Welcome to the Carter's Second Quarter Fiscal 2023 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 2023 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, and the Company does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. 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 and earnings release posted on the Company's website. On this call, the Company will reference various non-GAAP financial measurements. A reconciliation of those 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. I would now like to turn the call over to Mr. Casey.

Thank you, Tanya. 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 our second quarter sales and earnings, which are in line with the forecast we shared with you in April. For the third consecutive quarter, we saw higher-than-planned demand in our Wholesale segment. Our wholesale customers have been running leaner on inventories and in need of fresh new product to drive sales. In our Retail segment, comparable retail sales in the second quarter were in line with our forecast. Spring selling was sluggish earlier in the quarter with the late arrival of warmer weather. Thankfully, our retail sales picked up over the Memorial Day holiday weekend and that improved trend in sales has continued through July. And in our International segment, sales were a bit lower than planned, largely due to unseasonably cool weather in Canada. But similar to our experience in the United States, the trend in retail sales in Canada improved in June and has continued into July. As planned, inventory levels are down significantly in the quarter, and expected to trend even lower through the balance of the year. The mix and level of inventories were in good shape heading into the second quarter. And as a result, we were less promotional than last year. In the second quarter, we achieved a near record gross profit margin driven by the strength of our product offerings, improved price realization, lower inventory provisions and lower ocean freight rates. With lower inventories, cash flow year-to-date is meaningfully better than last year. That stronger cash flow enabled us to reduce borrowings and interest expense and returned over $100 million of excess capital to…

Thank you, Mike. Good morning, everyone. Beginning on Page 2 of our presentation materials, we've included our GAAP P&L for the second quarter. And on the following page, we have our GAAP P&L for the first half. Page 4 summarizes adjustments to our GAAP results in the second quarter and first half of the year related to organizational restructuring. Last year's second quarter included an adjustment for the cost to early retire pandemic-related debt as our liquidity and performance allowed us to deleverage and strengthen our balance sheet. This information is included for your reference. And this morning, I will speak to our results on an adjusted basis, which exclude these items. On Page 5, as Mike said, we achieved the forecast we shared with you on our last call. Net sales in the quarter were $600 million. Our U.S. retail comps declined 16%, consistent with our guidance of a decline in the mid-teens. Wholesale sales exceeded our forecast in the quarter driven by earlier demand for seasonal product. In the first half, we've seen also better-than-planned replenishment trends across most of our brands. International sales were a bit lower than we had forecasted, largely due to cooler weather, which affected consumer traffic in our business in Canada. Profitability, both operating income and EPS were above our forecast. Spending was well controlled and our strong cash position enables lower borrowing, which in turn led to lower interest expense than we had forecasted. The next page summarizes a few key metrics of our second quarter performance relative to last year. Second quarter sales and earnings were down. Our performance in the second quarter last year was relatively strong, although we began to see the significant impact of inflation on consumer demand, affecting sales in all of our channels. These effects continued…

[Operator Instructions] And our first question will come from Warren Cheng of Evercore ISI. Your line is open, Warren.

Hey, good morning. I was wondering if you can flush out the –

Good morning.

Hey, good morning. I was wondering if you can flush out the assumptions underlying that 4Q implied margin outlook. I think that's the piece the guidance that's jumping out to me a little bit. So I'm coming out with 400 basis points to 450 basis points of expansion. How much of that is tailwind from freight and that easier promotional compare? And I was curious if you can talk about the other key components underlying that function.

Yes. In terms of gross margin, Warren, expansion in fourth quarter is planned to be robust. I think you're in the neighborhood of what we're forecasting. I'd say over half of that relates to lower inbound transportation costs, as we've renegotiated those rates that come down really to pre-pandemic levels. And so there's a tremendous benefit that comes from that. We're forecasting improved margins in our retail business. That's a combination of continued progress with improving our realized pricing. We've had good results so far in doing that. We're assuming that we're going to continue to have progress on that front. Better margins forecasted in Canada, some improved margins in our wholesale business, which in part is due to an improving trend on product costs, also an improving trend on chargebacks from some of our larger customers. So a number of things contributing. The vast majority coming from those lower inbound freight costs.

Great. Thanks. And my second question, can we just double click on what to expect for the wholesale replenishment business in the second half? And how much of wholesale is typically a replenishment in the second half? And then how much of a hit did you take last year?

We got clobbered last year in the second half. That's when inflation peaked, consumer demand slowed down. In first half last year, our wholesale customers were building inventory, trying to get ahead of the port congestion and anticipating another good year, just like they had in 2021 with us, the anticipated 2022 would be another good year in the first half. But when inflation hit, it was probably late spring. If you recall, one of our largest customers announced that the consumer had slowed down. We were starting to see the same thing in the tail end of the second quarter. In the second half of last year, most of our wholesale customers were aggressively trying to get out of inventory. The order cancellations were significant for us. So we're planning wholesale down 7% this year, but only 2% lower in the second half. Replenishment now is planned down around 2% for the year, but it's planned up over 10% in the second half. Seasonal demand probably down around 10%. That's true in the first half, second and that seasonal product where they're saying, hey, we're just going to order much more conservatively. That's kind of been the general theme of our conversations with wholesale customers this year. We're going to approach 2022 conservatively seeing what we saw starting in the second half of last year. Keep in mind, that's when the inventory decisions had to be made by our wholesale customers largely starting in the second half last year when the consumer started to slow down. So replenishment – the nature of our replenishment business, that's the milk and eggs at the grocery store. These are the essential core products that families load up on, buying multiple quantities and then need to replenish those products frequently in those early months and years of life. So we're expecting meaningful – just based on what we're seeing in our business, we're expecting a meaningful improvement in our replenishment sales in the second half.

Thanks, guys. Good luck.

Thanks, Warren.

One moment for our next question. And our next question will come from Tom Nikic of Wedbush Securities. Your line is open.

Hi, everybody. Thanks for taking my question. It sounds like Carter's brand inventory is in a pretty good shape, both internally and externally. But I'm curious when you kind of look around the industry as a whole, what does inventory look like for private label brands, what does inventory look like for the mall-based competitors. And I'm just kind of curious what the broader environment looks like from your seat?

Generally speaking, with the larger, better retailers, they are running leaner on inventories. That's generally been the theme of our conversations with our largest customers. They're running leaner on inventories, trying to drive better sell-throughs, trying to strike the right balance between topline growth and achieving their margin objectives because when you run a leaner on inventories, you have better sell-throughs, you have less product on the clearance rack at the end of the season, you're seeing improved price realization, less discounting, fewer promotions. That's generally been the theme. That said, you asked about our specialty store competitors, it varies. We've been in some stores and they're loaded with product. Those who are more promotional bought more inventory than they're seeing in terms of consumer demand, and they ultimately have to move through it. So all I can speak to is the data we have is that we are running – inventories in our stores are down significantly from, say, the pre-pandemic period. We're probably carrying over 40,000 units in each of our stores on average. And today, it's probably closer to 25,000 units per door. So most of our inventory backrooms are light on inventory. And so we're trying to drive higher sell-throughs. Good retailers look for an 80% sell-through. Sell-through 80% at the desired margins and some portion of 20% goes on the clearance rack. Before the pandemic, we're probably taking about a third of what we were sourcing from Asia and putting it on the clearance rack. By comparison, this year, our sell-throughs will probably be better part of 80% and some portion 20% or less sold at clearance. So good retailers are focused on running leaner and inventory. We all saw the benefit during the pandemic when you couldn't get product in from Asia of running leaner on inventories. When we ran leaner, we saw less resistance to the higher prices and the fewer promotions. Consumers are looking for good product at good price, and that's been the experience that we've had kind of in this post-pandemic period. Better price realization, better margin. That's a much better model. It's a healthier model. Even though our wholesale customers have kind of right-sized and run lean around inventory, that's a healthier model for them. If it's a healthier model for them, it's a healthier model for us.

Got it. If I could add one more. I know in your prepared comments, you mentioned the wedding boom that happened in 2022. And I would imagine that there is some amount of lag time beyond just the normal nine months? Honeymoon babies happening out there, but have you looked into like what the average kind of lag time is between like a wedding and the first child birth and when does that give you any optimism for a 2024 recovery or I guess just trying to think how that plays together.

Yes. Again, there was a record number of weddings. I think it was like a 40-year high in weddings last year. And Baby, thankfully, 60% of our business is in baby apparel. And that continues to be the strongest part of our business. And even with the – we just talked about the replenishment, that is largely the nature of business, vast majority of our business with the largest retailers are heavily weighted to baby apparel. So that's why I think we've seen the success we've seen with exclusive brands. That's where we – our stores provide a superior experience for family shopping for baby apparel. Lag time, I can't say for sure. All I can tell you is that baby continues to be the strongest part of our business. It's the largest part of our business. And that's where the relationship starts. So our success over the years was we typically have the first purchase of a wardrobe that a family purchases for the child, long before that child arrives. It's typically the first thing you kind of have this vision. What's this beautiful child and were home from the hospital on their first day. So that's when the relationship starts. And we have the number one market share in newborn apparel, 5x this year of our nearest competitors. We have the number one market share in toddler. So our whole focus has been on extending the lifetime value of that relationship up to about a 10-year-old child. And before the pandemic, some of our fastest-growing segments, age segments in our business, we're the apparel for that older child. So lag time, not so sure, but we are encouraged by the number of weddings, record weddings. And we're encouraged by the birth rates, quite frankly, that we saw an elevated number of births in 2021. The experts, so to speak, the economists were way off their predictions in terms of how many children would be born, they expected as many as 500,000 fewer children will be born in 2021, and they were wrong. Thankfully, they were wrong. The number of births in the United States increased in 2021, and it stayed stable in 2022. So [first to moms] 29-year-old are actually up, first to moms 25 to 29 are down a bit and first of moms under 25 are down a bit. So anyway, it's stable. We're expecting stable, if not improving birth in the years ahead.

All right. Sounds good. Thanks very much and best of luck for the rest of the year.

Thank you, Tom.

One moment for our next question. And our next question will come from Ike Boruchow of Wells Fargo. Your line is open.

Hey, good morning, guys.

Good morning, Ike.

Two for me. Hey, Mike. First, maybe, Mike, for you, just when you think about how the business works in the back half of the year, how much risk does the current heat wave we're seeing in the country have to the seasonal transition you have planned? I mean when do you need – when do you install my baby screening in the background? When do you kind of need things to basically go back to normal? Is there a date where you kind of need to see that transition take place? Otherwise, it kind of messes up the flow of merchandise in the store. Just kind of curious how you think about that.

Ike, I missed the days we talked about weather. I missed those days. So yes, there's been a heat wave. We recently said, in years past before the pandemic before historic inflation, we'd be sweating out the weather. We don't – those things we don't worry about as much. The weather is never ideal. It's either too cold, too hot, too rainy, too dry so our business is good. Fall is off to a very good start. And I think it's largely based on the strength of the product offering, it's what we call transitional. Years ago, and this time of the year, we'd be shipping corduroys into the store and flannel shirts. And puffer dress, right? Today, we got beautiful shorts. Kids are going back to school, these days in shorts and t-shirts, so that's the product offering we have right now. Our comps in the second half are only down 7%. That's a 50% improvement over the first half. So we're actually encouraged by what we're seeing despite the fact it's brutally hot through many parts of the country. So we're doing okay. So weather – we're not thinking right now that weather is having any meaningful impact on our business. It maybe, but we're encouraged by the current trends in our business.

Okay. Great. That's helpful. And then just a bigger picture question. When you look at the guidance for wholesale, I think you're planning around $1 billion this year. About 20% below pre-pandemic. Maybe can you just walk us through this a bit. I'm kind of curious like what – so how do we think about those $200 million in lost revenue? Do you think those sales are they coming back? Is this kind of the new normal, this new run rate of the business? Is this the new normal? What exactly has happened to the exclusive business within wholesale in terms of penetration over the last couple of years? Just trying to understand how we should think about this current base business in the channel going forward?

Ike, I would say, overall, our wholesale business is strengthening. And as Mike shared with you, we beat our plans in the first half. We're only going to be down 2% in the second half. We do have an initial read on spring 2024, we have sold in the product for spring 2024. Summer bookings still to come. But based on what we have in hand for spring 2024, we plan to resume the growth in the first part of 2024. So we're excited about that. We got replenishment still about 30% to 40% of the business, so that's to come along with summer. But we feel good about that. You are correct about $1 billion business. Our operating margins are improving. I think we're up over last year in Q2 and by the end of the year, we'll have a – we believe, a very high teen operating margin and nearly back to 2019 levels of profitability. So the business is strengthening. It's healthy. It has migrated and it has changed a lot. You've got folks that are no longer in business with us. Consumers during the pandemic, they got comfortable rotating to, I would call it, the big three, Target, Walmart and Amazon, where we have really great relationships, strong exclusive branded business and I know a lot of our competitors would love to have businesses with all three of those we do, and that is about 51% of the business, we think it will be this year. And we think there's opportunity for growth there. We've got a good business with department stores, but it's lower than it was in the past. A, there's less of them, and B, they've had a little bit more traffic challenges. And then we got a business with the clubs and the promotional retailers as well. So it's a multi-pronged business. Our focus has been on profitability. We could certainly sell a heck of a lot more if we had lower prices and lower margins, but we've chosen not to do that. So we've worked on good strategic partnerships, healthy relationships. I think if things turn out the way we hope they will this year, we'll have about a $1 billion business with a very high teen operating margin, a good base to grow on going forward and optimism that we're going to have good growth going into 2024.

I guess my question is growing off of that back in normal run rates makes sense. But should we stop looking at like the $1.2 billion you had in 2019 as like as reasonable. Like have those – you mentioned department stores and buybuy BABY, should we just kind of like eliminate that from our memory and just think about normalized growth off of this billion?

Yes. I think you got to take into account the world has changed dramatically since 2019. So we are where we are, again, very healthy billion-dollar business, new base to grow off of with a lot of good initiatives we have as a company. And the retailers that we are partners with and that compete against each other are very different than they were pre-pandemic. And so we look at it as high teen operating margin, $1 billion business, good basis to grow and optimism going forward.

Great. Thank you.

And one moment for our next question. And our next question will be coming from Jay Sole of UBS. Your line is open.

Great. Thank you so much. Mike, you touched on the digital business a little bit in your opening remarks. Can you just elaborate a little bit? And maybe tell us, within the down 16% comp for Q2, what was your growth on e-commerce versus what was the growth in the stores? And then maybe secondly for Richard. Can you just walk us through the EBIT dollar guidance for the full-year total? Like what were the factors that changed from the – where it was before that $350 million to where it is now? Thank you so much.

We saw a better performance in the stores than e-commerce. I'd say the performance is about – we don't like to split it out the e-commerce from the stores, but the performance in the stores was far better than e-commerce. That said, the mix of e-commerce that we do this year will probably be around 33%. Last year, it was close to 37%. But in terms of the market, our e-commerce business is outperforming the market. For the market for kids apparel in the United States, e-commerce mix is closer to 20%, 28%. The credit card data that we've seen year-to-date would suggest e-commerce, what they call e-commerce pure-play apparel is down about 25%. We're better than that. Our performance in the first half has been better than that. I still say e-commerce is more impulsive purchase triggered by text, by e-mails. And with credit card debt being where it is, the delinquency rate is increasing most around 18 to 29 years old purchasers and that is some segment of our consumer base. So years for years, Jay, we'd be asked, where do you want the next incremental dollar of sales. You want it in the stores, because that's where the fixed cost is. We're encouraged that we're seeing very good performance. I think we're comping positive in our stores second half to date. So more people are coming into the stores. They want to get into the stores. They want that immediacy. They want the experience of the store. So I don't know if it's so much a Carter's factor as much as more people are shopping in stores, fewer people in shopping online than they were in years past.

And Jay, on the second part of your question, I would say the revisions to the EBIT guidance primarily just track to the lower – modest lower sales or risk adjustment that we made in our U.S. Retail business. So we're encouraged by this improvement in trend. We're still forecasting a nice inflection point over first half results in retail, perhaps not quite as dramatic of an improvement as what we had in our original guidance, which I think, given the environment, being just a bit more cautious on that front, but I think the revision to EBIT is largely based on the revision we made in our forward guidance on retail sales.

Got it. Super helpful. Thank you so much.

You're welcome.

Thank you. And I would now like to turn the call back to Mr. Casey for closing remarks.

Well, thank you all very much for joining us this morning. We look forward to updating you on our progress in October. Goodbye, everyone.

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