Welcome to Carter's First Quarter Fiscal 2022 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 issued its first quarter fiscal 2022 earnings press release earlier this morning. A copy of the release and presentation material 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 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, 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 company's GAAP financial measurements is provided in the company's earnings release and presentation materials. Also, today's call is being recorded. And now I would like to turn the call over to Mr. Casey.

Thanks very much. Good morning, everyone. 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. First quarter sales and earnings exceeded the plans we shared with you in February. Our supply chain performance continued to improve, inventory arrived earlier from Asia and enabled us to support higher demand from our largest wholesale customers. We also had stronger than planned growth in our international sales, driven by our operations in Canada and Mexico, and saw a higher demand than expected from our multinational wholesale customers. We had planned retail sales lower in the first quarter to reflect the impact of closing low-margin stores last year, the shift in the timing of the Easter holiday and the significant impact of the nearly $3 trillion in government stimulus that drove higher consumer spending in the first quarter last year. Recall that in late December 2020, President Trump approved a nearly $1 trillion stimulus package. Just 10 weeks later, President Biden approved a nearly $2 trillion stimulus package. A good portion of the stimulus was focused on helping families with young children. Following each of those stimulus payments, we saw a meaningful lift in our retail sales in the first quarter last year, including an over 30% increase in eCommerce sales. A year ago, many of us were still working from home. We believe the combination of the significant stimulus benefits and ease of shopping from home drove record online sales force in the first quarter last year. Thankfully, store sales in the first quarter were better than expected. We saw that positive trend begin last year with greater access to the vaccine and confidence in its protection, people are returning to shop in…

Thanks, Mike. Good morning, everyone. I'll begin on Page 2 of our materials with our GAAP P&L. Net sales were $781 million and reported operating income was $103 million in the first quarter. We had no non-GAAP adjustments in this year's first quarter and only minimal net adjustments related to COVID in the prior year. These adjustments are detailed on Page 3. So turning to Page 4 with some highlights of our first quarter performance. Overall, we delivered good results for the first quarter. We had planned sales and profitability down versus last year due to the noncomp of the significant government stimulus last year, the later Easter holiday this year and meaningfully higher transportation costs. Our results, though, were stronger than we had planned. Our inventory position was better than expected, which enabled higher shipments to our wholesale customers and spending was also lower than forecasted. As Mike pointed out, while our results were below last year's record first quarter performance, they were meaningfully above 2019's pre-pandemic level, reflecting the many benefits of the improvements we've made across the business. Our adjusted P&L for the first quarter is on Page 5. Sales were down 1% versus last year to $781 million. We posted over 8% sales growth in Wholesale and 11% growth in our International segment. Sales in our U.S. Retail business were down 10% versus a year ago, reflecting the tougher comparison to last year's stimulus and the later Easter holiday this year. Gross margin was 45.4%, which was down 440 basis points from last year. More than half of this decrease was due to the higher inbound transportation costs, which increased over $20 million or nearly 60% over last year. We expect transportation costs to be elevated well into next year, and they will be higher than…

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

Nice job on the quarter. I'm wondering if maybe you can talk about the inflationary pressures going into the back half in 2023, and the kind of the puts and takes that you're thinking about there, particularly as cotton prices are up pretty significantly? And then maybe also if you could just give us an update on where you're at with the supply chain issues, if you've seen an improvement at all? And if you expect the same expense in the back half or is some of that air freight will go away in the quarter?

So Susan, supply chain performance improved in the first quarter. So I'd say, it's gradual improvement. We got probably better part of 60% of the shipments to our wholesale customers are on time. The balance is running some portion of about 3 weeks late. I think that's generally what's going on in the market. In terms of inflation, the big chunks of inflationary pressures are in product costs and transportation, much more on the product cost side. So as we shared with you earlier, product costs will be up mid-single digit in the first half, high single digit in the second half. We've raised prices to make sure that we can achieve our margin objectives this year to have at least the same margins we had last year, if not have been better. The freight cost, since we chatted with you in February, are higher, probably about $15 million higher. And so we'll have to adjust our spending elsewhere in the business to overcome those higher ocean freight rates. So we've negotiated the other half of our ocean freight under contracts, which will -- now we've locked into through the first half of next year. Those negotiated freight rates under contract now are less than half the spot market rate. So we feel -- albeit higher, we feel as though we're in a good place through the first half of next year. What's going to help us in the second half is, we're comping up against significant and unusual air freight charges that we incurred in the second half of last year. So that will help mitigate some of the higher transportation costs that we'll now have in the second half. So transportation cost for us this year, even though ocean freight rates have more than doubled, our freight expenses this year will be up a little over 10%. So I think we reflected what we know in the forecast that we're sharing with you this morning. And we feel good. We feel good about the product offering. We feel good about our marketing strategies, and so we expect that we have the potential to have a very good year this year.

Great. That's very helpful. If I could just add one follow-up just on the AUR. I'm curious, in the quarter, were you able to realize all of the price increases that you were putting through? Or did you promote a little bit more than you were expecting at all? Or are the promotions still very rational out there?

I would say, we achieved the pricing objectives in our direct-to-consumer business. And what you saw in the first quarter, as we expected, off-price sales were higher because we cleared out -- as Richard shared with you, we cleared out the late-arriving fall and holiday product in the first -- that late arriving last year, cleared it out in the first quarter through the off-price channel. That's when you're going to get the highest and best value for that product by the weather. It's still cold, which it was. In the first quarter, we saw good demand for that product. So off-price as a percentage of our sales in the first quarter around 2% for the year, we expect it to be around 1%.

And our next question comes from Paul Lejuez with Citi.

Just on the first quarter, how much did the sales to off-price impact your gross margin in 1Q? Also curious what's going on in the D&A line? Look like that was a bit lower by looking at the cash flow statement. So curious how to model that go forward. And then you mentioned April started off a little bit weaker than anticipated. Just curious which pieces of the business and what you think the drivers are? And why you have confidence in reiterating the full year?

Yes. So Paul, of the 400 some basis points decrease in gross margin year-over-year in the first quarter, it's about 100 basis points that I would call mix. And I would say, the higher proportion of off-price channel sales is a good proportion of that. So call it 100 basis points of the 400 basis points was mix related, specifically related to off price. On your question on depreciation, it is down. It will be down kind of all year. From memory, depreciation is forecasted to be about $70 million, and I believe it was about $90 million for the full year last year. There's a couple of things that worked there. One, just the impact of having closed over 100 stores over the course of 2021. So expenses related to those stores are out of the base. And then I would say, in our technology spending, there's been a longer-term shift away from CapEx dollars more towards Software as a Service solutions for the various new technologies that we're putting in place. We had very low CapEx, I would say, in general in 2020 just during the pandemic year. So some of that's probably reflected and depreciation being a bit lower as well.

And then April?

For your question on April? Yes, Paul...

What drove it? That's kind of what I was asking. And then why you have confidence to kind of reiterate the year, if April has started off a little bit weaker?

April is a little soft. Our stores have been up, I think is about 8% in April. E-commerce has been lower. Easter was softer than we planned. That's really probably the key on that one. And we believe that we really haven't seen that warmer weather pop across the country yet. So it happens every season as the weather gets warmer in the spring and summer and cooler in the fall. We see a pop in our business we have not seen that yet. But April is a little bit below what we planned. We're comping at about a negative 1 right now in April based on by the slower start with Easter.

Got it. And then just if I kind of maybe one follow-up. What do your order books look like for the back half, if that's something you can talk about?

Well, wholesale, the business has been good. As you know, we beat Q1. We're up about 8%. We're planning the first half up mid-single digits and the second half up mid-single digits as well, I believe. So I think if we're successful with our plans in wholesale, our sales will be actually comparable to 2019 with the exclusion of off-price, planning good growth with the majority of the accounts. As Richard shared, we've got several new placements for some of our key strategies in Age Up and Little Planet and events with the wholesale partners. And I think one of the things I'm most interested to see how this develops is, we've had a change in the birth rate trends progressively better in Q2, Q3 and Q4. And as you know, the majority -- vast majority of the Wholesale business is actually baby related. So hopefully, that can be a tailwind for our business. And we had very strong selling in Q1 and year-to-date in our baby products, not only in our Retail business, but in our Wholesale business.

We have a question from Warren Cheng with Evercore.

I had a question on the retail profitability. The first quarter Retail segment margins were really impressive if you look at -- as you compare it to what you typically generate in the first quarter even with the higher freight. Can you just help us think about how to translate that on a full year basis? If you just look at your -- the changes to your footprint, we assume freight normalizes eventually. Just how to think about the kind of going forward retail profitability?

Well, the unlock in the business, Warren, continues to be improved price realization. So while we certainly have some inflationary pressure in product costs, I'd say, we're building back some compensation costs in that part of the business as well. Just returning store staffing levels to more appropriate models. The real unlock has been improving our price realization. Product costs are up. That price realization is expected to improve as we move through the back half of the year and certainly sort of move into second quarter and second half. So there'll be more of a contribution from that improved AUR even with product cost being up. So I would say, that's really the engine. That's really what's allowed us to drive a more profitable business, less brand erosive promotions, more focused on getting paid for our good work, buying inventory at a bit of a high fraction, but at some proportion of forecasted demand. So operating at a bit more of a scarcity model has reduced the amount of inventory that ultimately goes to clearance, which has become kind of a big issue in both the stores and the online channel. There's just less of that today.

And what I'd add to that, Warren, is the mix of stores. We continue to close the low-margin stores and open up higher-margin stores. That's the game plan. Over the next 5 years, we'll open up probably more than 100 stores net of closures because the margins, the EBITDA margins we're seeing on new stores are in the high 20% range. So very good returns on investment.

Got it. And is there a way to quantify that lift from all those different drivers? They said, if I just think about the stores that were closed, that were low margin, some of the freight headwinds that are happening now. And if you strip those out, is there a way to just quantify kind of the overall lift to the retail profitability versus pre-pandemic levels?

I'll give you a sense. We probably took out over $100 million of sales from store closures since 2019, and retail is more profitable having done that.

Got it. And then one quick follow-up. Just on the exclusives, can you give an update on what they represent as a percentage of wholesale today? And how the profitability of that business is involved during the pandemic?

Exclusive, they're just under half of the business in wholesale. I guess 48% exactly in the quarter, and profitability is good. It is -- profitability is slightly accretive to our overall Carter's CRI operating margins.

Our next question comes from Jim Chartier with Monness, Crespi, Hardt.

You mentioned you're contracted on freight work for the first half '23. Just curious how the first half of next year contract rates compares to the first half of this year? Are they still up in that 10%-ish kind of range?

Yes, they'll be higher. First half to first half will be higher, yes, next year.

Okay. And then you mentioned a rebound in tourist stores. What percentage of store sales historically come from tourism? And then when did you start to see those stores first rebound? And then where those stores performing relative to 2019?

I'd say, the tourists, they were talking about Orlando in Southern California and Central Valley up in New York. They're probably around 20% of the stores, but these are -- might be 20% of the stores, but these are mega stores. We probably do better part of $14 million in Orlando, where as a typical store, we'd open up does closer to $1 million. So these are -- so we're just encouraged. More people are getting -- if you've traveled like many of us have traveled in recent months, the planes are packed and more and more people are coming back into the United States, and we're starting to see that in the tourist location. So we're encouraged by that. So our best performing stores were in Florida, in California in the first quarter. And one, I think the weather was more spring like and two, more people are getting out and reconnecting with families and friends. So we'll see how that trend continues. We saw -- I would say, we saw it around the holidays. It started around the holidays, started to see it as we -- in the second half of last year, particularly over the holidays and it's continued into the first quarter.

Great. And then just in terms of kind of future cost inflation, I mean what's your confidence in terms of your ability to continue to raise prices, if inflation continues to be a problem in the next year?

I think there's more we can do on price. Again, our average price points are under $11 a unit. If you've seen the beauty of our product offerings, certainly extraordinary value. And we think -- we used to think about nickels and dimes and quarters, and through the pandemic, we realized that the consumer was -- we saw no resistance from raising the price to $1 or $2 since the pandemic began. So there's more -- if we need to do more, we can do more. And what we experienced back in 2011 when cotton prices went to over $2 a pound. The cotton prices -- at those prices more cotton was planted and within a year, the cotton prices dropped like a rock. So we'll see if that experience repeats itself going into next year, but the best information we have would suggest a combination of moderating demand and more capacity, more cotton being planted, that should be a benefit we should expect to start to see sometime next year.

Our next question comes from Jay Sole with UBS.

I just want to make sure I understand the differences between the second quarter guide given today and what was implied for second quarter last time. It sounds like there's a wholesale shift, maybe a little bit of a slower start to the second quarter. But maybe you can just outline the other differences between where the second quarter guidance is today and where it was last quarter, that would be helpful.

I think it's primarily the -- what you just said, Jay, we had about $14 million of wholesale volume that we had planned for second quarter that actually took place in first quarter. So that's a bit of a hole relative to the previous plan. And then in our Retail business, as we've said, the month of April has been off to a slower start. So that's roughly a $20-ish million revision, I believe, to our first half guidance. We did outperform a bit in Q1. So the combination of those 2, I guess, [indiscernible]. Transportation costs perhaps a bit higher in the second quarter than we had planned, but on balance, the profit outlook very consistent with what we had told you before for first half.

Okay. Got it. And then maybe it would be awesome to elaborate a little bit on the South America strategy that you talked about in the prepared comments. Maybe specifically within Brazil, there's a $3 billion total addressable market. What kind of market share do you think you can take in Brazil? And where are you now? And do you think you can apply this strategy to other countries?

Jay, we've got -- we're doing business about 90 countries where we call our kind of partners business, international partners, where individually, a lot of these partners are small collectively, it's a good-sized business for us. Better part of $100 million business, high-margin business for us. Riachuelo is the partner that has gotten behind the brand. Just like the experience we had in the United States where a lot of the major retailers were carrying the brand and saw the strength of the product offering, but Riachuelo decided to take the brand outside of their department stores and open up standalone Carter's stores. So they probably have a couple of dozen of them now. There's a plan to open up more of them, but we have partners in Peru, Chile, Uruguay. We have partners all over Latin America. I think you know our history in China was not particularly good, and there was sales volume, but no profitability. And there wasn't really much of a path to profitability in China. So we set our sights on Latin America, which has been a very profitable business for us. So we'll do far more in Latin America than we ever would have done in China and much more profitably.

Our next question comes from Brian McNamara with Berenberg Capital.

I think a lot has been said and written about promotions kind of ramping in as it relates to you and your brand. Curious if you could kind of talk to those concerns. I know a peer of mine asked the question earlier, I know you mentioned off-price too, but off-price is not a typical promotional channel, per se. So any color there would be helpful.

Sure. I think promotions are a function of the strength of your product offering, how you bought it, your forecast accuracy, the sell-throughs of the product offering. So during the pandemic, we kind of embrace the scarcity model. Good retailers like Target, we've learned that over the years by doing business with them. We've learned a lot from Target, Amazon, Walmart in terms of how to drive better businesses, the businesses we've had from them. We've learned from them, things that we could apply to our own business. So our stores -- I think in our stores right now, we're carrying less than 30,000 units per door. I think it's closer to 27,000 units per door. It used to be over 40,000. So there's very little in our back rooms, and so we've created a kind of an experience for the consumer, get it now while it's here. And so if we over buy, that's the risk in the balance of the year. And so our teams, our retail teams, our operations teams are mindful of being thoughtful on what we buy, focus on the things the consumer needs, edit the things that are perhaps not needed. And so it's -- promotions are all a function of are you being smart on the inventory buys. So that continues to be our focus here. We were less promotional in the first quarter. We plan to be less promotional in the balance of the year. To date, we're achieving our price objectives. Consumers not resisting the higher price at all given the strength and beauty of the product offering. What -- they had an update recently from our head merchant who said, some of the best-selling products we have are the highest ticket collections, which are the things parents would buy because their children are now traveling again, revisiting families going on, summer vacations. So we just have to be smart in terms of how we make those inventory commitments.

Great. And do you guys have an explicit expectation for births this year? I know a lot has been said. The estimates are kind of few and far between, but I'm curious, is that something that kind of drives how you look at particularly your baby apparel sales, and how you -- your expectations for that?

Yes. Thankfully, the trend there is positive. So we had some data we shared with you in February that we saw births start to increase in June than July then August continued to September. About 2 weeks ago, we got the data through the balance of the year. With every month, the births sequentially got better. I think in the fourth quarter, the births were up 6%. I don't know if coincidentally, our baby apparel sales in the first quarter were up 6%. So I don't know if there was a connection or not, but that's a reversal of what I would say has been a 14-year decline inverse in the United States. There was a peak number of beautiful babies born in 2007. 4.3 million children born in then with the Great Recession. Almost every year since the Great Recession began in 2008, there's been a decline in births. Again, the government poured $3 trillion into the economy a year ago, a good portion of that was focused on helping families with young children. There was a view of what would happen during the pandemic. Some of the hand-wringers said that there could be as much as 500,000 fewer births last year. First, we're actually up in 2021. So the outlook for births is good. Hopefully, it's sustained. How do we model that? We really don't. We focus on the strength of our product offerings, marketing strategies, strength of the relationships we have with the winning retailers, what we think is possible our direct-to-consumer business, but that's a very positive reversal of what had been a 14-year decline in births in the United States. So we're encouraged by it.

We have a question from Ike Boruchow with Wells Fargo.

Could you guys help us have a little bit more on the Easter shift. I think historically, it's been around a high single-digit percent of revenue impact quarter-to-quarter. Is that similar to what's happening this year, Q1 to Q2?

Yes. We modeled at about $10 million in our retail business.

Got it. So I guess what my question is, is based on the quarter-to-date guide, I guess down one to get to the up low single, it just seems like you're baking in a pretty meaningful acceleration in May and June because shift adjusted, the comps are more like down 10. So I guess I'm just trying to -- is it just warmer weather? Is there something else that gives you the confidence that you're going to see that kind of meaningful acceleration in the back half of the quarter? I'm just trying to piece together what's going on right now and what your expectation is for the remainder of 2Q in retail.

Yes, we're trying to read the business, obviously, every day, as I commented before. I think we have not seen that weather pop, number one. Number two is, we try to read the stimulus from last year and how much that impacted our business in March and in April. And I think that there was clearly an impact comping up against that in March and probably, more than we may have anticipated in April. So between those 2 factors, we continue to monitor the business, and we're optimistic that we'll see the turn, but it's early. And we're planning low single-digit comps for the rest of the year and the rest of the quarter, and we'll see how that materializes. The other point is, where the weather has turned, which is not many places, by the way. We have seen good business. We've had significant improvement, particularly some factors in the South and the West have really gotten materially better.

Understood. And maybe, Richard, on the cash flow guidance, you took it down $50 million. I'm just curious if everything else is maintained on the P&L in terms of EBIT and sales and everything. So what drives the $50 million reduction in operating cash flow versus 3 months ago?

I think on balance, it's just being a bit more conservative on the inventory. As we've commented, we're bringing in inventory in advance of good planned demand and also trying to mitigate some of these transportation delays. So my guess is, we will be a little heavier on year-end inventory than we had expected to be in our first forecast. And I think that will be a good thing because we'll have the inventory on hand to do the business that we're planning on doing.

Our final question comes from Tom Nikic with Wedbush Securities.

[indiscernible] here on for Tom. Just a quick one. I know you guys said you had freight rates locked in through first half of '23. I know we're a long way out, but we don't see spot rates start to recede. Should we assume that we'll see more increases in freight costs late next year as your contracts were low?

Time will tell. I don't think we have a crystal ball takes us into the second half of next year. Time will tell. What we've been told by some of our largest freight carriers is, they expect as capacity comes on board, things will start to moderate. And so we're just in a point right now where demand continues to exceed supply. So it's driven the rates up. We feel good about the rates that we've locked in into albeit higher. We've negotiated at least with one of the major carriers. If the rates drop, we have the flexibility. We have an effect of variable to the good side if the rates drop. We will benefit from lower rates than we've locked into right now. So our best outlook is through the first half of next year with some indication from the people we've been negotiating with that they expect because they're the experts in this that they would expect that rates have the potential to moderate starting in the second half of next year, but time will tell.

And that's all the time we have for questions. I'd like to turn the call back to Mr. Mike Casey for closing remarks.

Thank you. Thanks very much. Thank you all for joining us on the call today. Look forward to updating you again on our progress in July. Goodbye, everybody.

This concludes today's conference call. Thank you for participating. You may now disconnect.