Welcome to Carter's Third 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 issued its third 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 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 released 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 measures. A reconciliation of these non-GAAP financial measures to the GAAP financial measures 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. Thanks 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. For the final weeks of what's been a more challenging year than we had forecasted, we expected to build on the strong recovery and record earnings that we achieved last year. 2022 got off to a strong start. We saw high single-digit comparable sales growth through the early months of this year. But in the second quarter, we began to see the effects of historic inflation weighing on consumers and demand for our brands. Like many retailers, Carter's expected a good multiyear recovery from the pandemic. We knew that year-over-year comparisons would be impacted by the nearly $3 trillion of government stimulus last year, and we considered that in our growth plans. What we did not expect were the adverse effects of the absence of that stimulus this year, combined with a surge in gas prices, food prices and interest rates. Carter's primary target consumers are women and men in their late 20s and early 30s. This is typically the time in their lives when many marriages occur and family formation often begins shortly thereafter. These women and men are earlier in their careers, just starting out together and working hard to make ends meet. Our target consumers' household income is about $75,000 a year. This segment of the population has been particularly hard hit by inflation. The Federal Reserve has been raising interest rates aggressively to lower inflation. In the third quarter, Federal Reserve Chairman, Powell, said that the higher interest rates would bring, in his words, "some pain to households and businesses". We've seen some of that pain reflected in our sales this year.…

Thank you, Mike. Good morning, everyone. Beginning on Pages 2 and 3 of our materials, we've included our GAAP P&Ls for the third quarter and the year-to-date periods. As summarized on Page 4, we had no adjustments to our GAAP results in the third quarter and only minor adjustments in the third quarter last year. For the year-to-date period this year, we had charges related to the early repayment of debt. And last year, we had unusual charges related to COVID, restructuring costs and our store closing initiative. This information is included for your reference, and I'll speak to our results on an adjusted basis this morning. On Page 5, we've summarized our sales and profit performance in the third quarter. Our net sales declined 8% to $819 million. These results were below what we had expected by about 5%, but reflective of the overall market right now. Our U.S. and Canadian Retail businesses represented the majority of our sales decline versus last year, a result of lower consumer demand throughout the quarter. Our profitability was within the range we had guided to previously. We had operating income of $92 million in the third quarter, a double-digit operating margin and adjusted EPS of $1.67. Our year-to-date performance is summarized on Page 6. Given the disruption that record inflation has caused to consumer demand and to our cost structure, our sales and profitability are down versus 2021. Recall that 2021 was a year of record profitability for Carter's. Given the uncertainty in the market at the moment, especially related to the level and consistency of demand, our focus is on profitability, which has always been a differentiating characteristic of our company. To provide a little more color on our performance in the quarter, I'll turn to our adjusted P&L on Page…

[Operator Instructions] And our first question comes from the line of Warren Cheng from Evercore ISI.

I was wondering if you can give your thoughts on why the young family or young moms seems to be more discretionary with this category than in the past. So in your prepared remarks, you had some interesting insights on pressures weighing on the core consumer, which we all understand. But can you help us understand just why the consumer behavior seems to be different versus the last recession?

Well, the last recession didn't have a 40-year high in inflation. And when you think of our target consumer, primary target consumer, these are relatively young women and men, late 20s, early 30s, just starting out in their careers. Average household income around $75,000. And when you take it back -- when you look at -- talk about our direct-to-consumer business, probably would be about -- down 10% this year. You have to ask yourself, is that consumer, our target consumer, is that affected by some portion of 10% in their spending habits this year? We believe they have been. That's what we're seeing in the performance. So it is a less discretionary product category. But I think across the board, our target consumer has been most affected by this record inflation, and they're pulling back.

That's very helpful. And my follow-up is on the gross margins. So your gross margins, they were a bright spot in the quarter. You're still maintaining a level, almost three points higher than pre-pandemic. And it's great to see that you continue to have success with the retail price realizations. If we continue to see the softer level of demand or exacerbates, how do you think philosophically about using price to stimulate demand versus maintaining these great gains you've achieved since 2019?

Well, our intention, Warren, is not to go backwards on gross margin. We've had some hard-fought wins here in terms of improving our realized pricing, which we always felt was an opportunity in the business. It felt like the business had become overly promotional. The consumer had stopped listening and responding as much to deep discounts. We've tried a bit of that. Given demand is lower. We've tried a little bit of that higher promotional messaging recently, and it just really did not spark things. But we've built some better capabilities, which I think we're going to service long term. We have a group that's focused on pricing for the first time in our company's history, some great individuals we've added to the Company. We've also added some just new technology and tools to help those individuals be a bit more scientific about our pricing. So I think there's still room to go in terms of what we can maximize there. We also have a terrific supply chain that's continued to focus on our relationships with our suppliers. And I don't think we've completely maximized our opportunity to drive down product costs over time. So the combination of those, I think, returns well and the continued growth in our Retail business, which is the gross margin-rich part of our business.

And our next question comes from the line of Tom Nikic from Wedbush Securities.

I believe you said U.S. Wholesale for the year should be down 7%, which kind of implies that Q4 is down in the high 20s. That seems pretty dramatic. And that would result in like -- Q4 wholesale being like way below like fourth quarter of 2019. I mean, I guess, is there like -- and I know all year, you've been kind of talking about like the exclusive brands at the -- kind of the mass merchants doing well. The decline that you're seeing in Q4, is that basically just like across the board? Are there like some wholesale partners who just like kind of completely turned off the faucet? Like, I guess, if you could help us like kind of understand why Q4 is down so much, that would be helpful.

Yes. Tom, we expected it would be lower. I'd say that relative to the July forecast, it will be about -- in round percentage, it's about 15% lower than what we had expected in July for the fourth quarter. And it's largely because the wholesale customers -- keep in mind, like Carter's, everybody was bringing product in earlier this year to get ahead of supply chain delays. So here's one customer, we probably brought our product in probably four to six weeks earlier. Some of our wholesale customers brought product in as much as 12 weeks earlier, just to get a head of supply chain delays. Those decisions were made, I'd say, long before we saw the slowdown in consumer demand, which, at least for us started to be apparent to us sometime in May. So we knew the wholesale fourth quarter sales would be lower because they were elevated last year. If you recall, last year, we moved about -- it was probably because of supply chain delays, about $70 million of wholesale demand moved from the third quarter into the fourth quarter last year. So we knew as we planned this year that a good portion of that $70 million would not repeat in the fourth quarter this year. So I think a better way to think about it, our wholesale, we have changed our wholesale forecast for the fourth quarter by about 15% relative to what we shared with you in July, heavily weighted to department stores, but it's not only department stores. We've even seen with some of our exclusive brand customers say, "Hey, listen, we got enough. We brought a lot of product in early. We got enough to make our way through the balance of the year. So hold off sending us more." Even -- something we have rarely seen is automatic replenishment orders turned down. The beauty in our business with automatic replenishment, it's automatic. So as the register rings, triggers in water and more product is on the way from us to our customer to keep the fixture filled. But I think many retailers across the board, department stores, exclusive brand customers, I'd say, across the board, they're saying, "You know what, this can slow down in consumer demand. It's greater than we had anticipated when we made our inventory decisions this year. So we're going to dial it back." We're going to just -- there's -- they've got probably enough to make their way through the balance of the year. We'll still have good shipments in the fourth quarter, but certainly will not be at the level that we anticipated earlier this year, nor will it be the sales that they anticipated earlier this year.

Got it. And then a quick follow-up. So obviously, you had a really good year last year with stimulus. Do you think possibly what's happened is that last year with all the stimulus that happened, like parents bought maybe multiple years worth of clothes for their kids, so like maybe somebody with a newborn bought enough clothes last year to get the kid through two years old or something like that, and then that's possibly weighing on the 2022 performance?

I think that's possible. I don't know about multiple years, but I think that's possible. Again, I still say, when you think about our consumer, our consumer, how they've been affected by inflation -- I remember when I was in my late 20s, early 30s, our target consumer, we had three kids within 30 months, it was a paycheck-to-paycheck experience. Think about where you were in your late 20s, early 30s, paycheck to paycheck. Now if you have record inflation, you're pulling back. I've seen some of the news reports now as people are getting focused on home heating prices, fuel prices, particularly up in the Northeast, they are more than doubled. So it's -- I think the economy is in tougher shape than anybody envisioned, even in July, as we head into the balance of the year. So did they buy ahead? I think that's part of it. I think more of what we're seeing is they're just pulling back. They're buying more of what's needed and less of what's wanted in buying it when they need it. And again, there's still two good months to go, two important months to go. But a year ago, everybody was encouraged to buy early. All of the holiday marketing started early. People wanted to get ahead of it because it was a period of optimism, had the vaccines, they were starting to travel again, reconnecting with families and friends they hadn't seen over the Christmas 2020 holiday. The world is in a different place today than it was a year ago. So year-over-year comparisons over the past couple of years, I think, have been challenging, right? We keep on going back to 2019. Relative to 2019, our business, at least, particularly our Retail business, is much more profitable than it was in 2019. But I think it's going to -- we knew the recovery would be a bit uneven. I think it's been bumpier than most companies assume this year.

And our next question comes from the line of Jay Sole from UBS.

My question is just on margins. The adjusted EBIT margin for 4Q implies a pretty big step-down relative to '19 versus the year-to-date trend. So just wondering what's the split in the guidance for 4Q between gross margin and SG&A? And within the gross margin, how should we think about the pressure between U.S. Retail and U.S. Wholesale?

Jay, I'm probably a bit more focused on the comparison to last year's fourth quarter. I think 2019, in terms of just timing, is becoming a little distant to look at discrete quarters that far back. But we are focusing on having a good operating margin in the fourth quarter, roughly equivalent -- for the high end of our guidance, roughly equivalent to our fourth quarter margin last year. Within that, we're planning for expansion in gross margin. And that comes from a few different sources. One, we're spending a little less on transportation. While that's been injurious to the P&L all year, that becomes a little less so in the fourth quarter. It was this time last year when some of the rates really started to spike up. And so that comparison becomes a little less favorable -- a little less injurious, I should say. And product margin is expected to be good. So that continued progress in price realization, we started to widen out a little bit of the gap from a product margin point of view. The gap between pricing and product cost, that's beneficial. And then on SG&A, we're expecting a bit of deleverage, which is kind of offsetting. So you kind of have a good guide in gross margin, and a little bit of deleverage from SG&A, which is largely just driven by the lower sales. We've got tremendous favorability that we are driving from not having the outsized provisions that Mike was referring to in terms of performance compensation, charitable giving and such. That's offset, though, just by deleverage on the lower sales. But that's down to a very comparable operating margin for our forecast versus Q4 of last year.

Got it. Okay. And if I could ask one more? Just on the comp guidance for 4Q, given there's a little trend there between Q3 and Q4, can you tell us maybe how things look quarter to date? And sort of what has to happen in terms of like a catalyst for the for the trend to change? I mean in other words, like could we see this trend extension 2022, given inflation is so high and obviously, families are still going to be under pressure? Any thoughts about that would be helpful.

Jay, while our comp guidance is down about 10% to 15%, last quarter, we were down 11%. Like Mike stated, for the month of October, we're down about 13%. And it's an interesting month. The first couple of weeks, we had a good start when weather turned cooler and some of the areas, particularly in the Southeast, but week three and four have been softer for us. And when I look across the data we're getting from our retail partners, it's pretty much the same trend. So we're down about 13% with a few days to go, so let's call that October. I think one of the things we're looking at is, I think as people are buying closer to need, we're hoping what's happening is maybe the holiday shopping period is becoming a little bit more like it was a few years ago versus last year. And last year, folks were worried that there wasn't going to be enough inventory, so they were shopping earlier. And the hope is that, that shopping period is going to be more pronounced this year in November, maybe later in November. So that's you say what has to happen. I think our experience quarter-to-date is in the midpoint of our guidance for that to get better. We look for a really strong period late November, Black Friday. We started our marketing in a bigger way just this weekend and next week with daily deals and those sorts of things. But the inventory position that people have that we have is better than last year. Last year, we didn't have as many of the Christmas PJs and our retailer partners were running out of good. So people have the product to do the business. It will come down to what the consumer demand is and what they're willing to spend on children's apparel this holiday season.

And our next question comes from the line of Ike Boruchow from Wells Fargo.

Going back to Tom's question, just on wholesale, can you talk a little bit, Mike, I guess, you said 15 points lower versus what you thought three months ago? How much of that is just order book versus maybe cancellation that you're seeing ahead of holiday? And then just again, just given the decline that, that implies for Q4, is there any visibility into the spring wholesale order book? How is kind of net pricing look within that book? Any need for markdown dollars that you're expecting now in the first half for spring? Just any more color there would be really great.

Sure. And on the first, the split between lower demand, lower replenishment trends, you had to split it between demand and cancellations because of late deliveries, I'd say, it's probably 50-50. That's our best analysis. And whereas a year ago, it's a completely different environment. Our wholesale customers were scrambling for goods. It started, number one, of our largest customer, "Send us anything you got." This was a year ago. "Send us anything you got because anything you send us is sounding like it's free." That's what the environment was a year ago. This year, it's more if you're late, there's kind of a low tolerance for being late. Maybe a week or two late, fine. But if you're more than a week or two late, they're basically saying, "Listen, hang on to it." And this time of the year, especially as we're in the home stretch, the weeks of selling are fewer for fall products. So if you're late on full product, they're more likely to say, "Hey, don't need it, and hang on to it, and we'll bring it back next year." So demand, late shipment is probably 50-50. In terms of visibility into next year, I would say, by and large, our wholesale customers are approaching, at least the first half of next year, cautiously. And we had a couple of top-to-top meetings in recent weeks. And that's -- they've shared with us their experiences are similar to ours. So they're going to approach next year cautiously. And we would expect that there would be lower wholesale demand in the first half of next year. We don't have visibility into the second half, but we'll probably have a better visibility when we update you in February, what we think is possible in the second half of the…

Our final question for today comes from the line of Chris Nardone from Bank of America.

Can you talk about any proactive measures you've taken this year to cut back on some of your variable cost spending? And then how should we think about that potentially coming back as we head into next year?

Chris, I would say all of the usual suspects have been on the table and have been managed well by our teams, given the lower demand, lower unit volumes. So our DCs have worked very hard to lower the labor in the DCs relative to the unit volume that's going through. Our store labor has been ratcheted back to match the level of sales we're doing at the moment. I'd say, beyond that, though, it's really the fixed cost of this business, which are high, particularly in the direct-to-consumer part of the business. But that's been a challenge, just given the lower level of sales. So our objective is to stay as lean as possible and not add to that fixed cost structure. Where we need to, we will. And we're balancing what we believe is going to be a very strong recovery over time. We don't want to be so draconian in cutting back on spending that we harm the business for the long run. That's what we're managing to. We're managing to have this business be here for another 150-plus years. But we're staying extremely lean on the things that we can control in this environment. We're being very disciplined on inventory. I think the team has done a great job responding to the lowered outlook for demand and realigning our commitments for inventory. We're being very judicious on adding additional staff to the business just -- both in those variable cost centers and in our offices. The best thing we can do is just not get ahead of ourselves. But everything is on the table for review. We're looking at technology projects, marketing, everything that are big-cost centers are subject to review, and that's going to serve us well, and we'll be in a good position once the marketplace starts to recover again.

Okay. Great. And if I can squeeze in one quick follow-up, are you seeing any notable trends of trade-down activity in your category? Or are you even seeing consumers just trading into smaller baskets within your own retail channel? Clearly, there's a pullback in spend. But just if you could provide a little bit more color, that would be really helpful.

Yes, a couple of things. I think that there is -- there has been some strength in the private label businesses, we've seen that. Our business still is very good at the exclusive brands as well, but there's a little bit of that going on. And I think the other thing is folks are shopping. They're coming to us, but between what they're paying for food and gasoline and whatever and the overall inflation, they're buying less units. And that's probably the main thing, is the average check is a certain amount, but the unit volume, the number of units per transaction is certainly down. So she's buying five T-shirts, now she's buying four. That's kind of what we're seeing. So that's the differentiation, I'd say, from the past as buying exactly what they need and not what they want versus what Mike said before.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Mr. Casey for any further remarks.

Thanks very much. Well, thank you all for joining us on the call this morning. We look forward to updating you again on our progress. And best wishes to all of you and your families over the holidays. Goodbye, everyone.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.