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

Welcome everyone to this next session with Carter's. My name is Alex Walvis. I cover the discretionary brands in the apparel and accessories retailers here at Goldman Sachs. I am thrilled to be welcoming Carter's for this next session. Carter's as many of you know is the largest branded marketer in North America of apparel and related products exclusively for babies and for the young children. The company owns the Carter's and OshKosh B'gosh brands to the most recognized brands in the marketplace and also Skip Hop. With us today, we have Mike Casey, Chairman and CEO; we have Brian Lynch, President; we have Richard Westenberger, EVP and CFO. We're also joined by Sean McHugh, Investor Relations. So welcome all. Thank you for joining us today. I'm going to pass over to Mike to make a few opening remarks.

Alex, thanks very much. Thanks for inviting us to join you. Appreciate everybody joining us for a brief update on the business. I've got some -- just some opening remarks, just an overview for some who may be a bit less familiar with the company, and then we're going to leave plenty of time for your questions. As Alex shared with you, Carter's is the largest branded marketer of children's apparel in the United States. Last year, we owned the largest share of about a $27 billion market. That's twice the share of our nearest competitor. We own 2 of the best-known brand names in kids apparel, Carter's and OshKosh B'gosh, both brands have served the needs of multiple generations of consumers for the past 100 years. These are 2 beautifully complementary brands. Carter's SKU is a bit younger, it's the dominant brand in baby apparel. Oshkosh skews a bit older, its sweet spot is the toddler age range. But both brands over the years have been very successful extending the age range of the brand up to about a 10-year-old child. I would say it's probably the outer edge of the age range for our brands, it's up to a 10-year-old child. So it's focused on a younger child. We have the broadest distribution of kids apparel in the United States. Last year, our brands were sold in over 17,000 door locations in the United States. So even with significant store closures over the years, we still have significant distribution with the quality of the retailers that we do business with. We have been, for years, continue to be the largest supplier to the largest retailers of young children's apparel last year. Our wholesale business had sales in excess of $1 billion. So that's the kind of the history that was the core of our business years ago, wholesale. And like most wholesalers years ago evolved into outlets, and then we evolved from the outlets into specialty retail. And today, we're the largest specialty retailer of young children's apparel in the United States. We directly manage over 800 of our own stores from Maine to Hawaii. We've got beautiful stores up in Canada and also in Mexico. Also a very successful eCommerce business. It has been and continues to be our fastest growing, highest margin business. And then the third segment is International. So last year, International sales contributed about 12% of our total sales. We are on the largest share of the Canadian market, beautiful multichannel model, wholesale, retail stores, eCommerce. Say Canada, Mexico, Middle East, probably the largest, 3 largest contributors to our international sales. Also do business with Walmart, Costco and Amazon now globally. So last year, Amazon launched the Simple Joys brand in Europe. So we're kind of starting to find it interesting what parts of Europe the brand has resonated most with consumers. And we have this other component of our International business, where we do business probably with a couple dozen or more very fine retailers, smaller retailers doing a beautiful job representing our brands in probably some portion of nearly 100 countries. 2019 was a good year for us. We had sales of about $3.5 billion. It was our 31st consecutive year of sales growth. There's a consistency to what we do. This is not a hot and cold. We don't -- we haven't suffered some of the challenges other retailers have done, and kids apparel is a less discretionary purchase. We focus on the essential core products, the things that parents load up on, particularly for a newborn. Child grows through those wardrobes rapidly in those early years of life. 2019, not only record sales, but record cash flow last year, record earnings per share. So it was a healthy year for us. And earlier this year, we outlined what we thought was possible going forward, kind of the pre-COVID. So in February of every year, we say, hey, based on what we've learned, based on what the market opportunities, here's what we think is possible. So earlier this year, end of February, we laid out a game plan that would envision our company growing from roughly a $3.5 billion company, closer to $4 billion. That would be low single-digit growth as though we had sufficient margin expansion opportunities, which would enable mid-single-digit growth in operating income and better growth than that in EPS. Given our strong cash flow profile, we've had a good track record of buying back shares over the year. So we got a good growth plan with 2 months in, in January and February, we were seeing mid-single-digit growth. Everything was going well. Still recall March 9, we had our monthly business review and the update was, hey, 2 good months, we're on track to achieve the growth objectives. That was March 9, Monday, as I recall. 2 days later, everything changed. So 2 days later, World Health Organization said we've got a global pandemic on our hands. Shortly after that, President Trump said, "We have kind of a national emergency." And then everything started to change. So the pandemic will certainly weigh on the growth we had planned this year. We closed our stores like many retailers, closed in mid-March. I still remember the conversation, say, we're going to -- Mike, we're going to reopen them early April. I said, "Easiest decision is to close the stores. The hard decision is going to be when are we going to reopen them." So we intentionally did not give a date certain when we would reopen stores. I'm glad we didn't because we probably didn't reopen the stores until early June. It started in May and then got most of them opened in June. So 80 -- our stores were closed for about 80% of the second quarter. And the store model is the largest component of our sales. Thankfully, we have one of the strongest e-commerce platforms in young children's apparel. Suffice to say, I think it's one of the most profitable e-commerce platforms. And we saw a surge in online demand for our brands during that store closure period. Also had the benefit of doing business with Walmart, Target, Amazon, essential retailers with our exclusive brands. Our exclusive brand business was particularly strong in the second quarter, and we think that will likely be true in the balance of the year. So when you look at online demand for our brands, together with the deep relationships we have with the major retailers and then our direct-to-consumer business online, we expect our eCommerce sales this year will exceed $1 billion. Again, substantially, all of our stores were opened as we headed into the Fourth of July holiday. That was a particularly good holiday. We found the consumer behavior very interesting. I think it was a combination of a lot of things. The weather turning, the summer holiday, people coming out of isolation, tired of quarantining, you had the stimulus checks. So it was a combination of things, so we saw a surge in demand over the Fourth of July holiday. I won't comment on Labor Day today, but I will in October. But we were encouraged by what we saw, a strong demand over the holiday season. And we're also seeing that a little bit with Halloween. It's one of the -- it is the highest search term online for our brands, right, Halloween. So I think people are optimistic looking forward to the holidays, looking for a reason to celebrate. So again, we'll share more with you when we update everybody in October. I'll tell you by comparison, back-to-school, what we shared in July, that was off to a slow start. It was still interesting. We started to see good demand for what we'd say is playwear. We don't really have a huge back-to-school business. But typically, this time of the year, Oshkosh -- it's like the one time in a year Oshkosh actually outperforms Carter's, kind of this back-to-school period. And when there is a kind of a view that most kids would go back to school, we started to see good demand for playwear. And then when it was clear, most kids would be starting virtually all of a sudden, we started to see the playwear business dip and baby and the sleepwear business continue to be very good. So we're expecting the back-to-school period to continue to be tough given the different schedules. But I think what's important to know, baby and sleepwear sales is really the core of our business. And so baby sales, apparel sales are probably over 50% of our total company apparel sales. And we've got 5x the share of our [ neonatal ] child. And when you lay on top of that, sleepwear, again, that was the foundation the company years ago, baby apparel and sleepwear. Our sleepwear business has been is on fire because kids are virtually learning from home and they've been staying in their PJs. And so those businesses were particularly good for us in the second quarter, in July. And if you take baby apparel and sleepwear, that's probably 70% of our apparel sales. So we won't be unaffected by the staggered back-to-school schedule, but I think it's important for you to know baby and sleepwear sales. We think the pandemic actually gives us an opportunity to strengthen our position [ and outstanding ] relationships that we have with the winning retailers. Target, Walmart, Amazon, Kohl's, those are probably in our top 5 wholesale relationships. Expect that the disruption from the pandemic -- just like we saw with the great recession years ago, the disruption from the pandemic likely to result in fewer, larger, stronger, more financially viable retailers who are looking for stronger, fewer, stronger, better, more financially viable suppliers, and that's Carter's. No one has that book of business that we have with the major retailers. Our growth went forward, similar to what we shared with you earlier this year, 4 key strategy. Winning in baby, which is really the dominant category we focused in on. Aging up, making sure there's relevance to piling up to about a 10-year-old child. We updated you earlier this year, but that's been a good source of growth for us. Our merchants, our designers, our supply chain team have done a beautiful job putting together a product offering, which is attractive to a slightly older child and then expanding globally and profitably. So again, we've had -- we're on kind of our China 2.0 strategy right now. The first one, we had a lot of revenue, but not a lot of profitability. We just said, we're not interested in expanding globally and having losses attached to it. We're interested in margin-rich businesses. And so we will continue to expand globally. Again, thankfully, the businesses that we own, that we directly manage in Canada, in Mexico represent about 2/3 of what we define as international sales. So we'll have the ability to affect a good portion of that directly. We won't be reliant on some of the wholesale relationships that we have. And so that's organic growth, leading in e-commerce, winning in baby, aging up, expanding globally. And then inorganically, continue to look at other brands, which are -- were attractively valued these days relative to, say, a year ago or earlier this year. So we acquired OshKosh years ago, glad we did. Acquired the business up in Canada and Mexico, glad we did. Acquired Skip Hop, glad we did. So we are interested in acquiring good brands, good companies, highly selective. And -- but I think there's more attractive market opportunities. So we'll comment much on that, but just it's important for you to know we continue to look, and we'll pursue those things that we find more attractive these days. So at the net of it is I think we're well positioned to grow and continue to gain market share. We own the best-known brand names in kids apparel, brands that are trusted for quality, value, loved by multiple generations of consumers. Wherever you're shopping for kids apparel, you'll likely see a very strong presentation of our brands. Our distribution is from Walmart to Macy's and everywhere in between. So I made some forward-looking comments this morning. There are risks inherent in our business, and those risks are disclosed in our SEC filings. So hopefully, that overview is helpful to you, and we'll open up the meeting to your questions.

And Mike, thank you so much for sharing that overview and that update. There's a number of...

Any questions from the -- plenty here, plenty here.

Well, thank you so much for sharing that. There's a number of things we'd like to expand upon in your prepared comments. One of them was about how you're planning for the holiday season. Of course, there's a lot of uncertainty out there. You're confident about the lower economic sensitivity of your categories and the strength of some of your big retailers. But I wonder if you could talk in a little bit more detail about how you're planning the business, how you're planning your own receipts, and how you're positioning yourself to chase in the event that demand does come in stronger than anticipated.

So when everything kind of hit the fan earlier this year, we took a look at second half inventory plans, and we scaled those back. So both fall and holiday, we have scaled those back, now not necessarily for all businesses. Again, the exclusive brand business has been particularly robust. The essential retailers were able to stay open during the general store closure period, and that has been very good for us. So -- but I think, overall, we are planning more conservatively into the balance of the year. So -- and we had to make a decision on inventories, and we erred on the side of being more cautious on inventories. So if you recall at the end of the second quarter, inventories were actually lower year-over-year despite significant cancellations from some of our wholesale customers who had to close their stores. We were encouraged that, particularly with the exclusive brand customers, initially, they said, "Hey, listen, we don't know how bad that is going to be. Don't ship anything to us," initially. And then they said, "Hey, no, wait, we need it. Bring it in based on the sell-throughs, bring the product in." So I think initially, we had well over $100 million of inventory. We said we're going to pack and hold it, we'll bring it back next summer and no point and put it on the floor because a lot of the stores were closed. And so I think the last update we shared in July, that number had been reduced to about $70 million because a number of the customers said, "No, no, no, that things are -- we're seeing good selling. We're seeing over-the-counter and could get you more. So for some -- some customers we're actually chasing. In some cases, there are days where we say we wish we had more, particularly in sleepwear. That was kind of a point of view. Baby and sleepwear has been particularly robust. But on balance, we've made a decision, let's be more cautious on inventory commitments, I think that will serve us well because the last thing in the world you want right now is too much inventory. And in our outlook, what we shared with you in July is we're expecting at the end of the third quarter and at the end of the year, if we're successful with our plans, we'll have lower inventories year-over-year. Our focus is making sure we get -- come out of the block strong in '21, that we have good growth ahead of us. And we're not carrying over a lot of prior season inventory going into '21.

You mentioned some of that more confident ordering activity by retailers and your retail partners in an environment where their own demand was recovering. How much does that differ by partner type? How is your selling trending versus their sell through? And when would you expect those things to recouple? And how are those wholesale partners thinking about ordering kind of further afield perhaps into spring '21?

I'll tell you, my understanding is generally, most of the retailers are lean on inventory. So one thing I would encourage you to do, just do your own homework. But the last time I was in Target, shopping for my new grandson, I was surprised how much everything was picked over. And that wasn't just true with our brands with Target. It was true with Cat & Jack, it was true with Gerber and other things. So I think a lot of -- it may vary. But I think as kind of an over -- kind of an overview of where most retailers are, I think they're lean because they've a combination of the cancel goods and private label and our brands, they cancel good. So I think in some -- there are probably some days they wish they had more inventory. So that's actually a healthy place to be right now. You'd rather be in more of a chase mode than you're backing up with prior seats and goods.

Great. And as you talk about those trends within your wholesale partners, has this experience change at all how you're thinking about the mix of wholesale within your business longer term? And indeed, the mix of the different types of partners within wholesale? I'm thinking specifically about the particular strength that you've seen in the mass channel.

Sure. So just over the years, we've always focused on the winters. That has served us well, and we've got these deep relationships with the leaders in kids apparel, which, again, the top 3 would be -- call it top 4, including Kohl's would be Target, Walmart, Kohl's and Amazon. Those are the major -- and we have a deep relationship with each of them. You can make -- each of them have a unique brand from Carter's. And Kohl's having the flagship Carter's brand, but the other having their own unique brands that we developed for them. So I think that's going to be a good source of growth for us. I do think there may be some shakeout. There might be some marginal retailers that struggle to recover from the pandemic, time will tell. But that was the same experience we had back in the great recession when it hit. There was a shakeout, even in more recent years. Toys "R" Us, that was a very good customer of ours, particularly Babies "R" Us, high-margin because it was all baby, which is one of our highest margin product categories. And when we lost that customer, it was disruptive for a point in time. And I think probably within a couple of years, our level of wholesale sales bounced right back. And that book of business just got redistributed to other retailers. And a good portion of that went to Target, Walmart and to Amazon. So it's -- I think again, we've developed these relationships over decades. The major retailers view our brands as traffic drivers. They're bringing young families into their stores. They know it's a fairly frequent purchase because that child is growing through those wardrobes frequently in those early years of life. So we're expecting growth in wholesale. We're expecting growth in retail. I think whether it's our direct-to-consumer business or the wholesale business, the growth will be through eCommerce. That's where the growth is going to come from. It's just the consumer, particularly during the pandemic, has gotten very comfortable shopping online, and we've invested in capabilities which will enable them to shop online. And then pick up the product that same day in our stores. So I think we shared with you in July, our game plan going into the balance of the year would be that some portion of about 70% of our stores would be able to support eCommerce demand, shipping eCommerce orders out of our stores. So we've got some portion of, "Oh, I don't know, 600 or more stores that are now from Maine to Hawaii, shipping eCommerce orders and also offering curbside pickup. So we -- I think that's one of the significant learnings, opportunities to accelerate some initiatives to support that eCommerce customer in a way where she views the stores as an important part of the experience. She likes to shop online, but she likes the convenience of picking it up in the store.

Mike, I want to ask several more questions about your retail business and indeed on eCommerce. But for a moment here, I'm getting a number of questions in -- on the webcast, on trends in birth rates. So I'd like to ask about that. Do you have a perspective on how the pandemic and the ensuing economic situation will affect birth rates globally in the U.S. and how it affects your business?

Yes. So I've read the articles. And I've seen estimates as high as there might be 400,000 fewer births. And my guess is that's next year because whoever was planning on having a family this year that they made that decision before COVID. So those children will born this year. So we'll see. I think it will be interesting to see what happens in 2021. What I can tell you is my own personal experience. I've got kids in their late 20s, early 30s. And they've gotten married in recent years and because they started a little later, they've already started their family. So within I think in the last 2 years, I've got 3 grandchildren. And they tell me, "Hey, dad, just so you know, all of our friends are expecting. And so who -- we don't know." But typically, when there's a weaker economic environment, that affects the birth rates. That was true with the great recession. So we had a peak number of children born in 2007. 4.3 million beautiful babies born in 2007 and then the great recession hit. And then understandably so, people defer either starting the family or having that second or third child. And so we saw this kind of gradual decline since 2007 to what was about 3.8 million births last year. So that's over, say, call it, a 10-plus year time period. During that same time period, our business more than doubled. So again, births balance around. But again, our focus has been to reach more consumers through our exclusive brands, doing business with the winning retailers, building our e-commerce capabilities, investing in marketing, new marketing capability. So our focus has always been on just reaching more consumers, making it easier for you to shop. So sometimes when I read those articles, I think they're written by glass-half-empty people but -- because they don't know. We just don't know. But the other things we look at, strong housing market, very low interest rates. And again, usually, couples getting married, they now can afford to buy a house. And when you buy the house, you want to fill it up with a bunch of kids, put the swing set in the backyard. So time will tell. But our experience in a period where births have been declining has actually been good. And time will tell. '21 is going to -- I don't think you're going to see much of a movement in the births given the timing of when the pandemic hit this year. Next year it will be interesting. But we've operated and we've been successful in a period where births have been off a bit. No pandemic -- since the beginning of time, people fall in love and they have children, right? No pandemic is going to stop that. It may affect it short term, it won't be a long-term challenge.

Well, Signet told us in a session earlier today that more couples were staying together than not as a result of the pandemic. So that's true. That bodes well as well. So -- and you mentioned that your goal is to reach more consumers, but you are doing that with a different channel strategy than prior. One of the questions we are asking, one of the participants at the conference this year, is whether they expect to have fewer stores in the future versus the past. You guys specifically talked about this in the second quarter call, you announced plans to close around 25% of your U.S. store base partially offset by a few openings. Can you talk about those decisions? What drove them? Why now? And how we should think about your fleet longer term?

Yes. And so I think a tipping point for us and it was these omnichannel services, so being able to shop online at home and then pick it up in the store. So we studied, we went back. Our game plan initially was to open up some portion of 100 stores over the next 5 years and close slightly more than that. I think the number was like 115 stores. So it would be a net decrease. And then we studied where are the consumers taking advantage of these new omnichannel services. And again, our strategy over the past 10 years was to open up stores closer to the consumer. As we had success with these co-branded stores open closer to the consumer and with the success of our eCommerce business, we're seeing fewer visits to outlet centers and understand we sell. The value propositions is the same. And so as we looked at some of the more dated outlet centers as we looked at where we had more standalone stores, we said, you know what, let's -- and again, the further away you are from the consumer, the less likely the consumer is going to take advantage of these omniservices. She's not going to drive, and she doesn't have to drive 45 minutes to an outlet center when we've opened up stores much closer her our home. So I think that was a new dimension we added to our store closing criteria to say what stores are likely to support the e-commerce demand for our brands. And so we looked at that and we said, listen, how many stores do we have coming up for renewal and how many stores have kick out provisions and we said when those stores come up for renewal or with the -- if the kick out provision is available, we're going to take advantage of it. So we kind of looked beyond the horizon and say which way is the arrow pointing on some of these centers. And the reason why -- so people often say, "Why are you still opening stores?" A lot of times, we're closing a center where the lease is up after 10 years. And the center has become a bit tired. The cotenancy isn't ideal. The traffic patterns aren't as rich as they were 10 years ago because a better center opened up in a better location, better cotenancy, better economics. So we're closing 1 and opening up the better. And the return on those new stores have been good. So the game plan right now is to probably still open up some portion of 100 stores, close at least 200 or more, and the focus is on fewer stand-alone brand stores. You don't need a Carter's store and an OshKosh store. So fewer stand-alone stores, fewer outlet stores, more cobranded stores, both brands. Consumer loves shopping both brands in 1 location. And we still see our mall stores as an opportunity. The plan I saw might have some portion of 100 mall stores 40 years out because pre-COVID, mall stores were doing well. Now there's a point of view, there's 300 to 400 really good mall locations in the United States. And we said, is there some portion of 100 that makes sense for us to be in. And when Gymboree closed, we looked at every one of those locations. Most of them, we would have no interest in, zero, right, either because the cotenancy was weak or the demographics were weak, meaning not a lot of young families with kids in the area, or the economics just weren't attractive. So most of those spaces, we had no interest in. But there was -- out of looking at some portion of 600 or 700 locations, we said there's probably some portion of 100 worth exploring. But we'll be -- in light of everything we've seen during the COVID period, we're going to go slow on that. So that's the current game plan.