Carter's Inc

NYSE:CRI

Earnings Call Transcript 2019-Q2

[Operator]

Welcome to Carter's Second Quarter 2019 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; Sean McHugh, Vice President and Treasurer.

After today’s prepared remarks, we will take questions as time allows. Carter's issued its second quarter 2019 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 companies presentation materials about the company's outlook, plans and future performance are forward-looking statements. Actual results may differ materially from those projected.

For a discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the company's most recent Annual Report 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 those non-GAAP financial measurements to the GAAP financial measurements is provided in the company's earnings release and presentation materials. Also, today's call is being recorded.

And now I would like to turn the call over to Mr. Casey. Please go ahead, sir.

[Michael Casey, Chairman & Chief Executive Officer]

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.

We exceeded the sales and earnings goals that we shared with you on our last call. Our growth in the quarter was driven by our Retail and Wholesale segments. International sales were a bit lower than last year and reflected change in our model for China. Our profitability in the second quarter reflects the strength of our product offerings, better price realization and good control over spending.

The second quarter got off to a good start. We had the combined benefits of a late Easter holiday and transition to more spring-like weather in many parts of the country. We saw mid double-digit growth in sales in April with comparable retail sales up 17%. As we expected May was a tougher comparison to last year and we had good sales growth in June, the largest month of the quarter driven by comp store sales and the launch of our summer product offerings. July also got off to a good start with strong demand over the 4th of July holiday.

In our Retail segment comparable sales growth in the second quarter was at the high end of our 3% to 4% forecast and reflects good demand for our new product launches including Little Baby Basics, the core component of our Carter's brand providing the everyday essentials for families with newborn children.

The level of promotions in the quarter were bit higher than last year which we expected given the shift in the Easter holiday. We continue to see the strongest comparable sales growth in our co-branded source and mall-based stores. Given this positive multiyear trend in performance, we plan to continue improving the mix of our store locations by opening co-branded stores in more densely populated markets, enclosing underperforming stand-alone outlet stores as leases expire.

As we shared with you earlier this year we saw a nice lift in the sales in our outlet stores co-located with Gymboree during their store closure sales. We are now seeing a lift in our non-outlet store sales in centers where Gymboree has closed. Historically, the largest component of Gymboree's product offering was in the Toddler age segment.

Carter's has the largest share of the $5 billion toddler apparel market with 13% share twice the share of our nearest competitor. Given our strength in this portion of the market, we believe we are well-positioned to capture a meaningful share of the former Gymboree store sales.

As we shared with you earlier this year, we believe the Gymboree closures provide a new $100 million growth opportunity for us. To pursue that opportunity beginning this year, we plan to open 100 co-branded stores in mall locations over the next five years.

Children's apparel is a traffic driver to malls and we plan to very selectively pursue that better mall store opportunities. This plan reflects our multiyear evolution away from declining outlet centers in order to improve the convenience of shopping for the two best-known brands in young children's apparel.

We saw a good growth in our e-commerce sales in the quarter driven by demand from U.S. consumers. That growth was partially offset by lower demand from international consumers shopping on our U.S. website.

We believe the stronger dollar has weighed on international demand for our brands both in tourist store locations and online. Based on forecast of exchange rates for the second half we are expecting a stabilization in demand from international guests and double-digit growth in our e-commerce sales in the balance of the year.

In recent years, we've made significant investments in technology, which have among other things enabled us to offer free shipping every day on e-commerce purchases. After extensive testing last year, we recently launched a new service, which offers same-day pickup for e-commerce orders.

Within a couple of hours after e-commerce order, we can now text our customers to let them know their purchase is available for pickup in our store located close to their home. Many of those customers picking up their online order made an additional purchase during their visit. The response to this new service has been very positive with sales trending better than planned.

Other investments in recent years have enabled us to make the full scope of our online product offering available to customers shopping at our stores. If for some reason a store is temporarily out of stock, we can meet the consumer's needs, complete the transaction in our store and then ship the product directly to their home for free. We have the largest chain of specialty stores focused on young children's apparel in the United States from Maine to Hawaii.

To meet the increasing expectations for free shipping and fast delivery of e-commerce orders, we plan to launch a new capability in the second half this year, which will enable our stores to fulfill the e-commerce orders. Collectively, we expect these new omni-channel capabilities will improve the convenience of shopping with us, drive more traffic to our stores and improve the speed and lower this cost to serve our e-commerce customers.

To further improve the experience shopping with us in the second quarter, we launched a private label credit card to provide our customers with an enhanced loyalty program. Over the past year, we evaluated the potential benefits related to a credit card program and determined that it may deepen the connection with our customers, increase the frequency of visits and increase the lifetime value of the relationship.

Among other things our credit card customers will receive free shipping on all card purchases, double points to earn rewards faster and advance notice of sales events. The early response from this June launch is encouraging. And as the benefits from this new service become more meaningful, we will highlight its impact on our performance.

With respect to our Wholesale business, we had good growth in sales and profitability in the second quarter. We continue to see an acceleration in demand for our exclusive brands with Target, Walmart and Amazon. Over the past year, we've worked with Target on a plan to strengthen the market presence of our flagship OshKosh B'gosh brand in Target stores and target.com two of mom's favorite places to shop for young children's apparel.

In April, we launched our OshKosh B'gosh brand with Target in over 600 doors. Selling to-date is exceeding expectations. We're planning expansion with Target to over 1,000 doors beginning in spring 2020.

For generations our brands have been known for their strong value proposition great quality at a great price. Wherever you're shopping for young children's apparel, you'll likely see a strong presentation of our brands. We consider ourselves fortunate to have deep and enduring relationships with the best retailers of young children's apparel in the United States.

With their support our distribution in over 17,000 retail store locations has enabled us to extend the reach of our brands to more families than any other company in the young children's apparel. Among others, we believe Kohl's has done an exceptionally good job presenting the very best of our Carter's brand across our baby sleepwear and playwear product categories with a strong brand presentation heading into the back-to-school season.

Carter's is the best-selling young children's apparel brand in the related $5 billion e-commerce market. Together with our wholesale customers, we expect to exceed $1 billion in online consumer purchases of our brands next year. In our International business, sales were a bit lower in the quarter due to the change in our business model for China.

Our new licensing partner has assumed full responsibility for our previous relationship with Tmall. This new model has enabled us to de-risk our entry into this important market with a partner who has demonstrated expertise, building a successful retail business focused on children's apparel in China. As this new business model evolves, we'll share more of their progress with you.

Canada is the largest component of our International business. Its second quarter sales are comparable to last year. We had good growth online and slightly negative store comps attributed to persistent cold weather. Its product offering in the second quarter was geared to more spring like weather, which arrived later than expected. We had good sales growth in Mexico. We plan to replicate in Mexico the successful multichannel model we've built in the United States and Canada.

In the second half this year, we plan to open four co-branded stores in Mexico modeled after our best-performing U.S. store model. We also plan to launch e-commerce capabilities in Mexico by the end of the year. From our perspective the e-commerce market in Mexico was several years behind relative to the United States in terms of broad use for children's apparel purchases.

With a relatively small investment we can begin to connect with more consumers online and build a good database of customers in Mexico. We also had good growth with our International wholesale partners in the second quarter. These are good retailers including Walmart, Costco and now Amazon doing a beautiful job presenting our brands to families of young children in over 90 countries.

With respect to our supply chain performance our sourcing team has helped us mitigate the potential impact of List four tariffs. Our unmitigated exposure to those tariffs was estimated to be about $100 million on an annual basis. Since, our last call with you we have accelerated the receipt of products from China to the United States. We have reduced the mix of China sourced products from 26% last year to less than 20% this year developed a plan to further reduce our production in China, if needed and negotiated price concessions expected from our suppliers if List four tariffs are imposed.

Given to the effect of these efforts has meaningfully reduced our exposure to additional tariffs on China imports and reduced the level of price increases that would be needed to fully absorb higher product costs. It is clear to us that the threat of tariffs has weighed on our suppliers who have done an exceptionally good job for us over the past 20 years. The silver lining in this threatened disruption may be more abundant capacity in China at our cost objectives than would have otherwise been possible.

Since our last call with you we have negotiated lower product costs for spring 2020. Cotton and oil prices are lower than last year and labor costs are higher. But in our experience manufacturing capacity is the more significant driver of our product costs and the market's reaction to tariffs on China imports has enabled a more favorable outlook for product costs in 2020.

The tariff exposure is a fluid situation, but we believe we are well prepared to respond and mitigate the impact on our business if additional tariffs are imposed. Given our first half performance and plans for the second half we are reaffirming our previous outlook for sales and earnings growth this year. We expect low single-digit growth in each of our Retail, Wholesale and International segments in the second half.

Our Retail business is expected to benefit from a higher mix of co-branded stores including 15 new mall stores to capture former Gymboree store sales. And we will have fewer underperforming stores which were closed over the past year. We are meaningfully improving our websites this summer enhancing the presentation of our product offerings, search capabilities and checkout experience.

We also expect to benefit from our new omni-channel capabilities and an easier comparison this year to Labor Day holiday sales last year. In Wholesale, we expect to see continued momentum in our exclusive brand sales including greater demand for our toddler age product offerings. And in our International business we're forecasting better trends in Canada based on improvements in its product offering and continued progress in Mexico.

In the second half, earnings are forecasted to grow at a rate faster than sales given the strength of our fall in holiday product offerings, a good inventory position, progress with our pricing initiatives and continued control over discretionary spending. We are also forecasting better earnings contribution for Amazon, Skip Hop, Mexico and China in the second half.

As we've seen over the years, our business model has shifted more to direct to consumer and as a result our growth is more weighted to the fourth quarter. Over the past three years, we've managed to grow sales by 5% or more in the largest quarter of our year and we believe we have the ability and resources to enable that level of performance again this year.

I would like to thank our employees throughout the company who helped us achieve our forecasts in the first half. With their support, we expect 2019 will be another record year of sales and profitability.

Richard will now walk you through the presentation on our website.

[Richard Westenberger]

Thank you, Mike. Good morning everyone. I'll begin on page 2 with our GAAP income statement for the second quarter. Our reported results in the second quarter and first half included some unusual items, which are detailed in our press release today.

This morning we will mostly speak to our results on an adjusted basis, which excludes these unusual items for greater comparability. Today's presentation and earnings release provide reconciliations of our GAAP basis results to the adjusted basis of presentation. Please review this information as you evaluate our results.

Moving to page 4 with some highlights for the second quarter. Consolidated net sales grew over 5% year-over-year driven by good growth in our U.S. Retail and U.S. Wholesale businesses. U.S. Retail comparable sales were strong with growth of nearly 4%. Profitability increased nicely in the quarter with adjusted operating income up 12% and adjusted earnings per share up over 20%.

Turning to our adjusted P&L for the second quarter on page 5. Net sales were $734 million, up nearly 5.5% versus last year. Foreign currency exchange rate movements were a modest headwind in the quarter reducing our net sales by approximately $2 million. Our U.S. Retail and U.S. Wholesale segments both recorded solid top line growth. International segment sales declined modestly in part due to currency movements.

I'll cover our individual segment results in more detail in a moment. Gross margin was 44%, down about 50 basis points compared to last year. Gross margin benefited from lower inventory provisions than last year, but was pressured because of our pricing actions in total did not fully cover the impact of higher product costs in the quarter. Gross margin also declined due to changes in customer mix within U.S. Wholesale and higher shipping costs within the e-commerce channel.

Adjusted SG&A grew 2% achieving 120 basis points in leverage over last year. Expenses were well controlled during the quarter. We also had some favorable timing in SG&A as some planned second quarter spending is now expected to take place later in the year. Our adjusted operating income grew 12% with a 50 basis point expansion in adjusted operating margin.

Below the line, second quarter net interest and other expense was comparable to last year at $9 million. Lower foreign currency losses offset higher interest expense related to higher market interest rates and the refinancing of our senior notes. Our second quarter effective tax rate decreased to 21.1% compared to 22.8% last year, principally a result of recent clarifications of certain aspects of the 2017 tax reform legislation.

For the full-year, we're expecting our effective tax rate to be largely comparable to 2018 at approximately 21%. Our average share count declined 4% compared to last year, reflecting the benefit of our use of capital for share repurchases. So on the bottom line, second quarter adjusted EPS was $0.95, up 21% compared to $0.79 last year.

Page 6 summarizes our first half adjusted results. This year's first half net sales grew 2% and adjusted EPS declined approximately 3%. Changes in customer mix within U.S. Wholesale and higher e-commerce shipping costs reduced gross margin in the first half of the year. Spending in the first half was very well controlled and was comparable in total to last year.

Turning to page 7, with a recap of our balance sheet and cash flow. Our balance sheet and liquidity continue to be strong. At the end of the second quarter, our cash on hand and available capacity under our credit facility totaled approximately $750 million. Net inventories at the end of the second quarter grew 5% compared to last year, consistent with our prior forecast.

We ended the quarter with a meaningful improvement in our excess inventory position versus last year. A year ago, we were working with higher levels of excess inventory, in part due to the unplanned liquidation of Babies"R"Us. We are forecasting mid-single-digit increases in net inventories for each of the remaining quarters in 2019.

Operating cash flow in the first half was $104 million, roughly comparable to last year. For fiscal 2019, we're forecasting strong operating cash flow in the range of $375 million to $400 million. Capital expenditures in the first half were $25 million, most of the spending related to investments in new and remodeled stores and information technology initiatives.

We're forecasting another good year of investment in the business, with full year CapEx forecasted around $80 million, up about $20 million over last year. The increase relates to investments in retail stores, retail technology, including refreshing our e-commerce website and experience and other enterprise technology initiatives.

In the first half, we returned a total of $138 million to shareholders, comprised of $92 million in share repurchases and $45 million in dividends. Since 2007, we've returned nearly $2 billion to our shareholders.

Now turning to page 9 with an overview of our business segment results in the second quarter. Our consolidated adjusted operating margin was 8.7%, up 50 basis points over last year. Each of our business segments achieved improved margins in the second quarter. I'll provide some additional detail on our second quarter segment results in a moment. We've included our business segment results for the first half for your reference on page 10.

Turning to second quarter results for the U.S. Retail business on page 11. Total U.S. Retail segment sales grew over 5% in the second quarter. Total comparable sales grew 3.8%. We estimate that the Easter calendar shift benefited Q2 comps by approximately 2 points. Normalizing for the shift in Easter, the comps in the combined March-April time period were up about 5%.

We continue to make progress in optimizing our store portfolio. In the first half, we opened nine new stores and closed 20, ending the quarter with 833 stores in the United States. For the full year, we plan to open approximately 45 new stores. We will likely close a handful of additional stores this year beyond the 20, which we disclosed in the first half.

Consistent with our recent experience, co-branded and mall stores were our best-performing store types in second quarter with both comping meaningfully better than the chain average. We also continued to make good progress with our initiatives to enhance our customer's experience when shopping with us, and to improve our omni-channel capabilities.

Our buy online pickup in store capability, which provides our customers with same-day in-store fulfillment of their online orders is now available nationwide. Customer response to this service has been good, with adoption rates running ahead of our forecast.

Lastly, later this year we will pilot the fulfillment of online orders directly from our retail stores. Our objective is to shorten delivery times for e-commerce customers furthest away from our distribution center here in Georgia, better leverage our inventory and increase store productivity.

U.S. Retail segment margin was 11.9% in the second quarter, an improvement of 60 basis points over last year. This performance reflects the strong second quarter sales growth and also expense leverage. For full year 2019, we're planning U.S. Retail segment net sales to grow in the low single digits along with operating margin expansion.

On page 12, we've included a photo of a new co-branded mall store, which we opened in May in the Houston Galleria. This 3,000-square foot store is a former OshKosh store. Performance to-date has been very strong. Just outside the Galleria, we happen to have an existing Carter's store. So far we've not seen cannibalization of this location from the new store inside the mall. We're encouraged by this as we evaluate opening additional mall stores.

On page 13, we've included a picture of a new presentation of our core baby product in our retail stores in the U.S. This new baby experience, as we're calling it, was created in support of this year's Little Baby Basics assortment launch and is intended to showcase the beauty of our baby apparel, while bringing together related essentials and gifting items such as plush toys and blankets.

We've seen a nice lift in the performance of baby apparel and these related accessories, since this new presentation was rolled out. We believe this new presentation strengthens our position in the baby category as the clear market leader, with our market share of 24% which is nearly 5 times that of our nearest competitors.

On page 14 we've summarized some details of our new private label credit card which Mike has discussed. We're excited about the potential of this new program. And look forward to sharing more about it with you over time.

On page 15, our brands particularly Carter's continue to lead the way in customer engagement on key social media sites such as, Facebook and Instagram. Our marketing and merchandising teams collaborate extraordinarily well and presenting our products and engaging with consumers across social media.

Getting closer to the back-to-school shopping season and on pages 16 through 19, we've included some of our back-to-school marketing for Carter's and Oshkosh. Pages 16 and 17 showcase Carter's toddler product, a category where we have the leading market share and Carter's big kid product which we successfully introduced a year ago.

Pages 18 and 19 are all about Oshkosh highlighting the iconic denim heritage of this brand. As well as new product offerings which serve families who are looking to meet school uniform and dress code requirements.

The Skip Hop brand is also focused on having a strong back-to-school season. Page 20, features our successful Zoo character products for kids, including character backpacks and corresponding mealtime products.

Turning to page 21, with results for our U.S. Wholesale business in the second quarter, we had a very strong quarter in U.S. Wholesale with sales up 9% over the last year. In the quarter we saw a strong demand and over-the-counter performance for spring and summer seasonal products.

Continuing the trend from the first quarter we experienced strong demand in the second quarter for our exclusive brands, available at Target, Walmart and on Amazon. Segment operating profit grew 16% to $35 million compared to $30 million last year.

Segment operating margin improved by 90 basis points to 15.4%. This margin performance reflects lower inventory provisions, marketing spend and bad debt expense. These benefits were somewhat offset by changes in customer mix and lower royalty income.

We continue to focus on several key areas to drive the performance of our U.S. Wholesale business, including improving in store presentation of our brands, supporting our customer's e-commerce growth and growing the penetration of our older age assortments with these retailers.

For full year 2019, we expect low single digit top line growth in our U.S. Wholesale business with earnings roughly comparable to last year, at an operating margin of approximately 20%.

Page 22, shows one of our new Carter's shops at Kohl's. This is a good example to our commitment to invest in brand presentation with our wholesale partners. This picturing and brand imagery is designed to drive higher productivity and to highlight the strength and beauty of the Carter's brand.

Results to date have been very positive. And we're planning to roll out additional Carter's shops at Kohl's in the third quarter. Turning to page 23, as Mike mentioned, our recent induction of the Oshkosh brand at Target.

We're encouraged by the early results of this initiative. And believe will be another good opportunity for us to grow our business in the toddler space. And will be an element of capturing the former Gymboree store sales opportunity.

Moving to page 24, an International segment results for the second quarter, international segment net sales declined 3% on a reported basis and were roughly comparable on a constant currency basis.

In Canada, total retail comp sales increased 1%. But overall retail sales were below our expectations. E-commerce demand in Canada was strong with online sales growing over 20%.

Store comps declined, reflecting lower store traffic which we believe was influenced by the persistent cold weather in this market. Our business in Mexico continues to perform well. Second quarter net sales grew over 30%. It was very good performance in both the Wholesale and Retail channels.

As Mike said, we're just about to open up our first larger co-branded store in Mexico, replicating our store model which has proven so successful in the U.S. and Canada. International segment adjusted operating income was comparable to last year at $4 million.

Segment operating margin improved by 10 basis points to 5.2% reflecting, the absence of losses in China offset by a lower contribution from Canada. For full year 2019, we expect net sales, in our International segment will be comparable to last year with improved profitability.

Pages 25 through 27 highlight our expanding global footprint with our International partners. This component of our International business is comprised of approximately 40 partners operating in over 90 countries.

These international partner relationships are important to us, as they help us to profitably meet consumer demand for our brands in markets beyond North America. The photos on these pages show the first ever Carter's store locations in India, Argentina and Russia.

Selectively, our international partners currently operate over 800 retail locations around the world. Our brands are also available in over 1,000 additional Walmart and Costco retail store locations outside of the United States.

Moving now to our outlook for the balance of the year beginning on page 29, we're focused on delivering a strong second half with good growth in both net sales and earnings. We've summarized here some of those factors, which we believe will drive our performance in the second half, it's a long and meaningful list, which we believe supports our plan to build on the strong second halves and fourth quarters in particular that we've delivered over the past few years.

In terms of our specific plans for Q3 and full year on page 30, for the third quarter we expect net sales to increase approximately 1%, we're forecasting low single digit comps in our U.S. retail business and comparable sales in our international business.

Sales in our U.S. wholesale business are planned down in the low single digits, largely due to the timing of shipments. We're planning very good U.S. wholesale sales growth in the fourth quarter. We expect third quarter adjusted earnings per share to increase approximately 3% to 4%, compared to adjusted EPS of $1.61 last year. This outlook reflects gross margin expansion and modest growth in SG&A over last year.

For full year 2019, today we're reaffirming our previous guidance. We expect net sales growth of approximately 1% to 2% and adjusted earnings per share growth of approximately 4% to 6%. And we're expecting another good year of cash flow generation.

Risks we're monitoring include the success of our marketing and pricing strategies, the level of international consumer demand in our U.S. retail businesses, the performance of our wholesale customers and the status of trade negotiations between the United States and China.

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

[Operator]

Thank you. [Operator Instructions] Our first question comes from Heather Balsky with Bank of America.

[Heather Balsky, Bank of America]

I guess to start, I was hoping if you just talk about the promotional environment right now, especially now that you're past the Gymboree closures and liquidations and how your competition, do you see more rational players I guess in this environment? Thank you.

[Michael Casey, Chairman & Chief Executive Officer]

I'd say the promotions in the second quarter were generally in line with what we had expected. Easter came later this year and so the promotions are typically higher when you're in a holiday event. I'd say May promotions were a bit higher, because May generally was a tough month for many retailers, a bit of a post-holiday lull and I think cooler weather returned in May.

June for us was particularly good. Promotions for us in June were lower year-over-year, lower than the previous two months. And in the second half we expect our promotions will be comparable year-over-year. Still a lot of noise in the markets, but I would say inventories -- the promotions are largely a function of the quality of the inventory. Our inventories are in good shape. So we feel good heading into the second half of the year and we're expecting a level of promotions comparable year-over-year.

[Heather Balsky, Bank of America]

And just a follow-up in terms of I guess your wholesale partners. How do you feel about the health of that inventory right now?

[Michael Casey, Chairman & Chief Executive Officer]

Very good. It's very good. We're in good shape.

[Heather Balsky, Bank of America]

Okay. And one last follow-up, which is the SG&A shift, could you help quantify that?

[Richard Westenberger]

Sure. It was probably around $4 million or $5 million, we believe it will shift into the second half from second quarter.

[Heather Balsky, Bank of America]

Great. Thank you very much.

[Michael Casey, Chairman & Chief Executive Officer]

You're welcome.

[Operator]

Thank you. Our next question comes from Paul Lejuez with Citi.

[Paul Lejuez, Citi]

Hey guys. Curious if you can maybe quantify a little bit more the process changes that you saw by channel both retail and wholesale? And specifically, I'm wondering if you could talk about gross margin on a year-over-year basis by channel, retail versus retail, wholesale versus wholesale, curious about the -- what's going on behind the scenes on the gross margin line? Thanks.

[Richard Westenberger]

So I don't know that I'll speak to it by business. Consolidated as we mentioned, it was down about 50 basis points there were a number of drivers to that. We continue to have an ongoing mix shift within the U.S. wholesale business that is in part due to just the strong demand we're seeing from the exclusive brands, which and collectively are a lower gross margin business. It's a terrific operating margin business for us, but it's a bit lower on the gross margin front. We had very good wholesale growth as we said 9% in the quarter.

Retail margins also were strong. We continue to see growth coming from e-commerce, which is a very gross margin business for us. Probably had a bit more off-price channel activity in the second quarter than we've had year-to-date. That's more an issue of the timing of when that product gets liquidated in the market.

I'd say the outlook for gross margin is good. We are planning for gross margin expansion in the second half. There's a number of things driving that. Mike went through a number of the second half drivers. We think our inventory position is very great shape. We bought inventory in the retail channel more conservatively to the second half. I think that will be important for us. We do think in the wholesale channel that will be less of that off-price channel, our clearance activity than we had a year ago. So, I think the outlook is good and we're planning for consolidated gross margin expansion in the second half.

[Paul Lejuez, Citi]

Got you. And then you mentioned, I think both prices as you look out to spring of 2020. Any way you can quantify that for us?

[Michael Casey, Chairman & Chief Executive Officer]

Lower product cost. And low single-digit product cost decrease is expected for spring 2020.

[Paul Lejuez, Citi]

That side you see as down low singles?

[Michael Casey, Chairman & Chief Executive Officer]

Correct.

[Paul Lejuez, Citi]

Got you. Thank you. Good luck, guys.

[Michael Casey, Chairman & Chief Executive Officer]

Thanks very much.

[Operator]

Our next question comes from Susan Anderson with B. Riley FBR.

[Susan Anderson, B. Riley FBR]

Hi. Good morning. Nice job on the quarter. I was wondering if you - so I think you said that pricing had rolled out in second quarter, I think it should be fully in place in third quarter. So, I'm assuming a better benefit on gross margin. Maybe if you could give your thoughts around that. And then, I think you said July is off to a good start. Did you say what your stores are comping quarter to date?

[Brian Lynch, President]

Two questions. On the pricing, yes. I think what we commented as we had -- we took some pricing action in the first half. We did not totally cover the cost increases, we had our realized pricing. The pricing actions are -- were more strategic in the second half more fulsome, and we expect those to more than cover the cost increases in the second half. We feel good about that.

[Michael Casey, Chairman & Chief Executive Officer]

And the comps -- third quarter date. The third quarter got off to a very strong start. We had high single-digit comps over the 4th of July holiday, and typically as you see a post-holiday lull that together with the heat-wave in important markets in recent weeks, we've given some of that back. But we're currently running positive comps for the third quarter.

[Susan Anderson, B. Riley FBR]

Great. That's helpful. And then I guess another question on the Wholesale in second quarter, the upside there. I guess how much of that was due to the greater replenishment versus the timing shift? And then, I guess as we look out to third quarter and because of the timing, the negative growth there. I guess I was trying to factor in, you guys should be getting a benefit just from the Toys "R" Us pressure being gone. So I guess how much of a benefit should you get to offset that? Thanks.

[Brian Lynch, President]

I'll speak high level. I think we feel good about the Wholesale business. We're up low single-digits in the first half. We expect to be the same in second half. I would say the retailers have been playing their business more conservatively, particularly in the Carter's brand. Our replenishment businesses have been very strong. So we talked about the three exclusive brands that business has been surging.

Our business with Amazon is growing very rapidly. Simple Joy sales are really strong. We had really good Prime Day success, 3 times the sales of last year on Prime Day. And all of our brands were up meaningfully. And I think it's noteworthy that most accounts and our own Retail business also saw demand surge during Prime Day. So, we're optimistic about the business, but I would say the upfront bookings have been more conservative and the businesses has been driven by our replenishment businesses in exclusive brands and with our Little Baby Basics business and with our Skip Hop business going forward.

[Susan Anderson, B. Riley FBR]

Great. That’s very helpful. Thanks so much. Good luck next quarter.

[Brian Lynch, President]

Thank you.

[Operator]

Our next question comes from Ike Boruchow with Wells Fargo.

[Ike Boruchow, Wells Fargo]

Congrats on a good quarter. Just on sales, can you guys kind of discuss what you're expecting the rest of the third quarter? Obviously sounds like, July is off to a good start, but as we get into the back half, I think we're lapping a down 20% Labor Day week-end. And then on Wholesale, can you just quantify the timing shift impacting 3Q? And I have a quick follow-up on margins.

[Richard Westenberger]

Well, we're forecasting, as we said, Wholesale sales in Q3 down low single-digit. We're forecasting Retail growth up low single-digit and comparable sales in International. I'd say most of the timing shift as it relates in Q3 relates to that off-price channel activity that normalizes a bit as we move through the second half. So, very good growth planned in the fourth quarter and that's what we're focused on delivering right now.

[Ike Boruchow, Wells Fargo]

Okay. And then on margins, can you go into more detail on the cadence of gross margins off the back half? Should we be expecting similar levels of improvement in each quarter? And then, what the $4 million to $5 million SG&A shift into 3Q? Is that on marketing or what line item is that on for SG&A?

[Richard Westenberger]

On SG&A, I'd say, it's a few items. Certainly, marketing we felt like it was an opportunity to move some of that spend into the second half. Other areas would be just some deferred hiring some technology projects which are shifting more from original planning in the first half now those will take place in the second half.

In terms of gross margin, we are planning gross margin expansion in both Q3 and Q4 and I'd say it's roughly comparable in terms of basis points year-over-year.

[Ike Boruchow, Wells Fargo]

Okay, that's helpful. Thanks guys.

[Operator]

Our next question comes from Omar Saad from Evercore ISI.

[Omar Saad, Evercore ISI]

Thank you. Thanks for taking the question. Mike a couple of questions I wanted to get you to dive in a little bit deeper. Number one on real estate. Maybe you could expand upon the strategy. It sounds like you're closing outlets maybe deemphasizing that channel but also opening mall stores. What you're seeing in that channel especially post the Gymboree liquidation?

And then I also wanted to ask about the BOPUS initiative that you mentioned. Maybe talk about how many stores you've rolled it out in how long it's been? What you're seeing is it kind of universal across the board the adoption rate?

And then maybe if you have any thoughts on especially since you guys offer free shipping, why you think you're consumers are choosing to buy online and pickup in stores as opposed to get it in the mail? Thanks.

[Michael Casey, Chairman & Chief Executive Officer]

Yes. So, on the real estate strategy, again, this is probably a 20-year long strategy evolving out of the outlets. The outlet store is years ago like our history we're a wholesaler and like most wholesalers years ago, we had outlet stores. In those outlet stores, we used to refer to as ATM machines, highly profitable.

Then we -- knowing that only about 5% of kids apparel is bought in outlet stores, we started to open that same model in strip centers because strip centers felt more like outlets to us. And we've had very good success in the strip centers. And always stayed away from malls only because of the economics of the strip centers were more attractive. But the market has changed with people exiting the malls, new opportunities have arisen.

I think we shared with you earlier this year when Gymboree decided to close all their doors, our real estate team did a very good job evaluating 1,000 mall locations and they edited it out probably 90% of them for a variety of reasons either the economics weren't attractive or there was weak co-tenancy or the demographics were not attractive, meaning there weren't a lot of families with young children in the area of that mall. But they did identify some portion of about 100 mall centers that were worthy of consideration. So, we're leaning into it.

And it's largely because the economics are more attractive. The mall owners have reached out to us they see that children's apparel is a traffic driver to the centers. And so Richard showed you a beautiful picture of the Houston Galleria this morning just co-branding an existing store has given that store a meaningful lift without cannibalizing a store located just outside -- a Carter's store located just outside that Houston Galleria.

And so we probably open it up in 15 mall stores in the balance of this year. We already have about 50 mall stores today. They're our best-performing store actually better performing than our co-branded stores and strip centers.

So, we've got a little bit of visibility to what is possible. We'll open up 15 more if those 15 are good we'll continue to go down this path of opening up some portion of 100 stores.

And these stores do on average $1 million a year. So, that's a new $100 million opportunity in our Retail business that we did not envision did not plan on I would say earlier this year. But the Gymboree closures gave us a reason to think differently about the mall store opportunity. You open -- asked about BOPUS, Brian do you want to comment on that?

[Brian Lynch, President]

Yes. On the omni-channel initiatives we'll talk about BOPUS and same-day pickup. BOPUS has been popular. We've got about 13% of our online orders in the second quarter were shipped to our stores where the customer chose to swing by and pick those up.

I think she looks at that as another item of convenience when she's out running errands not unlike when she's doing target runs and other things. The good news is of those folks that picked up in the store about a quarter of those actually chose to purchase something else when they were in the store, so we think it's a win for the consumers and for us. That is chain-wide.

And then we also just rolled out same-day pickup and that was a nationwide rollout at the end of Q2. The customer response has been above the plan and really that's about speed. The order is available in as little as two hours to be picked up after she puts the order -- after she places the order online.

So, I think a number of different things some folks want it shipped to the house and some want it shipped to the store. We've still got two-thirds of our customers that shop only in stores. So, I think really the totality of the omni-channel initiatives within our retail experiences is what we expect to deliver good results going forward.

[Michael Casey, Chairman & Chief Executive Officer]

Yeah. Good question why opt to pick it up if you can just get it shipped to your home. People like -- people love our stores and they like the instant gratification. Within a couple of hours after ordering, you have the convenience of shopping at home. And then you also have the convenience if you could swing by within a couple of hours and pick up what you need. So, our stores are the best looking stores in children's apparel, so people like to go to those stores.

[Omar Saad, Evercore ISI]

Perfect. Thanks, Mike.

[Michael Casey, Chairman & Chief Executive Officer]

Thanks, Omar.

[Operator]

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

[Jim Chartier, Monness Crespi Hardt]

Good morning, guys. Thanks for taking my questions. So, first, I just wanted to kind of circle back to Labor Day last year. I think you said weather and kind of marketing were the two biggest impacts. So, on the weather front, anything you guys have done to the product assortment to make it more aware now to limit the impact?

And then on the marketing, have you done anything differently year-to-date that gives you confidence that the changes you'll make for Labor Day this year will work? Thanks.

[Michael Casey, Chairman & Chief Executive Officer]

Yeah. So, with respect to Labor Day, as I recall, we got clobbered over Labor Day last year. And Labor Day 2017 cool weather broke. So, we had an unusual surge in demand for our brands over Labor Day 2017. By comparison, weather was unusually warm over Labor Day 2018 and so our business was tougher. So that was the biggest weakness in our third quarter last year.

And it's hard to predict the weather, it's never ideal. But to your question there is -- our merchants, our designers have done a first-class job, making sure that our product offering is more responsive to weather patterns in that early fall period. So, we have many more wear-now choices, short pant, short sleeve and so highly responsive to what consumers are looking for earlier in the season.

Seasonal transitions are always difficult to forecast. But I think our teams have done a first-class job, making adjustments both the product offering and the marketing, so that we're expecting a meaningfully better Labor Day holiday season this year.

And I think we shared with you Labor Day for us is the second-largest holiday. Second only to the Christmas holiday. So, it's a meaningful -- by the time we update you again in October, we'll have a very good read on what kind of year 2019 is shaping up to be.

[Jim Chartier, Monness Crespi Hardt]

Okay. And then on the fulfilled by store, what percentage of e-comm sales do you expect will ultimately be fulfilled by stores? And then on the stores were -- they're shipping as time is the biggest driver. What's the current ship time on those orders? And then how -- what do you think you can reduce that to?

[Michael Casey, Chairman & Chief Executive Officer]

Yeah. So, the high view here with all these wonderful omni-channel capabilities that have been put in place, significant investments in technology. We're forecasting next year some portion of 30% of our e-commerce customers will be taken advantage of one of either buy online and shipment to store or buy online pick it up within a couple of hours, or the capability of what we call endless aisle. So that if you're in the store and you see something beautiful and we don't have the size you need, we'll ring you up in the store, we'll ship it to your home for free. And then new capability fulfilled from store. So we envision probably some portion of about 30% of our e-commerce orders will take advantage of those new capabilities.

[Jim Chartier, Monness Crespi Hardt]

Great. And then just the last question. You mentioned that your mall-based stores are the best-performing. Is that in terms of best comping stores or profitability as well? Thanks.

[Michael Casey, Chairman & Chief Executive Officer]

The comps, but the profits are rich as well. The four-wall contribution is not dissimilar from the other stores, but the comps have been the richest.

[Jim Chartier, Monness Crespi Hardt]

Great. Thank you and best of luck.

[Michael Casey, Chairman & Chief Executive Officer]

Thanks very much.

[Operator]

Our next question comes from Steve Marotta with C L King & Associates.

[Steve Marotta, C L King & Associates]

Good morning, everybody. Most of my questions have been asked and answered. Talk a little bit about that royalty income line and why it was down year-over-year? And when you think that the China business model will change, will begin to have a positive permanent impact on that line?

[Richard Westenberger]

On royalty income, it was down modestly, Steve, in the quarter, largely consistent with our forecast. A couple of things. We mentioned the introduction of Oshkosh at Target, that is replacing a legacy program with Target that was more of a royalty arrangement. We've also in-sourced some categories in the last year, so which are detrimental to the royalty income line, but they are accretive from a sales and margin point of view. I'd say those are the two biggest drivers.

[Michael Casey, Chairman & Chief Executive Officer]

Yeah. And on China, I don't -- we don't expect that the royalties from China will be meaningful over the next couple of few years. It's early days, time will tell. We're thrilled with the new partner. They are thrilled with the opportunity. They're doing a first-class job, stabilizing and improving the Tmall business. They just launched Carter's on vip.com. They're working with Costco. They're ready to launch the Carter's brand with Costco China next month.

They're pursuing opportunities with Walmart China as they're presenting our brands at a trade show to appeal to other wholesalers. And so the focus this year, I would say is on e-commerce and on wholesale. And then stores may come as early as next year. But it's early days. As it becomes more meaningful in terms of activity and contribution we'll share that with you.

[Steve Marotta, C L King & Associates]

Very helpful Thank you.

[Michael Casey, Chairman & Chief Executive Officer]

You’re welcome.

[Operator]

Our next question comes from Laurent Vasilescu with Macquarie Research.

[Laurent Vasilescu, Macquarie Research]

Good morning. Thanks for taking my question. Sorry to beat a dead horse here, but can you remind us how July, August and September performed last year so we can factor this in to our 3Q comp estimates? And then with July called out as a strong start with 4th of July and then some pullback or given back for the remainder. So we think that July was more like a mid single-digit comp?

[Michael Casey, Chairman & Chief Executive Officer]

Well, it's too early to say what July is going to be, but we're expecting a 2% to 3% comp for the quarter. And based on what we know today we'll -- we think that's possible.

[Brian Lynch, President]

And last year to answer your question we had a slightly negative comp in July we had a 1.9% in August and our comparable business in September. So we finished last year for the quarter at a 0.5% comp.

[Laurent Vasilescu, Macquarie Research]

Very helpful. Thank you very much for that. And then to follow-up on prior question can you parse out the dollar amount in the wholesale shift between quarters? And then great job on the exclusive initiative, can you remind us how much of your Wholesale business is tied to exclusives? Any percent contribution rate would be appreciated.

[Richard Westenberger]

We've -- we don't disclose the exclusive brands. We don't talk about individual customer relationships. So Laurent don't think we can help you with that. And in terms of quantifying further probably not appropriate given our segment disclosures.

[Laurent Vasilescu, Macquarie Research]

Okay. Fair enough. And then the one key presentation called out 45 store openings and with closure of 25 for 2019. Is that still the plan? And how should we think about the cadence between 3Q and 4Q?

[Richard Westenberger]

Yes. Roughly that is the plan for the full year. And most of the closures have taken place. Today they'll be a handful in the balance of the year. And as Mike said we're going to open about 15 of these new format mall stores in the second half.

[Laurent Vasilescu, Macquarie Research]

Okay. Very helpful. Thank you very much and best of luck.

[Richard Westenberger]

Thank you.

[Brian Lynch, President]

Thank you.

[Operator]

Our next question is from Jay Sole with UBS.

[Jay Sole, UBS]

Great. Thanks so much. You know, this question is on credit card program. Can you give us an idea just how fast you think you can ramp the credit card program up especially with the rewarding moments loyalty club members? And what impact it might have on sales and margin or reducing credit card fees?

[Brian Lynch, President]

Hey, Jay we're -- we just launched this thing. We've had a positive early response from our customers. We're really encouraged by the applications and the approvals and the spend for customer. And I would just say too early to put our numbers on it. Our goal over the next few years is to have a meaningful amount of our retail sales on the card. And it's a win for our customers because it's available credit for them. They get free shipping, loyalty points, special offers.

And of course it's a win for us because we got lower credit card fees what we hope to be incremental sales and really can establish a closer relationship with the customer. So we know that families come to us first when they have a baby, new families when they have that first child and we think that the Carter's card can really drive lifetime value for us with those consumers. So -- but too early to put a number on it. We think it's meaningful but it's very early days.

[Jay Sole, UBS]

Okay. I guess -- and then maybe on the OshKosh at Target. Can you just talk about when to sell in for that product began? Was that a 2Q event and then we'll see it ramp through 3Q and 4Q before we lap it next year or did it really start in 1Q?

[Michael Casey, Chairman & Chief Executive Officer]

It launched in April.

[Jay Sole, UBS]

It launched in April.

[Michael Casey, Chairman & Chief Executive Officer]

It launched in April to ramp up. So we launched with over 600 doors and expect to expand over 1000 doors for spring 2020.

[Jay Sole, UBS]

Got it. Okay. Thank you. And then my last question is you -- it's such a choppy year. You know, July four weekend very strong and then it slows down and I think the whole year has been like that. How are you benchmarking yourself versus other retailers of children's apparel because the whole environment has been choppy? Because we're talking about a 2% to 3% comp rate that's kind of been the growth rate. First half of the year was a little bit slower than that. How do you sort of tell in this environment how you're really performing and how you're market share is changing versus everybody else out there?

[Michael Casey, Chairman & Chief Executive Officer]

Well, the high view we're competing in a $27 billion market. That market's probably down some portion of $1 billion over the past year. So call that some portion of about 4%. And our business is growing. So, we -- there's no company that has a broader presence of children's apparel in the United States. So wherever you're shopping for kid's apparel, you'll likely see a very strong presentation of our brands. So we're uniquely positioned to capture the consumer wherever she is shopping. If she likes to shop in outlets, we're there whether we have the number one and number two market share for children's apparel in the outlets.

If you're shopping at Kohl's, Macy's, Walmart, Target, Costco, CMs, wherever you're shopping, you're going to see a nice presentation of our brand. So, I think that's why we've done so well. Over the years, there's been good economies, tough economies, there's been strong birthrates, weak birthrates, but this will be our 31st consecutive year of growth because, we're everywhere. We appeal to the masses from Macy's to Walmart and everywhere in between. So I think that's why we've done as well as we've done. Despite the market challenges, we have a way to manage and deliver growth.

[Jay Sole, UBS]

Got it. Okay. Thank you so much.

[Michael Casey, Chairman & Chief Executive Officer]

You’re welcome.

[Operator]

Our next question comes from Tiffany Kanaga with Deutsche Bank.

[Tiffany Kanaga, Deutsche Bank]

Hi, thanks so much for taking our questions. In launching the Oshkosh brand at Target, do you have a sense for the source of that floor space? Can you confirm? Is it as the category is growing and taking more space? Or are you rebalancing a bit versus your Carter's exclusive product? And also, how do you think about, it's positioning and price points versus CAT & JACK and versus Oshkosh in your own stores? Thanks.

[Brian Lynch, President]

Yes. I'll talk a little bit about Oshkosh. We're -- the Oshkosh brand overall, we do about $600 million in sales as a company and we're planning the sales and profits of year. So, we're happy to launch this in Target this April. We consider them one of the key apparel retailers in the United States. And as Mike said, we had strong selling in 600 doors and we're going to expand over 1000.

I would say overall, I don't know that I want to parse out Target's individual strategy. I will tell you in terms of our strategy with Target, we continue to have very strong business with all of our brands, with our Carter's branded Target, with Oshkosh selling is very good and also with our Skip Hop brand. So we are not necessarily losing space in the Carter's brands whatsoever or Skip Hop to support this launch. We feel good about our performance. We've met with the target teams recently and they've been very complimentary of the performance. They do a great job with their brands. They've launched several brands and a new one even in the last few weeks. They're some of the best retailers our there. They do an excellent job.

But I would say over the last few years, the way I would benchmark is our sales to Target continue to grow in an environment where they have put additional emphasis on their private brands and done a really good job of it we have grown as well. So, the rising tide has lifted all ships and we feel good about our business there. And we're excited about this new launch with Oshkosh.

[Tiffany Kanaga, Deutsche Bank]

All right. Thank you so much.

[Operator]

Our final question comes from John Morris with D.A. Davidson.

[John Morris, D.A. Davidson]

Congratulations on a great quarter let me add that. I want to check -- just check my thought process here directionally about the shift in the revenue growth which I guess looks like it's out of Q3 and into Q2, maybe about two point’s worth of revenue growth because of the timing of these shipments. Am I right in thinking that most of that is off-price? And am I right in thinking about that directionally or were there other shifts going on their on the revenue line? And then a couple of quick follow-ups.

[Richard Westenberger]

Yes. I would say within the Wholesale business they are always between quarter-end dates and that's why looking at the full year is probably the best benchmark that we can give you. And we're planning low single-digit growth in Wholesale. Revenues will be down slightly in that segment in Q3 and then they rebound pretty strongly in the fourth quarter, but for the full year, planning good solid low single-digit growth in that segment. That's how I would think about it.

Off-price is a component of that and fortunately this year, we're forecasting less off-price channel activity given our inventory position, given that we're comparing against the Toys "R" Us, Babies"R"Us liquidation a year ago and we're well past that. So that's how we think about it.

[John Morris, D.A. Davidson]

Okay. That's helpful. And then just to clarify earlier because on the SG&A shifting into the back half those additional expenses, is that going to be -- can you give us kind of a feel by quarter because I think implied by one of the earlier questions was that that $4 million to $5 million was going into Q3, but I don't think you guys had said that. I think you were saying it's going to fall into both quarters. Is that correct? And how should we think about that allocation?

[Richard Westenberger]

I would say it's going to fall into the second half. I don't think I'll parse it out between Q3 and Q4. We're planning for low single-digit SG&A growth in the second half and planning for some modest rate leverage as well. That's how we're thinking about the expense line.

[John Morris, D.A. Davidson]

All right. Thanks. Good luck for fall.

[Richard Westenberger]

Thank you, very much.

[Operator]

This concludes today's question-and-answer session. I will now turn the conference back over to Mr. Casey.

[Michael Casey, Chairman & Chief Executive Officer]

Okay. Thank you. Thank you all for joining us on the call. We look forward to updating you again on our progress in October. Goodbye.

[Operator]

Thank you everyone. This concludes today's teleconference. You may now disconnect.