the market is much healthier. It's a much healthier position, healthier in terms of the quality of the business, quality of the sales.

That's helpful. Richard, is the incremental air freight in the second half of this current year aimed more at supporting your wholesale customers or more aimed at supporting DTC?

I would say it has to do with both businesses. It's probably a bit more weighted towards wholesale than our direct business. But expediting product to support given the magnitude of the delays we're seeing, the production delays, it's necessary to support both segments of the business.

Our next question comes from Carla Casella with JPMorgan.

Just a question on CapEx. Did you say how much your total CapEx is for the tech investments, and kind of where your maintenance CapEx stands at this point?

Well, CapEx for the full year is projected to be around $50 million. That's up from around -- from memory, about $30 million a year ago. I would say at least half of that relates to technology projects, both in our retail -- in our retail stores and enterprise technology. Then there's a good chunk that relates to distribution. Our distribution centers, which I would say is more maintenance CapEx related. Some additional investment around conveyor equipment and such to improve our eCommerce operations. But I would say at least half of the CapEx annually is related to technology projects.

Okay. Great. And have you made up all of the rent payments that had been deferred last year, any other costs that had been deferred during the pandemic?

I would say largely, we have. There's perhaps some rent agreements that deferred rent was tacked on to the end of the rent agreement. But for the most part, I think we've caught up.

Okay. And then just one more question on the sales timing. You mentioned the Amazon shift. I'm wondering if there's been any other shift in terms of timing of back-to-school. Are people buying differently? And did you quantify the amount of shift from Amazon Prime Day moving back into the quarter?

We didn't, specifically on Amazon. We go to some lengths to not speak too specifically about individual customer relationships.

Okay. And timing of back-to-school, though in general, are people buying earlier or later? Any thoughts there?

Back-to-school, we're off to a strong start. We're optimistic. These families, the children did not go back last year. So they were running around in pajamas, and last year's stuff in the house. So it's a wardrobe replacement for the kids. We're optimistic at this point. We'll see what happens if they're going to be going back. But I would say our back-to-school business has been very strong. It started early, particularly with our OshKosh brand. With basic tees, shorts, denim, uniforms, those businesses are very strong out of the gate. Even in the South, I think in Atlanta here, the public school children go back-to-school next week. So it is -- we are right in the midst of it. And I would say that it's strong.

Yes. Southeast has been our strongest region in recent weeks.

There are no additional questions at this time. I'd like to now turn it back to Mr. Mike Casey for closing remarks.

Okay. Well, thank you. Thank you all for joining us this morning. We look forward to updating you again on our progress in October. Goodbye, everybody.

Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.