Welcome to Carter's Second 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 Chief Operating Officer; and Sean McHugh, Vice President and Treasurer. After today's prepared remarks, we will take questions as time allows. Carter's issued its second quarter fiscal 2022 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 ir.carters.com. Before we begin, let me remind you that statements made on this conference call and in the company's presentations material 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 presentations materials posted on the company's website. On this call, the company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the company's earnings release and presentation materials. Also, today's call is being recorded. And now I would like to turn the call over to Mr. Casey.

Thanks very much. Good morning, everyone. 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 this year, on our February earnings call, we reported a strong recovery from the pandemic in sales and a record level of earnings in 2021. Our progress last year indicated that consumers were also recovering well from the pandemic. The job market was improving, and wages and savings were rising. Children were returning to school, and people were traveling again, reconnecting with families and friends. More weddings were being celebrated, and the trend in births was improving. On our February call, we also shared our outlook for growth with you. Our plan this year envisioned another good year of growth, building on the strong recovery and record earnings we achieved in 2021. In February, our year-to-date comparable retail sales in the United States were up 7%. The year was off to a good start. On our more recent earnings call in April, we reaffirmed our outlook for growth this year. Among other things, we noted on that call that our second quarter was off to a slow start. Our plan envisioned a better contribution from the late Easter holiday in April. Our comparable retail sales in April were down 1%. And then in May and June, the trend in our retail sales weakened. It is increasingly clear that the strength of the market has changed since the beginning of the year. The post-pandemic optimism we all experienced last year has been disrupted. There are new challenges weighing on the consumer and our results. Our best analysis suggests that the trend in our second quarter sales correlates to the declining trend in consumer confidence during…

Thank you, Mike. Good morning, everyone. I'll begin this morning on Page 2 of our materials with our GAAP P&L for the second quarter. Noteworthy on this page, our reported pretax income of $47 million reflects a $20 million charge related to the early extinguishment of debt. As we told you on our last call, we retired $500 million in pandemic-related financing in early April. The $20 million charge represents largely the early call premium and make whole interest as this debt was not set to mature until 2025. We've treated these debt extinguishment costs as non-GAAP adjustments to our second quarter results. Beyond this item, we had no other adjustments to our GAAP results in the second quarter. Our first half GAAP P&L is included for your reference on Page 3. A full summary of our non-GAAP adjustments for the second quarter and first half as compared to last year is included on Page 4. In last year's second quarter and first half, we had some modest charges related mostly to restructuring and COVID-related expenses. The remainder of my remarks this morning will speak to our results on an as-adjusted basis. On Page 5, we have an overview of our adjusted results for the second quarter. Our second quarter performance was clearly below our expectations, largely due to lower top line sales, which were $701 million, which was 6% or $46 million below last year. The most significant driver of our lower year-over-year sales was our U.S. Retail segment, where sales declined $45 million versus last year. We attribute this decline in Retail to several factors. We had a challenging comparison to last year when the government was making extraordinary stimulus payments to consumers in response to the pandemic. And also, we saw a meaningful trend change in demand…

[Operator Instructions] Our first question is for Tom Nikic with Wedbush.

I guess, first, at a high level, historically, your business has been really recession resilient and -- especially when you look back at the 2008, 2009 recession where you were pretty consistent and continued to grow sales and stuff like that. Kind of wondering what's different this time. Why do you seem to be more affected by macro factors and from the external environment, so some of the things in the external environment, whereas in the past, you tended to be more resilient?

Your recollection is correct. During the recession -- Great Recession, we had good solid mid-single-digit growth in both '08 and '09. 2010 was a record year of profitability for us. And I think what's different this year, I think everybody -- I'll speak for our -- at least for our market -- primary market in the United States. We saw last year in 2021 a very strong recovery from the pandemic. There was this post-pandemic optimism that the world was going to be better. There were some reports that say that our country potentially could have something equivalent to the post World War II recovery in the market in the world. And so we saw our business rebound very strongly in 2021. Even the early part of this year, it was off to a very good start. Comps were up 7%. The year was underway. I think what is different about this year relative to the last recession is the shock that consumers have with the historic gas prices. Did you ever think we'd be spending $5 to $7 a gallon for gas in the United States? And so -- and there's no indication that, that's going to get better in the balance of the year. And that, combined with the historic inflation -- and then think about our customer base. Can you ever recall a time in our country's history where there's been a shortage of baby formula? So you had this kind of -- this combination of these factors weighing on the consumer that we began to see in May, June. It's continued in July, is that the consumers weighed down by these very abnormal factors that they've never experienced before. And that, coupled with we were entering what we all thought was a period of prosperity, a new time after a period of isolation for some portion of 2 years, that people were getting out and about again in 2021. The holidays for us in 2021 were terrific. And so -- it's -- I think that's what we saw in May and June and, to some extent, continued in July, is that there's a bit of a shock that consumers, at least in the United States, have never experienced before. That, together with other global events. So I think there's a -- I think we're in a different environment today than we were during the last recession.

Understood. I filled up my gas tank for $4.07 a gallon yesterday. So hopefully, we're trending in the right direction there.

I hope so. Yes.

Our next question is from Warren Cheng with Evercore ISI.

Your exclusive partners, Walmart and Target, they've made some pretty well-publicized comments about some of the demand in inventory -- the traffic in inventory challenges they've seen, especially in June and July. Can you give us an update on how those challenges are affecting your business or why you seem to be more insulated? Because I did notice your exclusive guidance is still plus mid-single for the year.

Brian?

Yes. Our exclusive brand business has been very good. And just overall -- just to give you some texture. Overall, Wholesale business, again, as Mike said, we're planning the full year comparable to last year. We're going to have growth with 4 of the top 6 accounts. We had originally planned it up mid-single digits, and our upfronts, our bookings were good. We had a mid-single-digit increase. But we did have some product delays, and the retail selling softened as we went through the quarter. The over-the-counter selling did soften at our top accounts sequentially as you went through the second quarter. So that created the need to proactively pack and hold inventory. Our cancellations have generally been in line with our expectations. But the inventory at our accounts overall is in pretty good shape. It's up low single digits. We do not have an inventory issue at the exclusive brands. We obviously have great relationships with those folks, and we've read their public comments, but I feel like we're in good shape there. Even Walmart, our inventory is actually lower than last year. So we had bookings to support the second half up mid-single digits. Now we're planning down low-single digits, but we'll have good growth for the year with the exclusive brands. And we're going to have -- I think even if you look at the second half, I think we'll have outsized growth in the third quarter because we're up against some significant lost sales we had in the third quarter last year when we had some shipping issues. So we're optimistic that our improved shipping performance should help early fall selling this year. And I expect that we'll continue to have good strength with the exclusive brands. Their teams, very talented teams at those accounts and our teams have great relationships and manage that business very well.

Let me just add to that. It's important for you to know that at Target and Walmart, a very high percentage of the product offerings we sell into those 2 retailers is baby apparel. Our baby apparel business is over 50% of our total apparel sales, and that has been the strongest component of our business. And in baby apparel, a good portion of what we do for Target and Walmart is on automatic replenishment. So as the register rings, it triggers an order that we send to those 2 retailers. If they turn off that replenishment, the shelves are empty. And that's not going to be a good experience for the consumers in the balance of the year. So baby apparel, the essential core products, bodysuits, washcloths, towels, bibs, blankets, all the -- pajamas, all the things that a child grows through rapidly in those early years of life. So that's why I think we've done so well at Target, Walmart and Amazon because some very high percentage of the product offerings for those retailers is in baby apparel.

Got it. That's really helpful insight. And then my follow-up, can you help me better understand the divergence we're seeing between Retail and Wholesale segments this year? I better understand the first half. The things changed pretty quickly, so retail performed. But the guidance seems to imply kind of that same gap in the second half. So can you just give your thoughts there and then how to think about that progression of mix going forward?

I think there's a few things. First of all, is timing. As I said, our direct-to-consumer business, we saw this impact pretty quickly when the gas and inflation took hold, as Mike said. So we saw that directly. Then in Wholesale, we were still shipping product, and we weren't talking about sell-throughs. As I said before, the over-the-county selling -- over-the-counter selling, I should say, at the wholesale accounts did decline sequentially during the quarter, and we have revised the second half. So our Wholesale business, we had a good business in the first half overall, but the second half is going to be down mid-single digits. So there is diversity, but not as -- the gap isn't what it was in the first half. And the other thing I would say is, again, we just talked about exclusive brands. It is a different business. We sell to people some of the key accounts we talk about, the biggest retailers in the country. There are such retailers that sell groceries and other items. And so I think there's a lower impact to them on traffic and other things than there are, for instance, in the department store channel or in some of the specialty channels.

I would say in the stores -- the stores actually had pretty good traffic. The best traffic to our stores, what we call our brand stores that are open closer to where consumers live in more densely populated areas. We still have about 30% of our stores in outlets. And as we've seen in years past, when gas prices spike, traffic to our outlet stores declines. It settles down when the gas prices settle down. But the stores -- actually, we were encouraged by the traffic to our stores. eCommerce was the one that surprised us. We started to see some weakness in the quarter in eCommerce traffic, which was down high single-digit. And I think part of that is due to the fact that the stimulus lapsed. There was stimulus in the market -- significant stimulus helping families with young children a year ago. So you have this wonderful environment ideal for an eCommerce environment that -- most of us were still working from home in the first half of last year, and you had the unexpected benefit of those stimulus payments, which drove very good growth in our eCommerce business.

Our next question is from Ike Boruchow with Wells Fargo Securities.

Two questions actually. I guess on the wholesale side, flat for the year. Exclusive's up mid-single digits. I guess just I'd love to get a little bit more color there. I would have thought that the exclusive brand, the Just One You and Child of Mine in the mass channel would have been under more pressure, but you're still forecasting pretty good decent growth there. So maybe just walk us through the puts and takes on Wholesale. And then just a follow-up is on 4Q. So the 3Q guide looks pretty reasonable. When I look at the implied 4Q, it looks like margins are up 17%, 18%. It just looks like you're embedding a nice inflection in margin. And I'm just kind of curious on the differences between 3Q and 4Q to understand how that -- how we should think about the margin differences between the 2 quarters for the rest of the year.

Wholesale, Brian?

Yes. Ike, it's Brian. I think a couple of things on Wholesale. As Mike shared before, exclusive brands, they continue to perform well. Those are our strongest businesses. I hesitate to say probably some of the strongest retailers out there, overall, they have been under pressure in certain components of their business as they reported. I think if you think about our business, it is a little bit different. As Mike said, the majority of what we sell them is baby product. Our baby product has performed better than playwear and sleepwear and other products as you go through the year. And what we sell them, by and large, are essential core products. So we love the business to even be even better with them. And there have been some challenges, some inventory that we proactively work with them on a pack and hold as you -- pack and holding as you look through the back half of the year. But overall, we've had good performance. And I think the 2 -- their companies and our group combined have done a really good job in inventory management and how we plan this business out. So it's not a significant challenge at this point. It's not easy, but we're excited about having growth this year. And as we look forward into the future, we would expect exclusive brands to continue to be good growth vehicles for our company. And we're excited about the marketing changes that Richard shared. And we're going to have more prominent position, I think, on the floor, on how we communicate our brands and reinforcing to the consumer that these great brands are Carter's brands in 6,000 stores and on their websites.

Okay, Brian. Richard?

Yes. Ike, on the difference between Q3 and Q4, we are forecasting fourth quarter to be really the driver of earnings growth in the second half. There's a number of things contributing to that. We're planning on gross margin expansion in the fourth quarter in particular. That's driven by a few things. We're forecasting good improvement in price realization. So product margin is expected to be higher. Q3 is a little bit on the gross margin line under a bit more pressure because of what Brian said around Wholesale is expected to have a very, very strong Q3 shipment period. So that flips around. And Retail is the bigger strength in the fourth quarter. We have an ongoing benefit on the margin line from spending less on airfreight. We spent those historic amounts last year. Even though ocean freight continues to be a drag on margin, it becomes less of a drag as we move through the year, particularly in the fourth quarter, and then that mix of retail jumps up. In particular, in the fourth quarter, we had some extraordinary spending a year ago, which we're not planning on repeating. We had such a strong 2021, a record year. We provided really extraordinary amounts for our people in recognition of that. So our -- the various categories, performance-based compensation, much less than a year ago in the fourth quarter. We did some special things in marketing a year ago. Because of the upside we were experiencing, we don't plan on repeating some of that marketing spend. And then we made some special provisions for charitable giving that I don't think we'll provide at the same level for us. So your observation is correct. Fourth quarter shows in our forecast as well as the stronger of the 2 periods. And then, of course, below the line, you have the ongoing benefits of the lower interest cost and the benefit of our cumulative share repurchase activity, which will benefit EPS.

Got it. Super helpful. And then, if I may, just any initial visibility into first half '23 order book or costs would also be interesting.

Yes, Ike. Sure that -- I would say just given the uncertain macro environment, there have been corporate directives to remain lean on inventory with our top customers. Looking into spring '23, we're still booking spring. We have some of the early commitments, and the accounts have accepted our pricing. Our costs are going to be up, I think, mid- to high single digits, and we've raised pricing to match that and make sure that we cover those. And so we're still booking exclusive brands. They book a little bit later, but -- which has been a growth vehicle for us. They represent about half the business. And as I said, we're excited about the branding there. But all in, first half, we'll have to see -- a little too early to call. I would say we could be under some pressure in the first half in Wholesale, primarily due to accounts that we sold the Carter's brand to. But it's kind of early to call it because we haven't finished booking. We haven't booked summer yet, and we haven't finished booking the exclusive brands. So that...

We'll know more in October. What we're encouraged by is that the wholesale customers continue to support our price increases, and I think they are supporting the price increases because they're seeing what we're seeing in terms of inflation into the first half of next year.

Our next question is from Jay Sole with UBS.

Mike, I just want to follow up on the comment you made that -- you mentioned the comp for April. You said it slowed down in May and June, and then it continues here in July. Can you just give us an idea of maybe how much it slowed down in May and June? What you see here in July? And sort of what the guidance is based on? Is it based on sort of like the total second quarter trend? Or is it based on what you currently see here in July?

It's more of what we saw in May, June and July. It was double digit. It was like -- I'm rounding. It's down 10 at some -- 10 again in May, June and now July. So the trend continues. So as we're trying to build the models for the balance of the year, trying to ask ourselves, so when does this get better? What changes in the balance of the year? Are gas prices going to return to $2 to $3 a gallon? And then with the recent news on the contraction in GDP. So we just said we -- for purposes of sharing with you what we believe is possible in the balance of the year, we are assuming, in Retail at least, that the current trends in our business continue because that's what we're seeing. This is not the time to be bullish on forecast. We're going to tell you how we're trending. We'll assume those trends continue in the balance of the year. That said, I will tell you, Jay, that there is some optimism on our retail team as they reflect on the quality and the level of inventory going into the back half of the year. And that's true with back-to-school. So we're starting to get some early read on back-to-school. And it's early, but -- it's early and good. And so we'll see whether or not the forecast is conservative, but it's appropriately conservative given the trends that we've seen since May. It's been a meaningful slowdown in traffic, and we are assuming that continues through the balance of the year. That said, there are a number of upsides we've shared with you this morning that may produce better results than we're sharing with you today in terms of the forecast.

Got it. And then if I can follow up on one more. You mentioned that the supply chain situation has improved. 80% of the fall goods have arrived on time. Does that mean that -- also that the lead times are shorter? Or is it just -- it's still taking longer, except things are arriving on-time on that longer rate? And then secondly, what has to happen to get back to 100% or to get back to where you were pre-pandemic?

Well, I think what we're dealing with from our suppliers, they've been dealing with some level of absenteeism due to -- still people are getting infected in Asia. And -- but the trend is improving. And how long will it take to get back to it? In good years, we'd probably be shipping some portion 95% on time. As a matter of fact, the First Love that Richard referenced, our -- the core of our baby product offering that launched in May, that shipped over 90% on time. So there are pockets of what I would say significant improvement. And so we're dealing with some factory delays, and they -- there was some impact of the China lockdowns. Our suppliers would say it was not significant, but it wasn't as if there were some component parts that they relied on from China that were running late. And I'd say more of the issue is on still the port congestion. And I think with the world slowing down, that will continue to get better.

Thank you. And ladies and gentlemen, with that, we conclude our Q&A session. I will pass the call to Mr. Casey for his final thoughts.

Well, thank you all very much for joining us this morning. We look forward [indiscernible] October.

And this concludes today's conference call. Thank you for participating, and you may now disconnect.