Carter's, Inc. (CRI) Earnings Call Transcript & Summary

This call is not for media representatives or Bank of America Securities investment bankers or commercial bankers, including corporate and commercial FX. All such individuals are instructed to disconnect now. A replay will be available for Bank of America Securities investment bankers and commercial bankers, including corporate and commercial FX. A replay is not available to the media. Good day, everyone. Welcome to the fireside chat with Carter's management team. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to David Buckley. Please go ahead.

Great. Thanks, Nicole, and thank you, everyone, for joining us this morning. So we are -- we're very pleased to have the Carter's management team here with us. Mike Casey, Chairman and CEO; Richard Westenberger, EVP and CFO, and Sean McHugh, VP and Treasurer. Gentlemen, thanks for taking the time to speak with us this morning.

Our pleasure.

So Mike, I just want to kick it off with you first. Just an outlook on kind of the state of the industry. I know there's been a lot written and discussed about the birth rates struggling to grow in really the last 10 years since the financial crisis. The average age of couples getting married continues to increase. There's been kind of delayed birth rate growth. And just curious, looking out over the next 5 years, how do you see the industry evolving from its current state?

The demographics have worked against us. The headlines last year, 32-year low in the birth rate, meaning fewer children per month. And then as you referenced, you do have many women awaiting longer to get married and as a result, starting their families later. The best information we have would suggest we're reaching a peak population of men and women in their late 20s, early 30s, which -- and that's the time when most of the -- they get married and start their family. So there's, at least, a hope, an expectation, some projections that there'll be a stabilization in the births. And over the past 30 years, the annual births in the United States have bounced around. It peaked at 4.3 million births back in 2007. And then with the Great Recession, every year, following 2007, or at least most years that we've seen a decline in the birth rate. It was around 3.8 million births last year. That said, our business has grown every year for 31 years. So we have lots of ways to grow. We're the -- have the broadest distribution of kids apparel in the United States, in Canada, increasingly in Mexico and other parts of the world. And we're fortunate that over the years, we evolved from what was largely a wholesale business, and then into outlets and then into specialty retail. So today, we're the largest specialty retailer of young children's apparel in the United States and in Canada. We're largest supplier of kids apparel to the largest retailers in the United States. And our brands are sold in over 17,000 store locations from Maine to Hawaii. So wherever people are shopping for kids apparel, they'll likely see a strong presentation of our brands. And unlike other apparel categories, kids apparel is less discretionary, especially in the age range that we focus on, which is a newborn to about a 10-year-old child. Those children are growing rapidly in those early years of life. And mom needs to get out, needs to go shop and needs to get the new outfit. And over time, for multiple generations of consumers, the #1 brand they look for is Carter's. And so we've been able to grow despite the fact that the market dynamics have worked against us. We've been able to manage growth in a no-growth environment. And we -- our forecast right now is we believe we can continue to do that.

That's great. So on the baby category, starting off there first. You've done a great job growing with some of your largest wholesale accounts. And I think you guys mentioned achieving record sales in top 4 accounts last year, double-digit growth in your exclusive brand sales. How have you been able to grow alongside your wholesale partners on private label brands? And how much remaining growth opportunities do you see with these accounts and the primary drivers of it?

Private label brands are among our largest competitors, especially in baby apparel. During the Great Recession, every major retailer built stronger private label offerings to provide opening price points, more open price point alternatives to the national brands. The best retailers strike a good balance between the national brands and the private label brands. They recognize that the national brands drive traffic to the stores and websites. So if you look at -- for those who still get a Sunday newspaper, if you look at the circulars in the Sunday papers, more often than not, they are highlighting the national brands, Carter's, in particular, because they know the national brands drive traffic to the stores. Private label, in total, of the $27 billion market, if you put all the private label brands together, it's about 24% of the market. And from memory, I don't know if any one of those brands has more than 5% or 6% share. By comparison, we have 14% share. So the Carter's brand has more than twice the share of the largest private label brand, and so private label will continue to be a formidable competitor. And they've always been good competitors, particularly since, I would say, beginning in 2008, where they invested more energy, beautiful presentation in their stores, usually give it a prominent space on the floor. And I'm biased. But if you were to go to Target, Walmart, if you were to go and shop on Amazon, the more dominant presentation on the floor is the Carter's brand. Go to Macy's. So again, we've got this broad distribution that appeals to a broad demographic. And our performance, over a long period of time, this is not a hot and cold business. This is despite a lot of things working against us, including the strength of private label brands that are managed by formidable retailers with greater resources than we have, we've been able to have good growth. So private label will continue to be a very strong competitor, but we've outperformed them over the years.

That's great. And then within the wholesale channel, how much remaining growth opportunity do you see with your top 4, 5 accounts? And is it primarily driven by additional category expansion or geographic expansion? Just touch on that.

Well, with every major wholesale customer we do business with is a public company and they've articulated their growth objectives and related strategies. I'd say, in the current environment, they're forecasting collectively. There are some winners and there are some people who are struggling. But you put them all together, I'd say, collectively, our wholesale customers are forecasting low single-digit growth. And I think it's fair to assume over time, our growth will be generally in line with the growth that they are forecasting. That said, not unusual to see our wholesale customers calling out kids apparel as a source of strength in their business this past year. And over the years, Carter's is often called out by name as a source of strength. And again, going back to kids apparel, it's a less discretionary purchase. It is a traffic driver. Years ago, Target called us and they'd [indiscernible] solicited, love to have the Carter's brand because they thought as though it would be a key component of their traffic-driving initiatives. In recent years, they -- Target, again, reiterated that kids would be an important part of their core strategy because it's a frequent purchase. It is a less discretionary purchase. So we are forecasting low single-digit growth in our Wholesale segment of our business, and largely because of the people we do business with. We're doing business with the winners. We're doing business with Target, Walmart, Amazon, others, and those increasingly are the places that people are shopping for kids apparel.

Okay. And next on the Age Up initiatives. You recently commented that the additional sizes generated over $100 million in sales last year. How big is your toddler business now? How much opportunity do you see to grow that business? And how does OshKosh factor into the Age Up strategy and highlighting the offerings that the Carter's brands have?

Yes. So toddler, the market for toddler is about a $5 billion market out of the $27 billion market. Last year, I think the -- our toddler sales grew about 4%. We're forecasting that toddler will continue to grow at a rate probably faster than the total company annual sales. And we have the #1 market share in baby apparel. It's about -- some portion of about 25% or more, and then about 15% share in toddler. So we see an opportunity with this Age Up strategy to hang on to the consumer longer, to increase the lifetime value of the consumer. So both Carter's and OshKosh, OshKosh is probably known more as a toddler brand than Carter's. But we've had good growth with this past year with Walmart, Target, Kohl's, Amazon, and then more specifically, with Target, with the launch of the OshKosh brand at Target. So we expect toddler will continue to be good source of growth for us.

Okay. And then I believe you mentioned Carter's expanding toddler sizes into more Walmart locations with the Child of Mine brand. Is the toddler offering in all doors at your top wholesale partners now?

Yes.

Or is there more planned expansion for this year and next year?

No, it's typically -- it's not in all doors. And you referenced Walmart specifically. Every customer, Walmart and others, they vary the door counts based on the needs of the specific store location, but we are expecting expansion of doors for toddler apparel this year.

Okay, that's great. And then you briefly mentioned the OshKosh at Target transitioning to an owned business from licensed. Have you guys quantified what the wholesale sales impact is from that this year?

We've not yet. With the legacy royalty licensing agreement that actually predated the acquisition of OshKosh by Carter's, so it has been in place for a number of years. It was a nice kind of stream of profits for us just because there wasn't a lot of SG&A attached to it. We do think that there's a nice opportunity as that business grows over time and under the wholesale model for us to replace those profits. It's not quite fully offsetting the lost royalty income at this point.

Okay. Just shifting to eCom next. Comments on the fourth quarter call that your eCom margins are down to the low 20%, having been pressured by consumer demand for shorter delivery times. So given that consumers continue to expect shorter and shorter delivery times, could you just touch on how you plan to regain margin, specifically in the eCom channel over time?

Sure. Well, I would say, if you went back a few years, the operating margins in eCommerce were in that kind of mid- to upper 20% range. They have declined to the low 20% range, largely because the cost to serve that customer has increased, I think, with what Amazon has -- the effect that it's had on the marketplace in terms of consumer expectations for free and fast shipping. So we have increased the amount of free shipping that we do. I sort of view it as kind of getting to a more or less steady state at this point. So depending upon if the consumer chooses to have products shipped to their local store or they are a credit card customer, a Carter's credit card customer, those orders have free shipping attached to them today. So I don't know that there's going to be a lot more dilution going forward from free shipping, specifically. I do think that the consumer does continue to expect more and more in terms of getting the product more rapidly, that's why we're excited by some of these omni-channel initiatives that we've put in place. So last year, we rolled out buy online, pick up in store, which allows for consumers to get those orders fulfilled within a couple of hours just at their local store. We've also tested fulfilling online orders from a subsection of our stores as a way of getting product to the consumer in a more rapid path, particularly those consumers that are further away from our multichannel distribution center which is here in Georgia. And we saw a meaningful improvement in terms of delivery speed, Net Promoter scores, customer satisfaction from those consumers that we were able to fulfill their orders last year. So we will expand that capability this year. I think that's part of how we can reduce the amount of money that otherwise might go towards expedited shipments, paying more for the small parcel providers and those sort of things. I would say we continue to have some of the same opportunities in eCommerce that we see for the broader retail business, which includes the stores and that is improving inventory management, buying less inventory, having it be more productive, having less of our inventory go to clearance, those opportunities attach to the eCommerce business and the margin structure of that business as well.

And so I would add to that, the receptivity we're seeing to the new Carter's credit card, for years, that was suggested as an opportunity for us. And to their credit, the retail team pushed for that. And what we're seeing in the early days of that launch of that credit card, which, my guess, is probably in the second half of last year is that the profitability of the Carter's credit card transactions is meaningfully better than other credit card transactions. I believe, in February, we referenced that over the next 5 years, that could be a source of about $20 million in improvement in retail profitability.

Just building on that, Mike. So I know it's been a pretty short period of time since you launched, but any surprising learnings from that program? I believe you mentioned how many participants are new customers to Carter's. If you could just mention that again and just anything you've been pleasantly surprised about...

The early read is that, at least, in February, it was running ahead of where we had planned it to be in 2019, and it's kind of the initial period. And we're pleased to see that how many customers are new to file. And it's a good experience. The best way to think about this credit card program, it's an enhanced loyalty program. So the consumer gets a heads up on sales. They get free shipping with no threshold to get extra points. And so it's a way of building a closer relationship with the consumer. We've got some good efforts underway with our new head of marketing on personalization. So it's just a way of deepening the relationship with our most loyal customers and increasing the frequency of purchases. So again, it's early days, but I think in the calls going forward, this year, we'll shed a little bit more light on the things that are going, better-than-planned things that perhaps are not going as well as planned. But what I'm encouraged by, with some reasonable assumptions over the next 5 years, it could potentially be a meaningful margin driver for the retail business.

Okay. And then, Richard, just going back to your comments on the omni-channel capabilities that you guys have rolled out. Could you just discuss how the margins of these new capabilities compared to a typical online transaction? And just how much these new features have contributed to eCom growth in the last few quarters?

Sure. I don't know that we've published a lot of statistics around it. The data that we've seen suggests that they are margin-accretive transactions for us and so they've been accretive to the retail margin. So we're seeing adoption rates of these services continue to increase as consumers become, a, more aware of them. We've trained our store associates to be more communicative around those capabilities. We've got signage and such in the stores that make them more aware of them. And then I think just consumer familiarity and adoption as they shop more and more online, we certainly make this a part of the consumer proposition. When folks are going to check out, they have the opportunity to have those products shipped to their local store or pick up same day. So we're seeing good adoption. Those rates are increasing. We do think that those are profitable transactions for us.

Okay, great. And have you guys ever disclosed the percentage of your wholesale business that's now being driven online and just how that's trended?

Yes. I don't know, not quite sure we have disclosed. But generally speaking, it's -- on average, it's around 15% of our eCommerce penetration of our wholesale sales are about 15%. I would say Kohl's and Macy's, much higher than that because they were some of the early movers, big investments in the eCommerce capabilities. By comparison, Target and Walmart, at the lower end of the range only because they have thousands of stores and they've had success with their grocery strategy. So it's a more frequent visit to their stores and it's just as easy to shop in their stores than it is online. But on average, it's about 15%. And by comparison, eCommerce penetration in our retail business is over 30%. And it was close to 36% around the holidays.

Okay. Okay, that's helpful. Just looking at the 5-year growth targets, you recently disclosed that 42% eCom penetration target by 2024. Can you just talk about the mix between mobile and desktop? And how you see each kind of subchannel of eCom driving the growth to that target in the next 5 years?

Sure. Well, the mobile mix was probably about 85% of all web traffic. Again, I'll often -- you look at -- because anywhere you are, people are looking back at their phone and they're constantly scanning and shopping and we've improved the capabilities where -- increasing my experience with our brands is there -- you're getting the equivalent of a text. And like most text, you don't ignore them. I ignore most of my e-mails, but you typically don't ignore a text message. So our marketing team has gotten very good at using the technology to more effectively communicate with the consumer. The mobile traffic last year was probably up 15% or more. I think we shared with you in February that our eCommerce team had the work, for a better part of a year on improving the online experience. They relaunched kind of a new web experience. Last summer, I'd say, a meaningful change in the trend in sales. So directionally, I think it was running up 6% or more before the launch and closer to 16% -- grew up to 16% after the launch. And so they improved the product presentation, the navigation, the search capabilities, the checkout experience. So we saw a nice lift from the good work that they had done. That same team is working on relaunching the mobile experience, which will probably be down sometime in the second half of this year. So it's -- our best consumer -- our highest value consumer is the one who shops both online and in our stores. She spends about 3x the amount of an open online-only customer or a store customer. And the beauty of our business is we have multiple brands. The highest value consumer we have is the multi-brand consumer, those who are shopping for Carter's, OshKosh and Skip Hop. Similar to the multi-channel consumer, she also spends about 3x the amount of a single brand consumer. I wouldn't want to be managing a single mall-based brand kids apparel. Having multiple brands, multiple distribution channels, appealing to a broad demographic from Walmart consumers to Macy's consumers, it's -- we have lots of ways to grow the business.

Okay, that's great. Just on the brick-and-mortar strategy, Mike, can you just talk about how you think about your store footprint over the next 5 years and the type of stores and locations and changes you plan to make on your current portfolio?

Sure. So we've had success with this kind of multiyear evolution away from outlets. Outlets will continue to be an important part of our portfolio. But whereas years ago, probably 80% of our -- or more, of our stores were in outlets. We're managing that to be closer to 25% over the next 5 years. There are still some very significant outlet centers down in Florida, other tourist locations, Central Valley, New York, and -- so outlets will continue to be an important part of our portfolio. But with the success of eCommerce and the success of our co-branded store strategy where we've opened stores closer to the consumer, more densely populated areas, there are fewer people who are making trips to outlet centers. In the high view, I think we referenced this in February, the high view is we will close more stores than we will open over the next 5 years. The latest analysis I saw is we'll probably close about 120 stores over the next 5 years as leases come up for renewal. No need to accelerate that effort. But by and large, these stores are cash flow positive. They have a low single-digit operating margin. So of those 120 stores, my guess is just round numbers, this isn't exact, but in round numbers, they're probably today, contributing about $100 million in sales and earning some portion of $5 million a year. So not very profitable. By comparison we'll open some course of 100 or more stores, but probably closer to 100. Those stores are doing over $1 million, and their profit contribution is somewhere in the range of 15% to 20%. And Richard showed you some of the good work being done, picking up some of the old Gymboree store locations and we're seeing good success with that. So we probably have some portion of about 70 mall-based stores. We've always shied away from outlet -- pardon me, mall stores because the economics were much more attractive in strip centers, so most of our stores are in outdoor strip centers. That said, our real estate team, in recent years, has encouraged us to think about malls differently because it's more of a buyer's market. We're getting good rents in the $30 to $40 range, and we can earn a very high return on investment with that rent structure. And so we've leaned a little bit more into malls. So we have 70 of our 850 stores are in malls. We've opened up, probably about 10 of a smaller baby, toddler format store in malls, one just north of here in Atlanta, a Perimeter center, a better mall, not an A+ mall, but a better center, beautifully executed. That was the store that Richard had shared with you. And with the success of those 10 stores, we have -- 10 of those type of stores will probably open up, another 10 this year. And those work well, as I shared with you last year, when Gymboree went out, we looked at every one of their store locations, and most of them, we would have no interest in. But there are probably 100 of their 600 store locations that were worthy of consideration. So we're going to proceed with caution for all the right reasons. But the early store openings have been good. So we'll do another 10 this year. And if those work well, that could be a potential upside to the longer-term growth objectives we shared with you in February.

So the majority of the 100 stores you plan to open will be mall-based. That's the plan currently?

I think a number of them will be, yes.

Okay. Can you just touch on the performance differences you've seen between the co-branded and single-branded stores, and just assuming that all new stores will be co-branded going forward?

That is our kind of typical model at this point is the co-branded box. And that has historically been more strip center locations. I think to Mike's comments, there is this emerging opportunity, we think, whether it's a selective group of mall stores where we can also introduce that same co-branded format. Historically, we've had the single-branded stores. We actually see an opportunity in the stores that still have single-branded nameplates above them. So stand-alone Carter's stores or stand-alone OshKosh stores, we're moving this year to co-brand, the merchandising assortment within the stores. So for instance, we'll have some of the great OshKosh B'gosh products in Carter's branded stores. It won't be the full kind of co-branded experience, but we think there's an opportunity to introduce both of that. But the productivity is good on these co-branded stores, I would say. Most typically, we look to open about a 5,000-square foot store. We would hope for first year revenue to be around $1.3 million or so, with a 4-wall operating margin, I would say, in the high teens to low 20s. That can vary around depending upon the start that a given store gets off to. So they're very high return formats. They tend to pay back their capital within a couple of years. That's typically the kind of return profile that we hope to see from a new store. The smaller format mall stores that Mike mentioned, the kind of 10-ish locations that we have today, a little less contribution on the top line. And we probably pro forma those stores at $900,000 to $950,000 a year, but very, very good 4-wall also in that kind of high teens, low 20% range.

All right. Just want to touch on more near-term topic, the impacts from the coronavirus. I know you guys discussed some potential impacts on the fourth quarter call. But just any updates you can provide. If shipments are delayed at the end of the second quarter, early third quarter, what could be the potential impact to the business this year?

So just to reiterate some of the things we shared with you in February, about 15% of our product comes out of China. It was -- it's probably about half of what it was the year before. But with the tariffs, we placed the product in other parts of Asia, in many cases with the help of some of our China-based suppliers who have manufacturing capacity in Cambodia, Vietnam, Malaysia, other parts of the world. And I was in touch with some of our suppliers -- largest suppliers early this week. By and large, people are back to work, and they're catching up. And as I shared with you in February, the best information we had was that we should expect some portion of a 3-week delay or more getting some product in -- from China because people were delayed by that amount of time getting back from the Chinese New Year holiday. So -- but by and large, people are back and working. I spoke with one of our largest suppliers and what's interesting is they say, "Listen, we're going to be in good shape. We're -- we've got our plants in Cambodia. They're making your products." Other people doing business in Cambodia are struggling to get component parts that are coming out of textile mills in China, but that's not the case with them because there are textile mills' in Malaysia. So it's case by case. Our operations team is in touch with our suppliers every day, tracking the movement of product. I would say the thing I still don't have enough visibility to today is the ripple effect. So I'm told over the next couple of weeks, we'll have more visibility to the transportation side of the sourcing operations. I think we'll make good progress on the manufacturing based on the work that's being done by suppliers to catch up. On the transportation side, it's still not clear to me. Is there going to be some port congestions as everybody catches up? Are there enough containers in China might -- what I heard earlier this week is some of the containers weren't making their way from Long Beach in California back to China for obvious reasons. People were concerned about sailing back into China. So those are things we don't have visibility to yet. And I'm told over the next couple of weeks, we will. So by our April call, we'll have more visibility to the impact. And I think what we've shared with you in February, is some of our early fall deliveries may be impacted. We might see some delays getting some things out the door as planned at the tail end of the second quarter, early third quarter. But it's still too early and I'd say, particularly on the transportation side. But in April, we'll have more visibility to it. I just know good people working to minimize the impact on our growth plans this year.

Okay. If there are delays, do you see this happening kind of before the Labor Day time frame? Or potentially impacting Labor Day as well?

Well, what has been characterized to me so far is a tail end of second quarter, early, early third quarter. So Labor Day hasn't been referenced as being at risk.

Okay. Just sticking on this year, how should we think about quantifying your potential gross margin opportunity? Obviously, you shared with us AUC is going to be down low single digits, taking some pricing, lapping some of the tariff impacts in the second half of the year. Obviously, there's more variables in play now with corona, but just how should we think about quantifying the GM expansion this year?

I think what we said is modest expansion in gross margin. I think the primary drivers are what you've mentioned, David. It's a favorable outlook on product cost in terms of what we have visibility in terms of the 2020 assortments. We are assuming that we continue to make progress, building on what we were able to achieve in 2019 on pricing. We're not talking about 10% or 20% improvement in pricing, but something more modest than that. And when you have that delta between pricing improvement and more favorable product cost, that's actually very, very helpful to the gross margin line. Most of the growth we anticipate will be driven by our retail businesses. Those are the more gross margin-rich parts of our business. So that should -- certainly should be a benefit. We do think tariffs are a bit of a modest headwind. So tariff exposure, right now, as we see it, is about a $10 million increase in those costs relative to 2019, but we certainly expect to make progress on our inventory management initiatives as well. I would say we have bought the fall more conservatively just with adopting some of the practices that we've seen with some of our wholesale customers where they are expecting more out of their inventory investment. They're expecting faster terms -- turns rather. We'd like to see less of our product going to clearance than has been the case historically. So all of those things combined should, in our forecast, lead to gross margin expansion. That's what we're planning at this point.

All right. Thank you, Richard. Nicole, if you're on, we'll queue up for Q&A now from the audience, if anyone would like a question?

[Operator Instructions]

While we're waiting, Richard, I just want to go back to a comment you made earlier about some of the changes you're planning to make to improve the efficiency of your inventory management. Can you just touch on some of the key things that you're doing to improve there?

Sure. Well, it starts with the buy itself upfront. I think we've made tremendous progress in terms of how we manage our relationships with our wholesale customers. There was a time when we would hold more contingency inventory. I'd say, we have moved away from that now. And we collaboratively plan that those businesses with our wholesale customers, such that we make the product that they think is efficient for them to buy and sell to their stores. So we've gotten sharper in managing the inventory in the wholesale channel. And then in retail, it's about getting the upfront buy more correct. And I think in many cases, being a bit more conservative, making sure that we're making smarter bets in terms of the significant check we write for inventory. There is some technology that has been added to the business that helps with that. We've added some technology that helps us with markdown optimization. When do you take that first and perhaps second markdown? When's the optimal time to do that? We probably have a bit more investment to do on that front. And then hopefully, that translates to better price realization as well. Certainly, promotional strategy goes into that as well in terms of how we're promoting these products, the promotions that we put together, the discounts that we offer to consumers. So I would say there's a lot of work that's being done around marketing effectiveness and promotional effectiveness as well. So not strictly related to inventory, but it all fits together in terms of trying to drive higher margins in the retail channel, in particular.

I would just add to that. Our head merchant, put in place a new process beginning last year we refer to as the 4-season calendar. And so the product is being developed at a time when you have more visibility to how the current year season is performing. So some good decisions that made on improving the product, making it more appealing to the consumer. So the best margin is on products selling well. So that's been the focus of the merchants. And to Richard's point, once you have visibility towards the consumer loves and what they don't love, you can make those changes more real-time with the new 4-season development calendar. So it improves the forecast accuracy and the quality of the volume. Fundamental check-ins past year, the merchandising process.

Got it. That's great. Nicole, are there any questions in the queue?

We do not have anyone queued up at this time. [Operator Instructions].

All right. If there's no further questions, we will wrap this up. Gentlemen, thank you, again, for taking the time to be with us this morning, and talk to you soon.

David, thanks very much. Thanks to Bank of America, too, for changing the format of the meetings this week and give us an opportunity to get together in a safer environment. So we appreciate all the good work you did for us this week.

Appreciate your flexibility, Mike. Thank you.

Take care.

All right. Bye-bye.