Welcome to Carter's Third 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 third 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 in 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, Chris. 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. We achieved our third quarter sales and earnings objectives. For the fourth consecutive quarter, we saw a higher than planned demand in our U.S. Wholesale segment. That higher demand drove our best quarterly growth in earnings since 2021. In our U.S. Retail segment, its third quarter profit contribution was in line with our forecast on lower-than-planned sales unseasonably warm weather in September weighed on our retail sales in the United States and Canada. It was reported to be the warmest September on record. The late arrival of cooler weather in Canada also drove lower sales in our International segment. In the third quarter, we saw better price realization and profit margins, which were driven by the strength of our product offerings, lower ocean freight rates and a better level in mix of inventories. We continue to make good progress rightsizing our inventory levels in the quarter. Inventories grew last year when inflation peaked at historic levels and consumer demand slowed. Our inventories at the end of the third quarter were down over 30% and expected to trend lower by year-end. Our progress with inventory reduction has improved our cash flow relative to last year by over $400 million through September. Given our stronger-than-planned cash flow, we have reduced our seasonal borrowings and related interest expense, and we believe we have ample capacity to fully fund our growth strategies and plan to continue returning excess capital to our shareholders. Our forecast for the year reflects an improving trend in our second half sales and earnings relative to our first half performance. In the second half…

Thank you, Mike. Good morning, everyone. On Pages 2 and 3 of our presentation materials, we provided our GAAP income statements for the third quarter and year-to-date periods. Page 4, summarizes adjustments to our GAAP results for the third quarter and year-to-date periods for costs we incurred this year related to organizational restructuring. In the second quarter of last year, our strong liquidity enabled us to strengthen our balance sheet by early retiring pandemic-related debt. The loss associated with this early debt extinguishment is included as an adjustment to last year's Q3 year-to-date GAAP results. This information is included for your reference and this morning, I will speak to our results on an adjusted basis, which excludes these items. Moving to Page 5. As Mike said, we achieved the sales and earnings objectives which we shared with you back on our July call. Net sales in the quarter were $792 million, slightly above the high end of our guidance range. These consolidated sales results reflect higher than planned demand in our U.S. Wholesale business. Retail sales in the U.S. and Canada were lower than we had forecasted, we believe a result of warm weather that contributed to unfavorable traffic trends particularly in September. Profitability, both operating income and earnings per share exceeded our forecast. The drivers of our better-than-planned profitability were strong expense management and continued progress in reducing inventories, which has led to better cash flow, lower borrowings and lower interest expense. Page 6 summarizes a few highlights of our third quarter performance relative to last year. Third quarter sales declined 3%. We had growth in our U.S. Wholesale business, which was offset by lower sales in our U.S. Retail and International businesses. Adjusted operating income grew 5%. Adjusted operating margin improved 100 basis points to 12.2% and driven…

Thank you. [Operator Instructions] Our first question will come from Warren Cheng of Evercore ISI. Your line is open.

Hey good morning. I just wanted to ask, I want to understand the comp expectation that's baked into the fourth quarter guidance. So it sounds like the exit rate from the second quarter was down in the high teens range. Did you see an improvement in the U.S. costs in October from that September level? And also, can you remind us, typically, if there's a late start to the season, is there a catch-up that occurs when the weather cools. So is it more of a pushout of the sales? Or are those September and October sales is just sort of lost for the season?

Warren, I'd say we've seen a strong correlation between the trend in our retail sales and the warmer weather or weather is cooler, the trends are better. So for the fourth quarter, we're assuming a high single to low double-digit negative comp in retail sales in the fourth quarter. The trend in October did slow relative to September. So we have seen – to put it in context, we're probably running some portion about $8 million off our retail plan in the fourth quarter to nearly $900 million quarter, and we see some upside in the wholesale side of our business. So again, we saw sluggishness that began in the second week of September. And even with that sluggishness, we outperformed the expectations that we shared with you in July. We were running probably a solid negative 7% comp through most of the third quarter and then started to lose ground in the final weeks of September. And then that continued into October. So not unusual, firstly, 80 degrees in New York this weekend. That doesn't exactly lend itself to shopping for fall and holiday product. Next week in New York, it's going to dip into the 30s at night in the highs and the 50s. So where we've seen that kind of weather change, we've seen a meaningful improvement in the retail performance. We've already started to see it in Canada. Colder weather, snow has come to Canada, and we've seen a meaningful change in the trend and their performance, we expect to see it as we head into the final weeks of this year.

Got it. Yes. I think October was warmer than May this year. And then, Mike, another is just a higher level question for you. If I step back, your gross margins are running more than 400 basis points higher than pre-pandemic levels, but your comps have been negative for almost two years now. And I think we all understand the pressure on your consumer, especially from – have been inflationary in nature. Has there been any thought on revisiting your approach to pricing in this environment and for us using that as a tool to help stabilize the comps.

Well, we have revisited the pricing. Pricing is competitive. We have good people at Carter's looking at our pricing relative to our competitors every day. We have raised our prices because costs went up, freight rates went up, but our competitors have raised their prices as well. Our biggest competitor are the private label brand competitors. And we're priced within $1 or $2 of the private label brands. And what we've seen over time, as long as we're priced within $1 or $2, we are competitive. We have tested, we have very smart people testing different pricing configurations, different prices, we've tested lower prices. It did not drive a change in unit velocity that would suggest that we should do that on a more sustained basis. So I think what we've seen in terms of the negative comps is more a reflection of the consumer spending through a roller coaster of experiences in recent years. Keep in mind, as Richard shared with you, we had record profitability in 2021. We came roaring back from the worst of the disruption from the pandemic in 2020, actually saw 2022 get off to a strong start, had high single-digit positive comps in our retail business in the early months of 2022 as we move through 2022. And all of a sudden, gas prices doubled and food prices went up and the consumer couldn't find baby formula and then when inflation peaks, good retailers. Some of our largest wholesale customers announced a significant decrease in the trend in consumer traffic and purchases. So I don't think we're unique in this. If we felt as though lowering prices would drive stronger comps, we would do it. We feel as though we are competitive. This is a very profitable company. We have been focused during this…

Thanks, Mike. Thanks, team. Good luck.

Thanks, Warren.

Thank you. [Operator Instructions] Next question will come from the line of Ike Boruchow of Wells Fargo. Your line is open.

Hi. Good morning, guys. A couple of questions from me. Two of them actually, I think, piggyback off of what Warren had just asked you. But Mike, just on the comps, I understand the guidance for 4Q, what's embedded. Can you just explicitly let us know quarter-to-date where you're running on the comps? Second question is on the product cost, I think you said you expected those to be favorable into the back half of this year and early next year. But I think, Mike, you said something along the lines of sharpening price points or gives you an opportunity to sharpen your price points. Can you just elaborate on what you mean? Are you talking about putting some price investment into the business, not flowing all that AUC into the margin. Just kind of curious what exactly you meant and have one more, but I'll hop on.

Sure. So heading into next year, we have visibility to wholesale demand for our spring and summer 2024 product offerings given the good work our supply chain team has done working with our merchants and designers, the product costs are expected to be lower going into the first half of next year. And so because the product costs are lower, the pricing will be for those early deliveries for spring and summer 2024 the pricing will be comparable to lower. So we are expecting margin expansion. So again, we see some opportunities on some key item price points to test lower pricing. We see less need for increasing prices given the progress that we've made on ocean freight rates and product costs going into next year. And again, our comps in the third quarter were down 10% and right now in October, running down about 16%.

Great. And last question maybe for Richard. I think you talked about SG&A down in 4Q. You guys have really been tight on expenses. Is there any initial thoughts on SG&A into next year? Should we continue to expect you guys to really keep that SG&A tight? And just kind of curious if there's any initial views you can kind of give us on the expense line? Thank you, guys.

Yes, Ike. I would say we continue, to Mike's point, be managing for profitability, margin preservation and cash flow. Those are the things that we have with the most control over in this kind of environment. We've done a lot of very good work looking at our cost structure of the organization. I'm really pleased with how they responded to the challenge. Everybody understands the environment that we're in. And the best thing we can do is just keep ourselves as lean as possible. As you saw in the press release this morning, we did take some charges related to organizational restructuring. That has lowered our staffing costs. There's other things that we've been looking at and making good progress on indirect procurement. We've been focused on marketing effectiveness. So our focus will remain on SG&A, keeping it as low as possible. I think it's too early to be specific on next year's plans, but you can be assured that it's an ongoing discipline and an area of focus for us, and we've made good progress in managing it this year.

Great. Thank you, guys.

Sure.

Thank you. [Operator Instructions] Our next question will come from the line of Jim Chartier of Monness, Crespi, Hardt. Your line is open.

Good morning. Thanks for taking my question. Just wanted to talk about product costs. Given kind of the big reduction in cotton over the last 12-plus months. I would have expected maybe some of that to flow through into lower product costs in the back half of this year. So I was hoping if you could talk about what some of the offsets to the lower cotton costs were for the back half of this year. And then maybe what some of those factors look like for spring of next year and fall of 2024? Thanks.

So Jim, I would say we are starting to see the benefit of lower cotton and other input costs in our product costs. I think that leads into the P&L kind of over time, you receive that product. It goes into inventory and then you realize some of that margin upside when you sell the product. Recall that we're still working through that pack and hold inventory that was procured at a time when product costs were elevated. Where we are seeing a tremendous benefit on is in these inbound transportation costs. That's been a big source that gets inventoried into the cost of the inventory as well. So we're expecting good favorability from that here in the fourth quarter. That is a benefit that will continue through the first half of next year as well. Once we get to midyear next year, we're more or less kind of anniversarying those lower rates that have benefited the second half of this year. But we are planning for lower product costs in the first half of the year. I think the biggest determinant of that even beyond cotton is just worldwide capacity. The global marketplace has meaningfully slowed down. And we have terrific teams here in Atlanta and in Hong Kong to work with our factories. We've had a series of meetings, top-to-top meetings with our largest vendors recently. And they're hungry. They love doing business with Carter's, we've been a source of great growth over the years, a good partner for them as well, and they are hungry for business. And so I think that available worldwide capacity is the bigger determinant. Cotton certainly is a benefit to us, but we're seeing good capacity across Asia, and we think that will drive even first half of next year. We don't have complete visibility to the second half of the year, yes. Hopefully, we'll have more of that to share with you on the next call.

Great. Thank you.

Sure.

Thank you. [Operator Instructions] And our next question will come from Jay Sole of UBS. Your line is open.

Great. Thank you so much. Maybe, Mike, I just want to follow up on the Wholesale business. I think you touched on this, but can you elaborate a little bit more on how the sell-through is at your big wholesale customers? I mean, how do you see the product, how do you see the sales moving in like Amazon Prime Day, for example, in October, like how did you see that event for the company? If you can tell us a little bit more detail on that, that would be super helpful.

Yes, Jay, the sell-throughs have been good in Wholesale. I'd say fall is better than last year. Now higher AURs, as Mike talked about, a good margins for the retailers. And I recall, they did buy seasonal lower. But sell-throughs have been good. Their inventory is in good shape. We commented on the supply chain is doing a heck of a job this year. We're near 100% on time. So we've got a meaningfully fewer cancelled plans. So they're faring well, I would say, particularly the top three are doing really well. We did have some orders move into Q3 from Q4, but we seem to have good momentum in the business. So I would say the outlook is positive. Our relationship with Amazon is good. Prime Day, we exceeded their expectations, but we look at it for on an annualized basis, and we feel good about our overall Amazon business.

Just the key thing we're looking at, Jay, as Brian said, the seasonal business was booked down in the second half of this year. Our wholesale customers had to make those decisions in the second half last year. That's the lead time and that's when inflation hit and consumer demand pulled back. So they made those decisions on the second half seasonal bookings in the second half last year. And that's booked down about 10%. But by comparison, the high-margin replenishment business for them and for us is playing up about 10% in the second half this year. That's the everyday essentials, that's the milk, bread and eggs equivalent at the grocery store. So those are the big fixture fills of bodysuits, wash clothes, towels, bibs, blankets, all the essentials that parents buy multiples of in those early days, months, years, years of life, that business, that replenishment business at wholesale is trending to be up 10% in the second half.

Got it. Okay. Super helpful. Mike, thank you so much.

Welcome.

Thank you. [Operator Instructions] Our next question will come from the line of Christopher Nardone of Bank of America Global Research. Your line is open.

Great. Thank you, guys. Good morning.

Good morning.

First question I have is, can you just walk us through the level of gross margin expansion that's embedded in your fourth quarter guidance? If you can try to help quantify some of the big drivers there. And then as a follow-up, as we zoom out and think about it to next year, can you talk about your confidence in stabilizing the retail business? And maybe talk us through some of the initiatives you have underway to help turn around that business? Thank you very much.

Sure, Chris. On fourth quarter gross margin, we do have significant expansion year-over-year plan. I think that's been a consistent element of our second half forecast. As you saw, posted an over 200 basis point increase in the third quarter. We've got something above that plan for fourth quarter at both ends of our guidance range, it's above 300 basis points of gross margin expansion. I'd say as it was in the third quarter, the single biggest driver of that is lower transportation costs. These lower ocean freight rates will continue to benefit the fourth quarter. That's the most substantial. I'd say that's at least 200 basis points of the improvement we have planned. Beyond that, we do have some further modest pricing realization improved. Product costs are lower as well as we talked about. We have a mix benefit that accrues to the fourth quarter just because the U.S. Retail business will be a bigger proportion of our sales mix in the fourth quarter than it was in third quarter. We're expecting, as Mike said, an improving sales trends. So that contributes. And then finally, and a much less significant factor is just our inventory position is much cleaner than it was a year-ago. As we continue to work through our pack and hold inventory. I'm anticipating we'll have less kind of inventory charges and related costs. So those would be the principal drivers of Retail.

Yes. I would just say in terms of Retail, we'll give you a better outlook in February. But when we think about the business overall, I think we've made significant improvements in product. Richard talked about the fact that we've got cost reductions coming through the P&L. And our approach in that was really threefold, investing and making the product better, make select price increase – price reductions, I should say, in kind of our key volume items and then improving profitability. So we feel good about the product. Our customer experience. We have teams working really hard to improve our customer experience, where we're reimagining our store experience. We shared some of the improvements in our side-by-side business there. We focus on kids different from baby toddler and then significant investments in our online experience to our website. We've just replatformed that site with a good headless architecture and got great creative on there. Marketing capabilities, we continue to strengthen. We've invested in technology and the team to strengthen our marketing capabilities as we go into next year. We're going to have continue to focus on store growth. We're going to have 50 new beautiful stores in the United States, which are the number one generation of new customer acquisition for our company. And overall, I think we've got a strong team. We've got a lot of good initiatives. We're doing the right things, I think in terms of in a difficult environment, managing the business effectively, a high-margin business with a strong outlook for the future. And some of it will turn on macro, too. We are assuming that things will improve as we go forward with inflation moderating and coming off of some of the challenges we've had this year.

Great. Thank you.

Thank you. [Operator Instructions] Our next question will come from Paul Lejuez of Citi. Your line is open.

Hey. Thanks, guys. I'm curious if the weather is impacting traffic and the business overall? Or is it just the seasonal piece of the business where it becomes more of a conversion issue or is it impacting traffic overall? And are you seeing that same pressure on sell-throughs within the wholesale channel amongst your big partners?

Yes. It's largely a traffic issue, both online and in the stores, and where weather is cooler, traffic is better. So it's not – conversion rates have actually been good. Conversion rate. Those who come our buy-in. Those who – and they like the product offering, the conversion has been good. The average transaction values have been higher, but it's largely been a traffic issue. And where weather is cooler, more seasonal traffic has been better. And I would say we have visibility into our performance in every major retail customer that we do business with. And I would say trends, you've seen a noteworthy impact of weather with our wholesale customers as well for our products.

Paul, I would say the customers that the big three we call Target, Walmart and Amazon. They've got a little bit more of a natural traffic flow for groceries and essentials and what have you. So those that component of the wholesale business, I would say, is less impacted by some of the traffic challenges, they're impacted. But if you're selling groceries as well, you're going to have more regular linear traffic trends.

Got it. And sorry if I miss what was the 50 new stores that you mentioned just on the last response, what was that for? Was that for next year or over the next couple of years?

This year. This year. That's the run-rate right now. We'll probably open up a better part of 50 this year, assuming we continue to see good experience. We're working on the 2024 openings right now. We assume that we'll probably open up a better part of 50 next year as well.

How about net openings, though? Are you thinking about some closings as well? Just as you've kind of seen the last two years of performance, are there stores that you need to reevaluate after the weak performance in DTC for the past couple of years?

We do probably close about a dozen low-margin stores this year when leases expire, rarely do we close a store early because the lion's share of our stores, nearly all of our stores are cash flow positive. So rarely, we closed them early. But when a lease comes up for renewal, you have to decide whether or not you're going to re-up for another 10 years. And we've done in recent years. We just assumed let that lease expire and move to a better location where there's better traffic patterns, better cotenancy, better condition of the center. We're seeing good results with the new store openings. But going forward, the next year, we'll probably close 10 or more stores as well. We did the heavy lifting on store closures when the pandemic hit probably closed about 140 stores since the pandemic probably gave up some portion of $140 million in sales. But by doing that, we've actually made retail more profitable because we pushed more store – more sales into existing stores. So that what we call that transfer benefit was meaningful. It was probably about 25% of the sales from store closed, stores went over to existing stores at higher margins. So we continue, I think there's – so something recently. I think some portion of 350 stores come up for lease renewal, lease consideration that every year gives us an opportunity to close stores that we don't think are going to contribute meaningfully to the growth in sales and profitability in the years ahead.

Okay. Thanks. But Mike, the comps have been down pretty significantly for two years in a row despite benefiting from that transfer. So how do we connect the dots there?

Well, you need a better mix of stores, you need to drive more traffic to those stores through better, more effective marketing capabilities. We have new marketing personalization capabilities. We've made significant investments in e-commerce. But the more we open up stores closer to the consumers and close some of these outlet stores that are located further away. I can tell you is we're seeing good returns on new store openings. It's the number one source of new customer acquisition and about 70% of kids apparel is bought in stores. So we continue to believe stores are important.

Thanks, guys. Good luck.

Thank you.

Thank you. This will end the Q&A portion of the conference. I would now like to turn the conference back to Mike Casey for closing remarks.

Thanks, Chris. Thank you all very much for joining us this morning. We wish you and your families a happy, healthy holiday season. We'll update you on our progress in February. Goodbye, everyone.

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day.