Carter's Inc

NYSE:CRI

Earnings Call Transcript 2022-Q1

[Operator]

Welcome to Carter's First Quarter Fiscal 2022 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 issued its first quarter fiscal 2022 earnings press release earlier this morning. A copy of the release and presentation material for today's call have been posted on the Investor Relations section of the company's website at ir.carters.com.

Before we begin, let me remind you that statements made on this conference call and in the company's presentation materials about the company's outlook, plans and future performance are forward-looking statements. Actual results may differ materially from those projected. For a discussion of factors that could cause actual results to vary from those contained in the forward-looking, 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 company's 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.

[Michael Casey, executive]

Thanks very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I'd like to share some thoughts on our business with you. First quarter sales and earnings exceeded the plans we shared with you in February. Our supply chain performance continued to improve, inventory arrived earlier from Asia and enabled us to support higher demand from our largest wholesale customers. We also had stronger than planned growth in our international sales, driven by our operations in Canada and Mexico, and saw a higher demand than expected from our multinational wholesale customers. We had planned retail sales lower in the first quarter to reflect the impact of closing low-margin stores last year, the shift in the timing of the Easter holiday and the significant impact of the nearly $3 trillion in government stimulus that drove higher consumer spending in the first quarter last year. Recall that in late December 2020, President Trump approved a nearly $1 trillion stimulus package. Just 10 weeks later, President Biden approved a nearly $2 trillion stimulus package. A good portion of the stimulus was focused on helping families with young children. Following each of those stimulus payments, we saw a meaningful lift in our retail sales in the first quarter last year, including an over 30% increase in eCommerce sales.

A year ago, many of us were still working from home. We believe the combination of the significant stimulus benefits and ease of shopping from home drove record online sales force in the first quarter last year. Thankfully, store sales in the first quarter were better than expected. We saw that positive trend begin last year with greater access to the vaccine and confidence in its protection, people are returning to shop in stores. We saw good growth in store sales in April, up over 8% as consumers got out to shop for spring outfits. Year-to-date, eCommerce sales are lower than we expected. Our year-over-year comparisons are expected to be less challenging in the months ahead. The final round of stimulus payments in the form of prepaid child tax credits began in the second half of last year. Those payments were smaller in amount and less impactful to our sales. Suffice it to say, the last 2 years have been unlike any other time in our lives and year-over-year comparisons are distorted by global events. A more meaningful comparison of our performance this year may be to the pre-pandemic period in 2019.

Through that lens, our first quarter sales grew 5% despite the closure of 115 low-margin stores that generated over $30 million in sales in the first quarter of 2019. Our operating income in the first quarter this year was 70% higher than the same period in 2019. Our significant improvement in profitability compared to 2019 reflects structural changes to our business made during the pandemic by focusing on fewer, better and higher-margin product choices, closing lower-margin stores, running leaner on inventories, focusing our marketing on brand building versus promotions and improving price realization. We believe the record operating margin achieved last year is sustainable. Given our current outlook for the year, we are reaffirming the annual sales and earnings guidance we shared with you in February. For the year, we're forecasting growth in sales in each of our retail, wholesale and international segments. The largest growth is expected to come from our Wholesale business. We're projecting growth with 5 of our top 6 wholesale customers this year. We continue to see good demand for our exclusive brands sold through the world's largest retailers, Walmart, Target and Amazon. These retailers disproportionately benefited from the pandemic. They provide one-stop shopping for the essential core products that families with young children replenish on a frequent basis, including diapers, formula and groceries. Carter's benefits from those frequent visits. We're also forecasting good growth with our flagship Carter's brand wholesale customers. Our more department store like customers were most affected by pandemic-related store closures in 2020 and consumer shifting to the essential retailers that remained open. Though our sales to these customers are not yet back to the 2019 level of sales, our flagship Carter's brand wholesale sales are projected up low single digit this year and at a margin rate higher than we realized in 2019.

Our growth in wholesale sales this year will reflect the rollout of our eco-friendly Little Planet brand to more stores and online at Target, Kohl's, Buy Buy Baby and Amazon. We've gained more floor space for our toddler swimwear, sleepwear and holiday product offerings for our flagship Carter's brand and exclusive brands. Skip Hop is launching a durables product offering under our Simple Joys brand with Amazon this year, focused on diaper bags, bath-time and playtime activities. And together with Target and Walmart, we are relaunching our brand marketing for our Just One You and Child of Mine brands to more prominently present in-store and online our Carter's brand, which is the best-selling brand in young children's apparel. That brand relaunch will be executed in time for the back-to-school shopping season. Carter's is the largest supplier of young children's apparel to the largest retailers in North America. These retailers view our brands as traffic drivers. We focus on essential core products like bodysuits, wash clothes, towels, bibs, blankets and pajamas. These consumer staples are purchased in multiple quantities in those early years of life. We sold over 25 bodysuits for every child born in the United States last year. Our average price points to the consumer are planned to be less than $11 per unit this year, up less than $0.80 per unit. It's a very affordable purchase and a great value given the beauty, quality and end use of our product offerings.

Our International segment is expected to be the second largest contributor to our growth this year. We're planning mid-single-digit growth in our international sales, driven by our operations in Canada and Mexico. We are the largest branded marketer of young children's apparel in these countries. These are multichannel operations with wholesale, retail store and digital businesses. Canada is the largest and most profitable component of our international business. We have more than twice the share of our nearest competitor. Canada is rolling out our new Little Planet brand to more stores given stronger than planned demand since the launch last year. During the pandemic, we invested in omni-channel capabilities in Canada, including same-day pickup of online purchases at our stores and ship from store capabilities. In the first quarter, over 26% of the online orders in Canada were fulfilled by our stores. These are margin-accretive transactions relative to shipping from our warehouse in Canada. With stronger digital capabilities, eCommerce penetration has grown to over 30% of our total retail sales in Canada, double the pre-pandemic penetration in 2019. We're planning double-digit sales growth in Mexico this year. We plan to replicate the success we achieved in the United States and Canada with our co-branded store model. We are converting our smaller standalone Carter's and OshKosh stores in Mexico to the larger, more productive store model. Over time, we see an opportunity to more than triple our store square footage in Mexico through store growth and our co-branded store model strategy. There are over 2 million children born each year in Mexico compared to less than 400,000 children born each year in Canada. As the leader in young children's apparel, we see both markets as good sources of growth in the years ahead. Our international wholesale sales are planned comparable year-over-year and more profitable than each of the previous 3 years. With good international wholesale partners, including Walmart, Costco, Amazon and other retailers representing our brands in over 90 countries, we believe these profitable relationships should contribute meaningfully to our growth objectives.

We're projecting low single-digit growth in sales and earnings in our retail segment this year. Our focus will continue to be on reducing the mix of lower-margin stores, opening stores and higher traffic centers that provide good returns on investment, staying lean on inventories and investing in omni-channel capabilities that drive traffic and margins. We are the largest specialty retailer in the United States focused on young children's apparel with beautiful co-branded stores from Maine to Hawaii. Our best performing stores so far this year are in the south and west, where weather was more spring like and tourism seems to be returning to the United States. Our toughest comps were in the Midwest and Northeast, where weather has not yet prompted consumers to shop for warmer weather apparel. Year-to-date, our best comps are in Florida and California, our lowest comps in New York and New Jersey. We saw the best traffic to our indoor mall stores, lowest traffic to our outlet stores. In years past, as gas prices rose, we temporarily see declines in traffic to our outlet stores. About 30% of our stores are in outlet centers. Given our progress with SKU rationalization, inventory management and price realization over the past 2 years, our store unit economics have improved and more attractive store opportunities are now available to us. Over the next 5 years, we plan to open more than 100 stores in the United States net of closures. This year, we plan to open 30 stores and close 20. We expect the impact to sales this year from store closures will be about $30 million compared to last year.

Our focus is on high-traffic open air centers that provide convenience for online shoppers, including curbside pickup, which became popular during the pandemic. Stores planned for closure had a low single-digit operating margin last year. Stores we plan to open are forecasted to earn more than a 20% 4-wall operating margin. That's been our experience with store openings in recent years. Nearly 70% of children's apparel is purchased in stores and stores continue to be the largest source of new customer acquisition. We're leveraging our stores to provide a convenient shopping experience for our online customers. Nearly 30% of our online orders in the first quarter were fulfilled by our stores. We expect that nearly 40% or more of our online orders will be fulfilled by our stores within the next 5 years. These transactions enable quicker delivery of the order at higher margins relative to shipping from our distribution center. Our marketing team did a good job in recent years linking the credit card transactions to our Rewarding Moments Loyalty Program, which incentivizes repeat purchases. Over 90% of our transactions last year were from customers in our loyalty program, which enables us to analyze shopping behaviors and provide a better experience for our best customers. Our supply chain continues to work through the challenges of transportation delays caused by the lingering effects of the pandemic. On-time deliveries to our wholesale customers and our stores improved in the first quarter. We're now routing over 60% of our imports through the East Coast with good results. Our East Coast ports are less congested than the West Coast and processing receipts quicker for us.

To date, we have not been materially affected by China's recent COVID restrictions. We source less than 10% of our total unit volume from China. Our suppliers source a large portion of our fabric and other component parts from the southern regions of China, far from the major cities being locked down further north. Shanghai ports have remained open, but are congested. Alternative ports are being used to mitigate congestion related delays. To mitigate the risk of further delays, we have placed factory orders 3 to 6 weeks earlier this year. This strategy should enable our product offerings to get here earlier. Late deliveries and inflation will weigh on the growth that would have otherwise been possible this year. We reflected higher product and transportation costs in our forecasts. For the year, we've estimated product costs up about 7%. We expect our freight costs will be up over 10% this year. Ocean freight rates have more than doubled versus last year. We have ocean freight rate contracts for about 90% of our unit volume through the first half of next year. The rates under those contracts are less than half the current spot market rates. Lower spending on air freight planned this year and next will help mitigate the higher ocean freight rates. The best information we have suggests that freight rates may decrease by the second half of 2023 as capacity improves and global demand moderates in the months ahead.

In summary, 2022 got off to a better start than we expected. We're forecasting good demand for our brands this year. Thankfully, the favorable trend in versed in the United States that began last summer continued through the balance of last year. Our Baby apparel product offerings represent over 50% of our annual apparel sales, and our Carter's brand has nearly 4x the share of our nearest competitor. In the first quarter, our baby apparel sales were up about 6%. It continues to be one of the strongest components of our product offerings. We've raised prices thoughtfully this year to help mitigate the effects of inflation. To date, we've seen no noteworthy resistance to pricing from our wholesale customers or consumers. Interestingly, some of our best-performing products year-to-date are the higher ticket special occasion collections. Consumers appear to be refreshing their children's outfits in anticipation of a summer vacation, getting back out on the road, reconnecting with families and friends. Carter's is the market leader in children's apparel. No other company in the kids apparel market has the scope of product offerings, depth of relationships with the winning retailers and long track record of success for many years serving the needs of multiple generations of consumers. We believe we've weathered the most challenging days of the pandemic. We'll continue to focus on the things we can control and mitigate the effects of what we can't.

I want to thank our employees throughout the world who enabled a stronger-than-planned start to the year and for their commitment to help Carter's achieve its growth objectives this year. Richard will now walk you through the presentation on our website.

[Richard Westenberger, executive]

Thanks, Mike. Good morning, everyone. I'll begin on Page 2 of our materials with our GAAP P&L. Net sales were $781 million and reported operating income was $103 million in the first quarter. We had no non-GAAP adjustments in this year's first quarter and only minimal net adjustments related to COVID in the prior year. These adjustments are detailed on Page 3.

So turning to Page 4 with some highlights of our first quarter performance. Overall, we delivered good results for the first quarter. We had planned sales and profitability down versus last year due to the noncomp of the significant government stimulus last year, the later Easter holiday this year and meaningfully higher transportation costs. Our results, though, were stronger than we had planned. Our inventory position was better than expected, which enabled higher shipments to our wholesale customers and spending was also lower than forecasted. As Mike pointed out, while our results were below last year's record first quarter performance, they were meaningfully above 2019's pre-pandemic level, reflecting the many benefits of the improvements we've made across the business.

Our adjusted P&L for the first quarter is on Page 5. Sales were down 1% versus last year to $781 million. We posted over 8% sales growth in Wholesale and 11% growth in our International segment. Sales in our U.S. Retail business were down 10% versus a year ago, reflecting the tougher comparison to last year's stimulus and the later Easter holiday this year. Gross margin was 45.4%, which was down 440 basis points from last year. More than half of this decrease was due to the higher inbound transportation costs, which increased over $20 million or nearly 60% over last year. We expect transportation costs to be elevated well into next year, and they will be higher than we had originally planned for the full year in 2022. The vast majority of our ocean container volume is under contracts, which extend into the middle of next year. Our contracted rates are well below current spot market prices, but still represent a meaningful increase over what we were paying last year. We've taken steps to raise pricing and reduce other spending across the business to cover these higher-than-expected transportation costs.

Gross margin was also pressured by a higher mix of wholesale sales and less retail sales. Our wholesale volume in the quarter included more off-price channel sales related to clearing out late arriving fall and holiday product. We're expecting that off-price channel sales will be lower over the balance of the year and meaningfully lower on a full year basis than in 2019. First quarter spending was lower than last year by $11 million. Store expenses were lower as a result of our permanent store closures, and compensation costs were also lower than last year. Distribution and outbound freight costs were higher as was our spending on marketing in the first quarter. Adjusted operating income was $103 million, down about 20%, which, as I said, was a smaller decline than we had planned. On the bottom line, adjusted earn earnings per share were $1.66 compared to $1.98 last year.

Turning to Page 6 and some highlights of our balance sheet and cash flow. Our balance sheet remains in great shape. We ended the quarter with substantial liquidity. Receivables were higher as a result of the strong growth in wholesale sales in the quarter. Inventory was up 21%. The quality of our inventory is very good. As I said, we've moved through the majority of late arriving product from prior seasons. A few things drove the year-over-year increase in our inventory. Units were up 9% and as planned, product costs were up over last year. In-transit inventory remains elevated, although less so than at the end of last quarter. As Mike mentioned, we are taking ownership of inventory 3 to 6 weeks earlier than typical given the higher transit times from Asia. Our inventory levels are expected to be higher year-over-year throughout the balance of the year with Q2 ending inventory projected up over 30% versus 2021. We're expecting year-end inventory will be up high single digits with most of the increase representing product cost inflation and units more or less even with last year. We see good demand for our products in the second half of the year, given the myriad of supply chain issues over the past couple of years. We are fortunate to have the resources and wherewithal to be able to bring in inventory early and hopefully better meet projected demand. Long-term debt, as presented on our quarter end balance sheet, was lower by about $500 million, which reflects reclassification of our pandemic-related senior notes as a current liability. We redeemed these notes in early April. This financing has been put in place to provide additional liquidity in the very early days of the pandemic. Fortunately, given the resilience of our business over the past 2 years, we didn't need this financing. By redeeming these notes early, we will lower our annual cash interest costs by $28 million. Our cash used in operations was greater in this year's first quarter than last year, which largely reflects the higher inventory level and higher performance-based compensation payments in the first quarter, which relate to the record performance achieved in the business last year. We're expecting to generate good operating cash flow for the full year in the range of $275 million to $300 million. We continue to return capital to our shareholders in the first quarter. We paid dividends of $31 million and repurchased $74 million of our shares.

On Page 8, we've summarized our business segment performance in the first quarter. At a high level, our consolidated sales decreased slightly by $6 million or 1% versus a year ago. Sales were lower in Retail, while we had good growth in both Wholesale and International. Our operating margin declined versus last year's record level, virtually all of which is attributable to the over $20 million increase in transportation costs. Corporate expenses were lower by $10 million due to lower consulting and performance-based compensation expenses.

Turning to some additional detail on our business segment performance in the first quarter on Page 9. In Retail, sales were down, as I mentioned, and our total retail comp declined by 7%. A year ago, our government made a record level of direct payments to American consumers as part of its response to the pandemic. These payments benefited our retail business last year and were not repeated this year. Additionally, sales were lower because last year, we closed over 100 low-margin stores to better focus our store portfolio on higher opportunity and more profitable locations. Finally, Easter is an important holiday in our business, and it fell later in 2022 versus 2021, likely shifting sales volume out of late March into the second quarter. As a result of these factors, traffic in our retail channels, both stores and eCommerce, was lower than last year. We believe some other factors likely also weighed on our direct-to-consumer business in the first quarter, most notably the surge in inflation and lower consumer confidence. Profitability in retail was affected by the lower sales and the higher transportation costs that I've mentioned. While business so far in April has been slower than expected, we are planning for low single-digit growth in retail comps for the second quarter and full year. In Wholesale, we had 8% growth in sales, which was above our forecast. As I said, our on-hand inventory position was better than we had anticipated and to a lesser extent, some customer demand came earlier, allowing us to ship more in the first quarter. These sales, about $14 million in total, had been planned previously to occur in the second quarter. We saw good growth across our wholesale customer base in the quarter, including with our exclusive brands. Profitability in wholesale was affected by a higher mix of off-price channel sales and higher transportation costs, including some residual spending on air freight.

We had a very strong quarter in our International business. We had strong growth in Canada, in Mexico and in our international Wholesale business, particularly with our Brazilian partner. In Canada, we saw strong growth in stores. A year ago, stores were largely still closed in Canada and sales rebounded strongly in this channel. Profitability was down about 50 basis points in International. Margins benefited from the strong recovery in Canadian store sales and higher sales in our high-margin international Wholesale business, offset by higher transportation costs, which are affecting all parts of our business right now.

On the next page, while our profitability in the first quarter was lower than last year, we've summarized the profitability that each of our businesses was generating before the pandemic in 2019. As you can see, each of our business segments was meaningfully more profitable in this year's first quarter than back in 2019. As Mike mentioned in his remarks, the changes we've made across the business, including focusing our product offerings to fewer longer life cycle choices, operating with leaner inventories, having a higher-quality store portfolio and a more effective approach to pricing and promotion has led to a stronger and higher-margin business. These improvements are helping us to manage through the current challenges of inflation in product and transportation costs among other areas.

On Page 11, one of our traditional product strength is around holidays and special events. These products are staples of our assortments, both at wholesale and in our direct channels. Now that we're hopefully on the other side of the pandemic, families are eager to celebrate, whether it's baby's first Valentine's Day, Easter or the Fourth of July. These products help us to deepen our relationships with consumers, and they drive brand loyalty and traffic. The nature of these products which are oriented around distinct and different events and holidays throughout the year drives visit frequency to our stores, our website and to our wholesale partners. On the next page, earlier this week, we launched a collaboration with Dunkin' Donuts. Everyone knows Dunkin', especially sleep deprived parents in search of caffeine. This limited capsule of Dunkin' themes products has largely sold out in only a matter of days since its introduction. Our friends at Dunkin' are fond of saying that America runs on Dunkin', and we would expand the stop to say that parenting runs on Carter's.

Moving to Page 13. I'm told millennials check their phones nearly 150 times a day, and they're incredibly active every day on social media. Our brands continue to lead in social media engagement, and we're building out our capabilities with newer and rapidly growing social media platforms like TikTok.

On Page 14. In addition to social media, it's important to offer consumers easy, efficient and fun ways to transact digitally. We've talked a lot over the years about our leading e-commerce website. As Mike said, our mobile app has quickly become very popular with our customers and now represents a meaningful proportion of our online sales. Our Carter's credit card and loyalty programs are also important elements of how we engage with our customers. Both of these programs have proven very successful. Our credit card and loyalty programs are used in the vast majority of our retail sales.

On Page 15, we have some great Little Planet imagery. We expect to see meaningful growth in Little Planet this year. The brand is expanding to 270 retail stores in the U.S. and Canada with new points of wholesale distribution, including Amazon, Target, Kohl's and Buy Buy Baby. We recently expanded our Little Planet product assortment to toddler sizes, and we're adding new categories such as swimwear and shoes.

On Page 16, last week, we marked Earth Day with the launch of our new ESG consumer-facing platform. Theme to raise the future one important element in addition to our social and governance priorities is communicating our commitment to creating a sustainable world, one which we and families raising young children can pass along to future generations. Our product hangtags and in-store messaging have been redesigned to emphasize our sustainability initiatives including the use of certified organic fabrics and recyclable materials in our products. These games will also have a prominent place in our messaging across our various social media platforms.

On the next few pages, we have some imagery and brand messaging related to several of our wholesale customers. Target, Walmart, Amazon and Kohl's are among the largest retailers of young children's apparel in North America, and they happen to be our largest wholesale customers. On Page 17, we have a terrific photo of the Just One You brand wall at Target in addition to photos of a couple of our highly productive floor fixtures. The brand wall is the high-margin replenishment component of our business at Target and is where consumers can easily find the must-have essentials for babies. We continue to expand our product offerings to target with the addition of swim and older age sleepwear. Four of our brands are sold to Target. In addition to Just One You, Target also carries OshKosh, Skip Hop and Little Planet.

On Page 18, our Child of Mine brand exclusively available at Walmart also continues to grow through new product introductions and expansion of existing categories. I mentioned our expertise earlier in events and holiday-oriented products, and we've launched events this spring at Walmart with an Americana named Red White & Blue Collection, targeting the Fourth of July. We're planning to expand our event offerings at Walmart in 2023. And at the bottom of the page, we've included some new branding for Child of Mine, which we will roll out this fall. This new branding more strongly emphasizes Child of Mine Carter's DNA.

Page 19 is a photo of some beautiful summer essential products from Simple Joys on Amazon. Consumers continue to make our Simple Joys brand the best-selling children's apparel brand on Amazon. In addition to the expanded assortment of playwear in sizes 4 to 8, we're planning on launching some new Skip Hop designed bath and playtime products and also diaper bags under the Simple Joys brand later this year.

On Page 20, Kohl's is our largest wholesale customer for the flagship Carter's brand. Kohl's has been a great partner in the breadth and depth of the Carter's assortment, which it carries. The branding and product presentation of the Carter's brand in-store and online at Kohl's are among the most effective in the wholesale channel. In Q2, we will refresh our core baby assortment at Kohl's and are planning good sales growth.

Turning to the next page. We've spoken on recent calls about our growing presence in Brazil with our partner, Riachuelo. Brazil is a large and attractive market with 2.7 million new babies born each year. Today, Riachuelo has opened nearly 30 Carter's branded stores in Brazil. Shown here are the newest stores in Brazilia and Sao Paulo. The Carter's branded stores add to over 260 Carter's shop-in-shops within Riachuelo department stores across Brazil. We're looking forward to the continued build-out of this high opportunity market.

On Page 22, we continue to expand globally into new markets, shown here as a new Carter's store in Uruguay. This is a smaller market in South America, but the Carter's brand has strong brand awareness in this country. Our partner here has now opened 5 Carter's branded stores in addition to managing the eCommerce channel in this market.

Turning now to our outlook, beginning with second quarter on Page 24. Net sales are projected to be in the range of $750 million to $775 million, which would represent growth of just under 1%, up to about 4%. We're forecasting operating income between $95 million and $105 million and adjusted diluted EPS of $1.60 to $1.80. We're expecting lower wholesale sales given the move of some demand previously planned for second quarter into first quarter. We're forecasting continued improvement in price realization, and we will have increased costs for freight and transportation. Earnings per share is expected to benefit from lower interest expense and our share repurchase activity. Relative to our previous first half guidance, we've adjusted the lower end of our previous outlook for sales by about $20 million or about 1% to reflect the slower start to the second quarter. First half earnings are in line, if not somewhat better than what we had planned previously.

For the full year, on Page 25, as we told you on our last call, we're expecting another good year both in sales and earnings. Our forecast is that we will build on last year's record performance. So today, we are reiterating our full year guidance. We're forecasting net sales growth of 2% to 3%, adjusted operating income growth of 4% to 6% and adjusted diluted EPS growth of 12% to 14%. There are many factors which we believe will contribute to this projected performance and some of the more significant ones are listed here. There's no shortage of challenges in the marketplace right now. We've spoken of several of them: inflation across many important costs of the business, including product input costs and transportation, the risk of slowdown in the economy and possible resurgence of COVID, including potential disruption to factories and ports in Asia. But the last couple of years have demonstrated the strength of our business and the resilience and creativity of our employees. Across Carter's, our teams are committed to delivering a very successful 2022.

And with these remarks, we're ready to take your questions.

[Operator]

[Operator Instructions]

Our first question comes from Susan Anderson with B. Riley.

[Susan Anderson, analyst]

Nice job on the quarter. I'm wondering if maybe you can talk about the inflationary pressures going into the back half in 2023, and the kind of the puts and takes that you're thinking about there, particularly as cotton prices are up pretty significantly? And then maybe also if you could just give us an update on where you're at with the supply chain issues, if you've seen an improvement at all? And if you expect the same expense in the back half or is some of that air freight will go away in the quarter?

[Michael Casey, executive]

So Susan, supply chain performance improved in the first quarter. So I'd say, it's gradual improvement. We got probably better part of 60% of the shipments to our wholesale customers are on time. The balance is running some portion of about 3 weeks late. I think that's generally what's going on in the market. In terms of inflation, the big chunks of inflationary pressures are in product costs and transportation, much more on the product cost side. So as we shared with you earlier, product costs will be up mid-single digit in the first half, high single digit in the second half. We've raised prices to make sure that we can achieve our margin objectives this year to have at least the same margins we had last year, if not have been better.

The freight cost, since we chatted with you in February, are higher, probably about $15 million higher. And so we'll have to adjust our spending elsewhere in the business to overcome those higher ocean freight rates. So we've negotiated the other half of our ocean freight under contracts, which will -- now we've locked into through the first half of next year. Those negotiated freight rates under contract now are less than half the spot market rate. So we feel -- albeit higher, we feel as though we're in a good place through the first half of next year. What's going to help us in the second half is, we're comping up against significant and unusual air freight charges that we incurred in the second half of last year. So that will help mitigate some of the higher transportation costs that we'll now have in the second half. So transportation cost for us this year, even though ocean freight rates have more than doubled, our freight expenses this year will be up a little over 10%. So I think we reflected what we know in the forecast that we're sharing with you this morning. And we feel good. We feel good about the product offering. We feel good about our marketing strategies, and so we expect that we have the potential to have a very good year this year.

[Susan Anderson, analyst]

Great. That's very helpful. If I could just add one follow-up just on the AUR. I'm curious, in the quarter, were you able to realize all of the price increases that you were putting through? Or did you promote a little bit more than you were expecting at all? Or are the promotions still very rational out there?

[Michael Casey, executive]

I would say, we achieved the pricing objectives in our direct-to-consumer business. And what you saw in the first quarter, as we expected, off-price sales were higher because we cleared out -- as Richard shared with you, we cleared out the late-arriving fall and holiday product in the first -- that late arriving last year, cleared it out in the first quarter through the off-price channel. That's when you're going to get the highest and best value for that product by the weather. It's still cold, which it was. In the first quarter, we saw good demand for that product. So off-price as a percentage of our sales in the first quarter around 2% for the year, we expect it to be around 1%.

[Operator]

And our next question comes from Paul Lejuez with Citi.

[Paul Lejuez, analyst]

Just on the first quarter, how much did the sales to off-price impact your gross margin in 1Q? Also curious what's going on in the D&A line? Look like that was a bit lower by looking at the cash flow statement. So curious how to model that go forward. And then you mentioned April started off a little bit weaker than anticipated. Just curious which pieces of the business and what you think the drivers are? And why you have confidence in reiterating the full year?

[Richard Westenberger, executive]

Yes. So Paul, of the 400 some basis points decrease in gross margin year-over-year in the first quarter, it's about 100 basis points that I would call mix. And I would say, the higher proportion of off-price channel sales is a good proportion of that. So call it 100 basis points of the 400 basis points was mix related, specifically related to off price. On your question on depreciation, it is down. It will be down kind of all year. From memory, depreciation is forecasted to be about $70 million, and I believe it was about $90 million for the full year last year. There's a couple of things that worked there. One, just the impact of having closed over 100 stores over the course of 2021. So expenses related to those stores are out of the base. And then I would say, in our technology spending, there's been a longer-term shift away from CapEx dollars more towards Software as a Service solutions for the various new technologies that we're putting in place. We had very low CapEx, I would say, in general in 2020 just during the pandemic year. So some of that's probably reflected and depreciation being a bit lower as well.

[Paul Lejuez, analyst]

And then April?

[Michael Casey, executive]

For your question on April? Yes, Paul...

[Paul Lejuez, analyst]

What drove it? That's kind of what I was asking. And then why you have confidence to kind of reiterate the year, if April has started off a little bit weaker?

[Michael Casey, executive]

April is a little soft. Our stores have been up, I think is about 8% in April. E-commerce has been lower. Easter was softer than we planned. That's really probably the key on that one. And we believe that we really haven't seen that warmer weather pop across the country yet. So it happens every season as the weather gets warmer in the spring and summer and cooler in the fall. We see a pop in our business we have not seen that yet. But April is a little bit below what we planned. We're comping at about a negative 1 right now in April based on by the slower start with Easter.

[Paul Lejuez, analyst]

Got it. And then just if I kind of maybe one follow-up. What do your order books look like for the back half, if that's something you can talk about?

[Michael Casey, executive]

Well, wholesale, the business has been good. As you know, we beat Q1. We're up about 8%. We're planning the first half up mid-single digits and the second half up mid-single digits as well, I believe. So I think if we're successful with our plans in wholesale, our sales will be actually comparable to 2019 with the exclusion of off-price, planning good growth with the majority of the accounts. As Richard shared, we've got several new placements for some of our key strategies in Age Up and Little Planet and events with the wholesale partners. And I think one of the things I'm most interested to see how this develops is, we've had a change in the birth rate trends progressively better in Q2, Q3 and Q4. And as you know, the majority -- vast majority of the Wholesale business is actually baby related. So hopefully, that can be a tailwind for our business. And we had very strong selling in Q1 and year-to-date in our baby products, not only in our Retail business, but in our Wholesale business.

[Operator]

We have a question from Warren Cheng with Evercore.

[Warren Cheng, analyst]

I had a question on the retail profitability. The first quarter Retail segment margins were really impressive if you look at -- as you compare it to what you typically generate in the first quarter even with the higher freight. Can you just help us think about how to translate that on a full year basis? If you just look at your -- the changes to your footprint, we assume freight normalizes eventually. Just how to think about the kind of going forward retail profitability?

[Richard Westenberger, executive]

Well, the unlock in the business, Warren, continues to be improved price realization. So while we certainly have some inflationary pressure in product costs, I'd say, we're building back some compensation costs in that part of the business as well. Just returning store staffing levels to more appropriate models. The real unlock has been improving our price realization. Product costs are up. That price realization is expected to improve as we move through the back half of the year and certainly sort of move into second quarter and second half. So there'll be more of a contribution from that improved AUR even with product cost being up. So I would say, that's really the engine. That's really what's allowed us to drive a more profitable business, less brand erosive promotions, more focused on getting paid for our good work, buying inventory at a bit of a high fraction, but at some proportion of forecasted demand. So operating at a bit more of a scarcity model has reduced the amount of inventory that ultimately goes to clearance, which has become kind of a big issue in both the stores and the online channel. There's just less of that today.

[Michael Casey, executive]

And what I'd add to that, Warren, is the mix of stores. We continue to close the low-margin stores and open up higher-margin stores. That's the game plan. Over the next 5 years, we'll open up probably more than 100 stores net of closures because the margins, the EBITDA margins we're seeing on new stores are in the high 20% range. So very good returns on investment.

[Warren Cheng, analyst]

Got it. And is there a way to quantify that lift from all those different drivers? They said, if I just think about the stores that were closed, that were low margin, some of the freight headwinds that are happening now. And if you strip those out, is there a way to just quantify kind of the overall lift to the retail profitability versus pre-pandemic levels?

[Michael Casey, executive]

I'll give you a sense. We probably took out over $100 million of sales from store closures since 2019, and retail is more profitable having done that.

[Warren Cheng, analyst]

Got it. And then one quick follow-up. Just on the exclusives, can you give an update on what they represent as a percentage of wholesale today? And how the profitability of that business is involved during the pandemic?

[Michael Casey, executive]

Exclusive, they're just under half of the business in wholesale. I guess 48% exactly in the quarter, and profitability is good. It is -- profitability is slightly accretive to our overall Carter's CRI operating margins.

[Operator]

Our next question comes from Jim Chartier with Monness, Crespi, Hardt.

[James Chartier, analyst]

You mentioned you're contracted on freight work for the first half '23. Just curious how the first half of next year contract rates compares to the first half of this year? Are they still up in that 10%-ish kind of range?

[Michael Casey, executive]

Yes, they'll be higher. First half to first half will be higher, yes, next year.

[James Chartier, analyst]

Okay. And then you mentioned a rebound in tourist stores. What percentage of store sales historically come from tourism? And then when did you start to see those stores first rebound? And then where those stores performing relative to 2019?

[Richard Westenberger, executive]

I'd say, the tourists, they were talking about Orlando in Southern California and Central Valley up in New York. They're probably around 20% of the stores, but these are -- might be 20% of the stores, but these are mega stores. We probably do better part of $14 million in Orlando, where as a typical store, we'd open up does closer to $1 million. So these are -- so we're just encouraged. More people are getting -- if you've traveled like many of us have traveled in recent months, the planes are packed and more and more people are coming back into the United States, and we're starting to see that in the tourist location. So we're encouraged by that. So our best performing stores were in Florida, in California in the first quarter. And one, I think the weather was more spring like and two, more people are getting out and reconnecting with families and friends. So we'll see how that trend continues. We saw -- I would say, we saw it around the holidays. It started around the holidays, started to see it as we -- in the second half of last year, particularly over the holidays and it's continued into the first quarter.

[James Chartier, analyst]

Great. And then just in terms of kind of future cost inflation, I mean what's your confidence in terms of your ability to continue to raise prices, if inflation continues to be a problem in the next year?

[Michael Casey, executive]

I think there's more we can do on price. Again, our average price points are under $11 a unit. If you've seen the beauty of our product offerings, certainly extraordinary value. And we think -- we used to think about nickels and dimes and quarters, and through the pandemic, we realized that the consumer was -- we saw no resistance from raising the price to $1 or $2 since the pandemic began. So there's more -- if we need to do more, we can do more. And what we experienced back in 2011 when cotton prices went to over $2 a pound. The cotton prices -- at those prices more cotton was planted and within a year, the cotton prices dropped like a rock. So we'll see if that experience repeats itself going into next year, but the best information we have would suggest a combination of moderating demand and more capacity, more cotton being planted, that should be a benefit we should expect to start to see sometime next year.

[Operator]

Our next question comes from Jay Sole with UBS.

[Jay Sole, analyst]

I just want to make sure I understand the differences between the second quarter guide given today and what was implied for second quarter last time. It sounds like there's a wholesale shift, maybe a little bit of a slower start to the second quarter. But maybe you can just outline the other differences between where the second quarter guidance is today and where it was last quarter, that would be helpful.

[Richard Westenberger, executive]

I think it's primarily the -- what you just said, Jay, we had about $14 million of wholesale volume that we had planned for second quarter that actually took place in first quarter. So that's a bit of a hole relative to the previous plan. And then in our Retail business, as we've said, the month of April has been off to a slower start. So that's roughly a $20-ish million revision, I believe, to our first half guidance. We did outperform a bit in Q1. So the combination of those 2, I guess, [indiscernible]. Transportation costs perhaps a bit higher in the second quarter than we had planned, but on balance, the profit outlook very consistent with what we had told you before for first half.

[Jay Sole, analyst]

Okay. Got it. And then maybe it would be awesome to elaborate a little bit on the South America strategy that you talked about in the prepared comments. Maybe specifically within Brazil, there's a $3 billion total addressable market. What kind of market share do you think you can take in Brazil? And where are you now? And do you think you can apply this strategy to other countries?

[Michael Casey, executive]

Jay, we've got -- we're doing business about 90 countries where we call our kind of partners business, international partners, where individually, a lot of these partners are small collectively, it's a good-sized business for us. Better part of $100 million business, high-margin business for us. Riachuelo is the partner that has gotten behind the brand. Just like the experience we had in the United States where a lot of the major retailers were carrying the brand and saw the strength of the product offering, but Riachuelo decided to take the brand outside of their department stores and open up standalone Carter's stores. So they probably have a couple of dozen of them now. There's a plan to open up more of them, but we have partners in Peru, Chile, Uruguay. We have partners all over Latin America. I think you know our history in China was not particularly good, and there was sales volume, but no profitability. And there wasn't really much of a path to profitability in China. So we set our sights on Latin America, which has been a very profitable business for us. So we'll do far more in Latin America than we ever would have done in China and much more profitably.

[Operator]

Our next question comes from Brian McNamara with Berenberg Capital.

[Brian McNamara, analyst]

I think a lot has been said and written about promotions kind of ramping in as it relates to you and your brand. Curious if you could kind of talk to those concerns. I know a peer of mine asked the question earlier, I know you mentioned off-price too, but off-price is not a typical promotional channel, per se. So any color there would be helpful.

[Michael Casey, executive]

Sure. I think promotions are a function of the strength of your product offering, how you bought it, your forecast accuracy, the sell-throughs of the product offering. So during the pandemic, we kind of embrace the scarcity model. Good retailers like Target, we've learned that over the years by doing business with them. We've learned a lot from Target, Amazon, Walmart in terms of how to drive better businesses, the businesses we've had from them. We've learned from them, things that we could apply to our own business. So our stores -- I think in our stores right now, we're carrying less than 30,000 units per door. I think it's closer to 27,000 units per door. It used to be over 40,000. So there's very little in our back rooms, and so we've created a kind of an experience for the consumer, get it now while it's here. And so if we over buy, that's the risk in the balance of the year. And so our teams, our retail teams, our operations teams are mindful of being thoughtful on what we buy, focus on the things the consumer needs, edit the things that are perhaps not needed. And so it's -- promotions are all a function of are you being smart on the inventory buys. So that continues to be our focus here. We were less promotional in the first quarter. We plan to be less promotional in the balance of the year. To date, we're achieving our price objectives. Consumers not resisting the higher price at all given the strength and beauty of the product offering. What -- they had an update recently from our head merchant who said, some of the best-selling products we have are the highest ticket collections, which are the things parents would buy because their children are now traveling again, revisiting families going on, summer vacations. So we just have to be smart in terms of how we make those inventory commitments.

[Brian McNamara, analyst]

Great. And do you guys have an explicit expectation for births this year? I know a lot has been said. The estimates are kind of few and far between, but I'm curious, is that something that kind of drives how you look at particularly your baby apparel sales, and how you -- your expectations for that?

[Michael Casey, executive]

Yes. Thankfully, the trend there is positive. So we had some data we shared with you in February that we saw births start to increase in June than July then August continued to September. About 2 weeks ago, we got the data through the balance of the year. With every month, the births sequentially got better. I think in the fourth quarter, the births were up 6%. I don't know if coincidentally, our baby apparel sales in the first quarter were up 6%. So I don't know if there was a connection or not, but that's a reversal of what I would say has been a 14-year decline inverse in the United States. There was a peak number of beautiful babies born in 2007. 4.3 million children born in then with the Great Recession. Almost every year since the Great Recession began in 2008, there's been a decline in births. Again, the government poured $3 trillion into the economy a year ago, a good portion of that was focused on helping families with young children. There was a view of what would happen during the pandemic. Some of the hand-wringers said that there could be as much as 500,000 fewer births last year. First, we're actually up in 2021.

So the outlook for births is good. Hopefully, it's sustained. How do we model that? We really don't. We focus on the strength of our product offerings, marketing strategies, strength of the relationships we have with the winning retailers, what we think is possible our direct-to-consumer business, but that's a very positive reversal of what had been a 14-year decline in births in the United States. So we're encouraged by it.

[Operator]

We have a question from Ike Boruchow with Wells Fargo.

[Irwin Boruchow, analyst]

Could you guys help us have a little bit more on the Easter shift. I think historically, it's been around a high single-digit percent of revenue impact quarter-to-quarter. Is that similar to what's happening this year, Q1 to Q2?

[Richard Westenberger, executive]

Yes. We modeled at about $10 million in our retail business.

[Irwin Boruchow, analyst]

Got it. So I guess what my question is, is based on the quarter-to-date guide, I guess down one to get to the up low single, it just seems like you're baking in a pretty meaningful acceleration in May and June because shift adjusted, the comps are more like down 10. So I guess I'm just trying to -- is it just warmer weather? Is there something else that gives you the confidence that you're going to see that kind of meaningful acceleration in the back half of the quarter? I'm just trying to piece together what's going on right now and what your expectation is for the remainder of 2Q in retail.

[Richard Westenberger, executive]

Yes, we're trying to read the business, obviously, every day, as I commented before. I think we have not seen that weather pop, number one. Number two is, we try to read the stimulus from last year and how much that impacted our business in March and in April. And I think that there was clearly an impact comping up against that in March and probably, more than we may have anticipated in April. So between those 2 factors, we continue to monitor the business, and we're optimistic that we'll see the turn, but it's early. And we're planning low single-digit comps for the rest of the year and the rest of the quarter, and we'll see how that materializes. The other point is, where the weather has turned, which is not many places, by the way. We have seen good business. We've had significant improvement, particularly some factors in the South and the West have really gotten materially better.

[Irwin Boruchow, analyst]

Understood. And maybe, Richard, on the cash flow guidance, you took it down $50 million. I'm just curious if everything else is maintained on the P&L in terms of EBIT and sales and everything. So what drives the $50 million reduction in operating cash flow versus 3 months ago?

[Richard Westenberger, executive]

I think on balance, it's just being a bit more conservative on the inventory. As we've commented, we're bringing in inventory in advance of good planned demand and also trying to mitigate some of these transportation delays. So my guess is, we will be a little heavier on year-end inventory than we had expected to be in our first forecast. And I think that will be a good thing because we'll have the inventory on hand to do the business that we're planning on doing.

[Operator]

Our final question comes from Tom Nikic with Wedbush Securities.

[Unknown Analyst]

[indiscernible] here on for Tom. Just a quick one. I know you guys said you had freight rates locked in through first half of '23. I know we're a long way out, but we don't see spot rates start to recede. Should we assume that we'll see more increases in freight costs late next year as your contracts were low?

[Michael Casey, executive]

Time will tell. I don't think we have a crystal ball takes us into the second half of next year. Time will tell. What we've been told by some of our largest freight carriers is, they expect as capacity comes on board, things will start to moderate. And so we're just in a point right now where demand continues to exceed supply. So it's driven the rates up. We feel good about the rates that we've locked in into albeit higher. We've negotiated at least with one of the major carriers. If the rates drop, we have the flexibility. We have an effect of variable to the good side if the rates drop. We will benefit from lower rates than we've locked into right now. So our best outlook is through the first half of next year with some indication from the people we've been negotiating with that they expect because they're the experts in this that they would expect that rates have the potential to moderate starting in the second half of next year, but time will tell.

[Operator]

And that's all the time we have for questions. I'd like to turn the call back to Mr. Mike Casey for closing remarks.

[Michael Casey, executive]

Thank you. Thanks very much. Thank you all for joining us on the call today. Look forward to updating you again on our progress in July. Goodbye, everybody.

[Operator]

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