Hello, and welcome to Carter's Third Quarter 2020 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer. After today's prepared remarks, we will take questions as time allows. Carter's issued its Third Quarter 2020 Earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted to 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 recent annual and quarterly reports filed with the Securities and Exchange Commission and the presentation materials posted on the Company's website. On this call, the Company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the 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.

Thank you very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I like to share some thoughts on our business with you. Carter's is making good progress, recovering from the market disruption caused by the pandemic. Thanks to the support of our employees worldwide. We exceeded our sales and earnings goals in the third quarter. We achieved a record gross profit margin in the quarter with improved price realization and fewer and better promotions. We reduced our spending and inventories below prior year levels. We also strengthened cash flow and liquidity in the quarter and gained market share. With respect to business trends, we got off to a good start in July with sales running more than 90% of prior year sales. We had substantially all of our stores opened heading into the 4th of July weekend and retail sales over that holiday shopping period comped up 7%. In August, we saw sales trend to about 87% of prior year sales as schools delayed reopening. With children starting their school year learning virtually at home, there was less of a need to shop for back-to-school outfits. September was the largest month so far this year in sales and earnings contribution. September sales ramped up to 95% of prior year sales. That's the best performance we've seen since the pandemic began to impact us in March. Our Labor Day holiday sales were the strongest in the past three years, with comparable retail sales up 15% during that shopping period. And in October, sales are trending over 90% of prior year sales. With respect to product performance, we continue to see good demand for our baby apparel and sleepwear product offerings. Our baby apparel and sleepwear contribute about…

Thank you, Mike. Good morning, everyone. I'll begin on Page 2 with our GAAP income statement for the third quarter. As Mike noted, our third quarter results were meaningfully better than we had planned. Net sales in the quarter were $865 million, down 8% from last year. Reported operating income was $114 million, an increase of 35%. And reported EPS was $1.85 compared to $1.34 a year ago, representing growth of 38%. Our third quarter and year-to-date results for both 2020 and 2019 contained unusual items, which we've detailed on Page 3. We've treated these items as non-GAAP adjustments to our reported results to enable greater comparability. My remarks today will speak to our results on an adjusted basis, which excludes these unusual items. Moving to Page 4 on our adjusted P&L for the third quarter. Net sales declined 8% to $865 million, which is a meaningful improvement over the 30% decline we saw in the second quarter. We continue to see strong demand online with our U.S. eCommerce business achieving a 17% comp and eCommerce comps in Canada up nearly 60%. While gross profit dollars declined 5% due to lower sales, gross margin rate improved by 180 basis points versus last year to 44.4%. This represented record quarterly gross margin and was driven by improved price realization and continued progress in reducing excess inventory. Royalty income was roughly comparable to last year at $9 million. Spending was very well managed during the quarter. Adjusted SG&A declined to $24 million or 8% across a broad range of expense categories. Adjusted operating income grew 4% to $120 million and adjusted operating margin expanded 160 basis points to 13.8%, driven by our strong gross margin performance and management of spending. Below line, we had higher net interest expense than last year due…

[Operator Instructions] Our first question is coming from Paul Lejuez with Citigroup. Please go ahead.

Can you talk about what's happening at point-of-sale at the big three retailers you're partnered with on the Wholesale business? Just in terms of what's happening in POS versus the rest of the business, the rest of the wholesale business? I'm trying to get a sense of sell-through versus sell-in and what that might imply for when business might stabilize? Just if you could comment on that.

Sure. I'd say sales of the top three, the ones that you're referencing, has been brisk. I think, by and large, many of our wholesale customers are lean on inventories, in part because we, earlier this year, when the pandemic hit, curtailed our inventory commitments for fall and holiday. We did not do that for the exclusive brands. We did do that in the core Carter's Wholesale business. But with respect to Target, Walmart, Amazon sell-throughs, point-of-sale, over-the-counter, sales have been brisk, and we expect it will continue to be through the balance of the year.

And Mike, did I hear you say that you're planning your spring demand to be flat versus last year. Is that at a company-wide level? Maybe if you could talk about how you're thinking about demand in Retail versus Wholesale for spring?

Sure. That's relative to spring '20 and that's the Carter's brand, we're planning the Carter's brand spring '21 comparable to spring '20. So there's some indication based on that demand that things may stabilize. Time will tell. I think a lot depends on how we get through the holidays. We have two important months ahead of us. And I think of some retailers, I remember our top-to-top meetings earlier this year in January. It was clear some retailers did not have the holiday performance that they had expected. So, they planned holidays '20 more conservatively, and that's a better place to be to be leaner on inventories. At least what we're getting a signal for spring '21 that there might some be some stabilization and that perhaps they may have recognized they went a little too lean on spring '20. So, we'll see. But the next two months are important for many retailers, just to see if they can get -- to continue to see good momentum in their online businesses. I'm sure you follow Shopper Track, but Shopper Track trends for soft goods, for apparel, it's been down over 30%, sometimes closer to 40%. So store traffic has been tough. eCommerce business has been very, very good for us and for our wholesale customers.

Right. Aren't you lapping really big declines in spring of '20? So to plan the business down, just wondering, do you risk not having enough inventory if things do bounce back?

Yes. Yes, that is a risk. Yes, it sure is. And we decided earlier this year to run leaner on inventories. I think it's a much healthier model when you're lean on inventories. You're seeing better sell-throughs. You're seeing better price realization. You're seeing less product on the clearance rack at the back of the store at the end of the season. So at least near term, with the uncertainty in the market, we're going to continue to run lean on inventory.

Our next question comes from David Buckley with Bank of America. Please go ahead.

I want to ask about the better profitability across all channels, the improvements in gross margin and expense management. Looking to fourth quarter and into next year, how much of this do you view as sustainable, particularly as sales trends continue to recover?

I'd say we're focused on improving the profitability of the business that we have, David. There's uncertainty around the level of consumer demand. I think that uncertainty and the volatility on the top line may continue, to Mike's point, into next year. So our focus has been improving profitability really throughout the P&L. So, we're extremely encouraged by the improvement in gross margin. I'd say the single biggest contributor to that improved gross margin is the fact that we're improving our price realization in our own retail operation. Most of that's coming from eCommerce, which had become extremely promotional as a channel for us over the last few years. So, we've reversed that. And it goes hand-in-hand with that leaner inventory position. I think we've got the confidence of the beauty of our products, the quality of our brands to get paid a bit more for that, and that's what we're seeing in the P&L. So, we're certainly planning for continued progress on gross margin. We've also had a strong focus on spending management, and that discipline will continue as well.

That's great. Just given the higher profitability, can you guys also discuss how eCom performed as 3Q progressed? How it started fourth quarter? And then what type of channel mix shift are you anticipating for the fourth quarter there?

Yes. eComm has done very well. It's strong sales and profitability, higher price realization through fewer promotions, so we feel really good about that business. Comps remain strong in Q2 and when stores started to open up early in Q3, it continued to do well. August was a little softer because we really didn't have that back-to-school event, but it rebounded strongly in September. So we've got good eCommerce business, it continues to be strong in the fourth quarter, and we're optimistic going forward.

We will go next to Susan Anderson with B. Riley. Please go ahead.

Nice job managing the quarter. On the U.S. wholesale segment, it looks like sales were still fairly significantly down the department store channel. I guess I'm curious how much of that is still due to weak demand there versus inventory constraints? And are you expecting it to continue to improve sequentially? And then just really quick on eCommerce, I think you said 24% was shipped from stores. Maybe if you could talk about the EBIT margin difference between shipping online orders from the DC versus the stores?

The wholesale performance reflects more curtailment of inventories that ranked that higher than conservative planning by our wholesale customers. They wish we had more inventory but we cut fall in holiday inventories for our wholesale customers back some portion of 30% or more earlier this year. Glad we did. Glad we did. And then the margin differential on shipping from the stores versus the DCs?

It's better. I don't think we're going to parse it out in DC based on that, but it's better all the way around. It's better from a customer experience point of view. We're seeing some capacity constraints in the small parcel channel. So consumers are able to get that product from our stores more rapidly. It makes more effective use of the store-based inventory. So, we're pleased to see the adoption from consumers and I think from an operational and execution point of view, getting better at it every day.

It's a meaningful new capability. So the most expensive way to support the eCommerce customers shipping it from our distribution center to their home. We've got 850 beautiful stores from Maine to Hawaii, and we're leveraging those stores to improve the speed of delivery and the profitability of fulfilling those eCommerce orders. And it also makes a better use of the inventory in those stores. So you can -- we have technology that can identify where there might be some extra inventory, and that inventory is best used to support that eCommerce order. So this is fairly new capability, and what we refer to as omni-channel capabilities, leveraging the stores to provide a better experience for the e-commerce customers. Those are margin accretive activities.

Next, we will move to Ike Boruchow with Wells Fargo. Please go ahead.

I wanted to focus on -- hey, Mike, just on the wholesale channel. I think, Mike, you talked about like leaving sales on the table for Q4, which I totally understand with the inventory, but I think you talked about $50 million. Can you maybe give a little context behind the $50 million? Is that all off price? Is that all low margin revenue? Just would like to understand what that revenue actually looks like.

Ike, it's Brian. Just to -- this has been a question we've heard a good amount about. So I just want to clarify. The Q3 shipments of our brand, the Carter's brand, were meaningfully lower. The exclusive brands were higher. And the reason for that, if you look back in March, we had relationships with all of these retailers. Outside of the three exclusive brands, most folks called us and said, we don't need the summer product. We're going to cancel our orders. And we had a decision to make at that time. So we then proactively canceled about 30% of the fall orders that they had given us. And so that is across the board. And so, the relationships are very good. Our wholesale partners are very pleased with our product performance, product's selling really well. The challenge is they don't have enough of it. And that is a proactive step that we took that caused that because we had a lot of uncertainty going forward. So we did have lower off-price sales because we've been managing the inventory better, and we're moving that product through our own retail stores. But as far as the rest of the wholesale customers, the main issue really is they don't have as much of our inventory as they would like because we proactively took steps to reduce it given the unknowns for fall and winter.

Yes. That part of the business, Ike, that's a high-margin component of our business, the core Carter's wholesale business is a very good margin business for us. And we intentionally decided to reduce the risk of having too much inventory in the second half of the year. We're encouraged by it. That's an opportunity for next year. So, it's a much better place to be when you're seeing very good sell-throughs. Everybody's lean on inventory. They wish they had ordered more, and they'll have an opportunity to order more for the second half of next year now.

Well, I guess just to wrap that up. I mean, I guess my question is. I know you're not giving guidance on wholesale, but $50 million is about 15% of rev. So should your wholesale business in Q4 look kind of similar to what it did in Q3, down 15%, but with better margins potentially? Just trying to understand how your bookings look and how we should be expecting your wholesale business to look in Q4.

Yes. I don't think we want to be precise around segment guidance for the quarter. I think the complexion of what's driving the business is what Mike and Brian have described. We have great momentum in the exclusive brands. We expect that, that will continue. We'll see good demand from those retailers. I think the Carter's brand will be down for the reasons that have been described that we cut back on inventory, which from a risk mitigation point of view, in the early days of the pandemic was absolutely the right strategy. And I'd say those retailers are also hungry for inventory as well. They're coming to us and asking for additional product. In some cases, we're able to support it. And as I said in my remarks, the replenishment demand for Little Baby Basics currently is really strong in the wholesale channel. And those are some of the folks who buy the core Mother Ship Carter's brand.

Our next question is coming from Jim Chartier with Monness, Crespi & Hardt. Please go ahead.

Like, I just wanted to kind of follow up onto comment about flat spring 2021. Is that just for the Carter's brand at wholesale? Or is that for overall Carter's including retail?

Carter's, the flagship, Carter's brand wholesale.

Okay. And so, is it reasonable to assume that the exclusive brands are planned up given the momentum that you've seen in that business?

Well, their order cycle is a bit different. We'll share more of that with you in February. We're expecting continued good growth with the exclusive brands.

And I guess how does spring flow or shift between first and second quarter? And is summer 2021 looking flattish as well? Or is that -- I expect it to be better than that.

Yes. We'll share more of that with you in February, but some of spring does start to go in December this year. That's just the normal cycle. They like to get some fresh product on the floor during the holidays and going into January. So, some of that spring does go in the fourth quarter.

Okay. And then the $50 million wholesale impact. Is that more pronounced in third quarter than fourth quarter? Or is it more pronounced in fourth quarter?

Well, I think fall is the bigger season than holiday. So I would say, more pronounced in the third quarter.

Okay. And then lastly, on our playwear, it seems like back-to-school, big impact on playwear in third quarter. Should that business improve in fourth quarter just because you don't have -- you're less dependent on back-to-school to drive that business?

Yes. So, it's back-to-school is behind us. That's -- it's -- we saw that dip in August. That was the worst of it. And then in September, as people realize kids weren't going back-to-school, they shift into other product categories. And we have the benefit. For the first time in three years, we had the benefit of the cooler weather rolling through, and that is always a stimulus in our business. Any time weather turns from warm to cool and then in the spring from cool to warm, that's a reason to get out and shop. So we saw that in a meaningful way in September.

Right. And then on the store closures, are those store closures EBITDA accretive to the business overall?

I'd say they're low-margin stores. I'd say low single-digit operating margin. We're opening up stores with operating margins closer to 20% and closing the low single-digit operating margin. It's just that because -- in years past, we'd say, as long as it's cash flow breakeven or better, why close them. But you got to look at where the arrow is pointing and the consumer loves these co-branded stores, the performance of the stand-alone Carter's and OshKosh stores, we made a year or so ago to exit those stores. A lot of times when we're closing a store because a better center has opened up in an adjacent market, so we're often asked. Why are we opening stores when people are closing stores? We open up stores because we make a lot of money in those new stores. And consumers love seeing our stores. It's a beautiful brand experience. So we'll open stores closer to the consumer, co-brand stores in better centers with better margins, and we're going to close when leases either come up for renewal or there's a kickout provision that gives us an opportunity to make a decision as to whether or not we're going to reinvest in that center or exit it. And we're more inclined -- in light of everything we're going through, we're more inclined to exit some portion of 200 or more stores. About 80% of those will happen over the next couple of years. So our focus is fewer, better, more profitable stores located close to the consumer that have a higher likelihood of serving those omni-channel consumers, those who love to shop online and swing by the store and pick up the product.

Next, we will move to Jay Sole with UBS. Please go ahead.

Mike, would it be possible to elaborate on why you're saying October was up over 90% of prior year sales when September was at 95%? And maybe is there something going on there that can explain the trend?

Sure. It's an experience we've had over the years. Any time you see a surge in demand, like we did in September with the cool weather, there's a lull. And so when weather like here in Atlanta returned to like 80, 85 degrees, you're not thinking so much about long sleeve, long bottom outfitting. So, it's a normal type of experience that when you see a surge like we did in September, you see a lull immediately after that. But we feel good about the fourth quarter. I think we have a handle on the fourth quarter.

And maybe can you just describe for us, what's the normal contribution of October to 4Q, like on a percentage basis? And how much -- how important is November, December?

I'd say September is the largest in terms of sales and earnings contribution. October will be smaller than that. I think November and December combined are more important than October, for sure just given the holidays.

Got it. And then maybe is it possible just with sell-through at wholesale being good and inventories being lean, is it -- can you paint some scenarios -- is it possible, maybe there could be a pull forward of inventory into the channel in November and December, what retailers want you to do that? Could you do that? So maybe just frame some range of scenarios for that possibility?

I would actually say, we have seen our customers saying, hey, if you got it, bring it in, bring it in, we're happy to take it. That's true this year. It's been true for years. Depending on the sell through, if we have the product, we're happy to ship it to them earlier. And my guess is we'll see some of that this year.

Got it. And then just one last one for me. Mike, you talked about less sales to off-price this year. Is that like a strategy that you continue to want to deemphasize that channel? Or is that something where next year you could see wanting to refill and replenish that channel as well with the rest of the retail partners?

It's one of the learnings we've had this year that we could better leverage our stores, our beautiful stores throughout the country, including Canada. Canada was a huge help to us moving through some of the excess that was created when stores closed for several weeks. So no, there's no plan, hey, let's go back and sell a lot of low markets and stuff to the off-price retailers next year. That is not -- we like the strategy that we put in place in '20, and we hope that continues in years ahead.

Our next question comes from Steve Marotta with CL King & Associates. Please go ahead.

Good morning, Mike and Richard. Third quarter SG&A as a percent of sales was roughly even with last year, which is pretty remarkable given the sales decline as well as the massive shift in distribution channel mix, towards e-commerce and digital. Is there anything in the quarter, from a discretionary standpoint, that was withheld? And I guess the underlying question is, given seasonality aside, can we think about this as a bit of a run rate from an SG&A standpoint? And then I have one quick follow-up.

Sure, Steve. I would say there were a lot of things at work in SG&A in the third quarter. We had favorability across virtually every line item within the spending accounts. We were favorable on those selling expenses that you might expect to be favorable just given where the top line was. So stores expenses were lower. We pulled back on marketing. I think our marketing team has done a great job, kind of more real-time reading the mood and the sentiment of the consumer. If they're not out listening and not in a mood to shop, we've been able to kind of pull back on marketing, and we did that in the quarter. Distribution expenses were lower. Where we saw some higher expenses would make sense to, I think relative to eCommerce fulfillment costs were up. That tracks to the 17% comp that we did. And then I'd say across most of the G&A accounts, most of the administrative areas, we saw favorability as well. We had asked the organization to curtail spending just given the business got a little choppy in the middle of the quarter. So the teams did a fine job pulling back on spending where they could. We also have favorability at the moment as it relates to our various performance-based compensation provisions, just given how the years unfolded. Those are much lower than they were a year ago. I wouldn't expect the run rate to be the same in the fourth quarter, mainly because we've chosen to lean into some investment spending, first and foremost, because we have the ability to do so. We're not concerned about liquidity. I think we've been effective over the years where we could lean forward and make some investments, which we think will yield long-term benefit. That's what…

That's very helpful. So what I heard was it's not -- wouldn't be a big surprise to have SG&A deleverage in the fourth quarter?

Correct.

I got you. And one quick follow-up is, as it relates to royalty income, it was down significantly in the second quarter on a year-over-year basis, relatively flattish in the third quarter. Can you talk about that differential and how we could think about the line item going forward?

Yes. I think we -- to your point, year-to-date, it's down much more considerably than it was in third quarter. I think we've started to anniversary now some of the structural changes or strategic changes that we've made in some of those relationships. So the Genuine Kids agreement that we had with Target for a number of years, that was a significant source of the decline in the earlier quarters. That starts to normalize a bit and then some of the categories that we had in-sourced. So, that's now sales and margin for us relative to royalty income. I think we're starting to overlap some of that as well. I think there have been some market disruptions for a number of our license partners where they've had difficulty getting their product out of China and Asia. They're subject to some of the same kind of transportation and delivery issues that we've seen with our apparel products and then just the disruption in wholesale channel. When they sell those products to their wholesale customers, we earn a royalty. Hopefully, as the market starts to recover, the roughly stream to us, will continue to improve.

Our next question is coming from Warren Cheng with Evercore ISI. Please go ahead.

I just wanted to ask a question on the strong digital growth you're seeing, both owned and partner. Do you have the customer data to see how much of that is channel shift? So the sales that used to flow through your own stores, your partner stores, and how much of that is new customers coming out of the brand?

You're refereeing ongoing growth, Warren?

Yes, I'm referencing the online growth both your own eCommerce and you mentioned some really good growth numbers out of your partner eCommerce stores -- or your partner eCommerce business, especially with your exclusives?

Yes. So, I think it's a shift to the consumer from stores to online. Particularly during the pandemic, I think people are more comfortable shopping at home. They're going to follow a Shopper Track, we do. And it's -- traffic in these stores has been down. And thankfully, the people who are coming into our stores are coming to buy, not coming to shop. The units per transaction, the average transaction value is higher. And so -- but more and more people are shopping online because of the convenience and because of the -- I'll speak for our own kind of eCommerce capabilities, the beauty of the product presentation, the ease of navigation and search capabilities, the ease of checkout. Richard commented on the relaunch of our app, which will happen in the fourth quarter. So I just think that is a -- it's going to be with us for a while. That's where consumers are shopping. And they enjoy the convenience of shopping. It is interesting to me, in the kids apparel market, still about some portion of 70% of children's apparel is bought in stores. So, I think it's just the nature of young children's apparel. You want to go in. You find out you're expecting a child. You want to go in with your family and enjoy that experience of shopping for that first wardrobe for your beautiful new baby in the store. And my guess is our e commerce penetration, I think, was close to 40% in the third quarter. My guess is it will be probably close to 40% for the fourth quarter, and that's about 10 points higher than it was a year ago. As we move through '21, hopefully, there's a vaccine, the fears related to the virus subside and we'll start to see store traffic improve again. But we're very fortunate that we have, I would say, one of the most successful and certainly one of the most profitable eCommerce platforms in kids apparel and that will help us some on other things to weather the storm until it settles down.

Got it. And then my follow-up is just on the exclusive programs. What is the price and volume trends? What are the price and volume trends been for that side of the business? And is there an opportunity to add more breadth to those offerings across categories or age groups?

Well, I think in terms of breadth, we have added, to the exclusive brands, we've got more online product for those accounts. And we've expanded, I think we said earlier the year, we've expanded in the toddler for target, Walmart and Amazon. Those businesses are doing really well. And then we're looking at bigger sizes, starting with sleeper. So there has been increase in the SKU base for what we sell those accounts as that business has grown and deserves a broader array of our products.

And that will conclude today's question-and-answer session. Mr. Casey, at this time, I will turn the conference back to you for any final remarks.

Thanks very much. Thank you all for joining us on the call this morning. Appreciate your support this past year. From all of us here at Carter's, we wish you and your families a happy and healthy holiday season together. We look forward to updating you again on our progress in February. Goodbye, everybody.

Thank you. This concludes today's call. Thank you for your participation. You may now disconnect.