Carter's Inc

NYSE:CRI

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen welcome to Carter's Second Quarter 2020 Earnings Conference Call. On the call today are Mr. Michael Casey, Chairman and Chief Executive Officer; Mr. Richard Westenberger, Executive Vice President and Chief Financial Officer; Mr. Brian Lynch, President; and Mr. Sean McHugh, Vice President and Treasurer. After today's prepared remarks, we will take questions as time allows. Carter has issued its second quarter 2020 earnings press release earlier this morning. A copy of the release and presentation materials 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 statements, please refer to the company's most recent annual and quarterly reports filed with the Securities and Exchange Commission and the presentation materials posted on the company's website. On this call, the company will reference to various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the company's earnings release and presentation materials. Also, today's call is being recorded. And now I'd like to turn the call over to Mr. Casey. Please begin sir.

[Michael Casey, Chairman and CEO]

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 would like to share some thoughts on our business with you. Our performance in the second quarter was meaningfully better than we expected. As you may recall for the safety of consumers and our employees we closed our stores in mid March and they remained closed for nearly 80% of the second quarter. Historically our stores have provided the largest source of revenue to our business and from a market perspective in the United States nearly 80% of children's apparel was purchased in stores last year, only 20% of children's apparel was bought online. Thankfully following our store closures in March we saw a surge in online demand for our brands. We also saw significant demand for our exclusive brands with Target, Walmart, and Amazon, and other essential retailers that were able to remain open.

In the second quarter we improved our marketing strategy which enabled better price realization and a higher gross profit margin. We reduced spending and inventories below prior year levels and significantly improved liquidity with a highly successful bond offering the day after our previous update with you in May. Though the pandemic has weighed on the growth we had planned this year, the impact to date has been far less than we expected. In terms of business trends we saw the largest drop in sales and earnings in April. We returned to profitability in May with sales about 80% of last year. In June our consolidated sales improved to about 90% of prior year sales and sales trends in July are consistent with June about 90% of last year.

By the end of June over 90% of our stores in the United States and Canada together with most of our wholesale customers stores had reopened. Assuming no meaningful disruption from the recent spike in confirmed cases of the corona virus we expect sales and earnings in the balance of the year will gradually continue to improve relative to our second quarter performance. That said our sales and earnings in the second half are not currently expected to achieve prior year levels. We'll share our thoughts on that outlook with you this morning.

From a product perspective in the second quarter online demand was robust across our baby, sleepwear, and playwear product offerings. Products for all age ranges from a newborn to a 10-year-old child did well online. We saw the strongest demand for our sleepwear product offerings with children staying home from school and distance learning. Skip Hop's home and play time product offerings also sold well in the quarter with family spending more time at home together. We delayed the launch of our little baby basics product offering typically timed for May until late June to support store reopenings. This is the core of our baby product offerings and the best-selling newborn apparel in the United States. That refreshed product offering is off to a good start.

In our playwear product offerings casual dressing far outperformed fancier outfits. Thankfully very high percentage of our product offerings is focused on casual dressing. We also saw good demand for our 4th of July product offerings. Consumers were clearly looking for reasons to celebrate that summer holiday. Not surprisingly, back-to-school outfitting is off to a very slow start due to the delay in school reopenings. With stores closed for most of the quarter, we had a digital first mindset which we believe made it easier for consumers to shop with us. Through our websites we highlighted tops, bottoms, and accessories designed to be purchased together, our made to match product offerings drove a disproportionately higher rate of sales and profitability. We also previewed beautifully designed facemasks for children. We marketed the facemasks as a preorder opportunity to our best customers and nearly sold out within the first week. Facemasks will continue to be a component of our product offerings for the foreseeable future.

Since our last update our merchandising, design, and sourcing teams have completed our Spring 2021 product offerings, which we will launch in the fourth quarter this year. Given travel restrictions, our sales team had its first virtual sell-in meeting with our wholesale customers using digital product images. Our wholesale customers and retail teams responded very positively to this new product offering. We will firm up the forecast for Spring 2021 later this year. Thankfully, given a more favorable environment for input costs and excess manufacturing capacity in Asia, we're forecasting lower product costs for Spring 2021.

In the first week of May, we began to reopen all of our stores in the United States. Our retail team did an excellent job preparing our stores for resumed operations, including bringing over 13,000 of our co-workers back to work. Though traffic to our stores has not yet returned to pre-COVID levels, those who were visiting our stores came to buy. We saw a significant increase in conversion rates, units purchased per transaction, and price realization driven by fewer and better promotions. Our marketing and retail teams focused on the benefits of enrolling in our rewarding moments and credit card programs. At the same time, they thoughtfully walked back less effective promotions, which enabled better margins on our second quarter sales.

With substantially all of our stores now open we are seeing a meaningful difference between our stores located in tourist locations and our other stores. Sales in our stores historically driven by tourists and international guests were down over 20% after reopening. By comparison in the post opening period, non-tourist store locations comped up 15% in the quarter. Last year our tourist orders represented about 10% of the store chain and contributed nearly 20% of our store sales. Given the resurgence of the corona virus especially in Florida, Texas, and California we expect demand from international guests and tourists will continue to be under pressure through the balance of this year. Thankfully, more than half of the lost sales in the second quarter due to store closures was offset by a significant increase in e-commerce sales. In the second quarter we saw triple-digit growth in online demand for our brands in 8 of the 13 week period. Profitability on e-commerce sales more than tripled in the second quarter with fewer promotions needed given the strong online demand for our brands and a good inventory position.

Historically, international demand on our U.S. websites had been robust. These international guests are big ticket buyers purchasing our high margin baby apparel. Online demand from domestic consumers increased over 120% in the quarter. By comparison, online demand from international guests dropped 4% and contributed only 11% of total online sales in the quarter, compared to 22% last year. The biggest decreases came from guests in Brazil and Argentina, two of our largest international markets which have been significantly affected by the corona virus and currency devaluation.

In recent years, we've invested in technology that enables our stores to fulfill online purchases. Increasingly, consumers prefer to pick up their online purchases in our stores. Many are now choosing our same day pickup service. As our stores reopened we saw a store fulfillment of our online purchases increase from 20% to 30% of our e-commerce transactions. The largest increase in our omni-channel sales came from shipping online purchases from our stores to the customer's home. These relatively new capabilities provide a better experience for consumers and are margin accretive relative to shipping from our distribution center to their homes. By the end of August, we expect over 70% of our stores will be able to fulfill e-commerce orders.

To better serve consumers during the pandemic we have also made curbside pickup available. To date nearly 50% of consumers picking up their orders at our stores have opted for curbside service, which is also margin accretive relative to shipping to the home. Our omni-channel customers, those who shop in stores and online, are our highest value customers spending nearly three times the amount of a single channel customer on an annual basis. Our speed of delivery of e-commerce orders from our distribution center, thankfully, has returned to normal generally within four to five days. Delivery speeds were slower than desired earlier in the quarter. Many online retailers had a similar experience. As online demand surged during the store closure period we carefully ramped up staffing in our distribution centers to ensure the safety of our employees. We're grateful for the dedication of all our distribution center co-workers, many of whom have been supporting holiday level demand for our brands since the end of March. They've also helped us ensure a safe work environment for thousands of our employees.

Given the continued acceleration in online demand for our brands, we have decided to exit more stores over the next five years. Prior to the COVID experience, we had planned to close more stores than we would open by 2024. In round numbers we plan to open about 100 co-branded stores in densely populated areas over the next five years that continues to be our plan. We had also previously planned to close 115 stores, mostly standalone brand stores and outlet stores in declining centers. Based on a re-evaluation of our store portfolio we now plan to close over 200 stores, or about 25% of our stores in the United States by 2024. Our average lease term is less than two and a half years, including early termination options. We plan to take advantage of those early kick out provisions and exit more stores as leases expire. Our focus is on fewer, better, and more profitable stores located closer to consumers that among other things, enable the same day pickup of online purchases.

In the next few years, we expect it will be a buyer's market for retail store locations and we plan to pursue those better market opportunities. As some of our competitors and wholesale customers closed stores, we believe we will see a transfer benefit from those stores closures as well as ours. We continue to see about 20% of sales from stores that we close transfer over to our other stores in adjacent markets. Those sales flow through at a very high margin given the fixed cost structure of our stores.

In the second quarter, we saw the second largest decrease in sales in our wholesale segment due to store closures and related order cancellations. E-commerce demand in wholesale was up over 100% to last year, each of our top four wholesale customers saw triple-digit growth in online demand for our brands. In the second quarter we were encouraged by certain retailers pulling forward orders previously placed on hold in March. For some of our largest customers we have been in a chase mode and where possible we're moving up the receipt of certain product offerings to service higher than planned demand. Collectively, we expect to see continued growth with our exclusive brands in the balance of the year. Our exclusive brands are now expected to grow to about 50% of our wholesale sales this year, up from 40% last year. Other retailers who suspended store operations in the second quarter are expected to curtail inventory commitments in the balance of the year.

We believe there's a higher risk of additional store closures due to the pandemic and shift to online demand. Anticipating those changes in demand, we reduced our planned inventory commitments for certain wholesale customers. With the largest planned decreases in our wholesale sales in the balance of the year with off price retailers. Historically, we've seen better price realization and profitability moving excess inventory through our own stores. Accordingly, we plan to temporarily keep open certain stores that were scheduled to close this year to drive inventories lower at better levels of profitability.

International sales contributed about 9% of our total sales in the second quarter, down from 11% last year largely due to store closures in Canada and Mexico. The e-commerce component of our international business tripled in the quarter and its growth covered about a third of the lost store sales. The wholesale component of our international sales was also lower. We're encouraged by the higher demand we're seeing from Walmart in Canada and from Amazon's launch of our Simple Joys brand in Europe. Many of our other wholesale relationships are with several smaller retailers representing our brands throughout the world. We expect sales to those retailers will be weighed down by the pandemic, stronger dollar, and other local market challenges in the balance of the year.

With respect to our supply chain we're seeing some delay in the receipt of product from Asia, like Carter’s our suppliers are focused on keeping their employees healthy and safe while they manufacture our products. We're also seeing some backup at the Asian West Coast ports, which is compounding late deliveries from some of our suppliers. The delay in shipments from Asia is a higher risk than normal in the balance of the year. Our supply chain team, together with our channel leaders, had done an excellent job reducing our exposure to excess inventories and related losses. Inventories were much lower than planned at the end of the second quarter and lower than last year. We expect inventory levels to run lower than 2019 for the balance of the year. Among other things, our supply chain team is now focused on supporting the acceleration in e-commerce demand through the year-end holidays. With the surge in demand we've seen since March we believe we're better prepared heading into the holiday season this year.

In summary, we believe Carter’s is weathering the disruption of the children's apparel market better than we had expected. We consider ourselves fortunate to own two of the most iconic brands in young children's apparel. Our Carter's and OshKosh B'gosh brands have been enjoyed by multiple generations of consumers for the past 100 years. We own the largest share of the baby apparel, sleepwear, and playwear markets for young children. We focus on essential core products bought in multiple quantities on a frequent basis in those early years of a child's life. Our average price points are less than $10, providing a great value to consumers in a weaker economic environment. We are the largest supplier of children's apparel to the largest retailers in North America. We are also the largest specialty retailer of young children's apparel and our Carter's brand is the best-selling children's apparel brand online in the United States and Canada.

Together with the support of the largest retailers of young children's apparel, we expect the online sales of our brands to exceed $1 billion this year. The disruption caused by the corona virus is expected to weigh on the growth we had planned in the balance of the year. That said, we have thousands of dedicated employees on the frontline every day representing our brands and serving the needs of all families with young children. I'm grateful to all of our employees for supporting Carter’s through this significant disruption in their lives and livelihoods. With their support I believe Carter’s will outperform the market through this pandemic, emerge stronger from it, and continue providing the very best value and experience in young children's apparel. Rich will now walk you through the presentation on our website.

[Richard Westenberger, EVP and CFO]

Thank you, Mike. Good morning, everyone. I'll begin on Page 2 of our materials with our GAAP income statement for the second quarter. We delivered a much stronger quarter than we had expected. Net sales were $515 million, down 30% from last year. Reported operating income was $21 million, down 68% and reported EPS was $0.19, compared to $0.97 a year ago. Our second quarter reported results for 2020 and 2019 contains some unusual items, which we have detailed on Page 3. We've treated these items as non-GAAP adjustments to our reported results for greater comparability. In this year's second quarter these items include COVID-19 related expenses, store lease impairments, and organizational restructuring costs. Recall that in the first quarter we had additional meaningful charges related to goodwill and intangible asset impairments. My remarks today will speak to our results on an adjusted basis, which excludes these items.

Turning to Page 4 on our adjusted P&L for the second quarter. Again, net sales were $515 million, down 30% from last year due to lower sales across the business with the most significant sales declines occurring in our stores and in our wholesale channel due to COVID. As Mike said, a real bright spot in the quarter was exceptionally strong demand in e-commerce with triple-digit growth in both the U.S. and in Canada. While gross profit was down because of the decline in sales, gross margin rate improved by 170 basis points driven by improved realized pricing and good progress in moving through our excess inventory. Royalty income declined to $4 million from $10 million last year, due primarily to store closures in both the retail and wholesale channels. Royalty income was also down due to business model changes including product category insourcing.

We managed expenses well in the quarter, we're spending down about $70 million year-over-year. Spending was lower across most expense categories, particularly store expenses given the closures in the quarter, as well as lower spending on distribution, trade, and marketing. Operating expenses related to e-commerce, such as fulfillment costs were up versus last year given the significant growth in sales in this channel. Adjusted operating income was $41 million compared to $64 million last year. We achieved an adjusted operating margin of 8%, which was down only 70 basis points compared to 8.7% in the second quarter of last year. The low lying interest expense was $15 million, up from $9 million last year due to higher borrowings on our revolving credit facility and new financing executed in the quarter. Our average share count was 4% lower compared to last year, driven by share repurchases in 2019. As part of our liquidity improvement initiatives we suspended share repurchases in the first quarter. On the bottom line our adjusted earnings per share were $0.54 compared to $0.95 last year. Again, these results were substantially better than we had expected.

Turning to Page 5 with some balance sheet and cash flow highlights. We ended the second quarter with a very strong balance sheet, which reflects in part our improved inventory position and working capital initiatives. Our total liquidity at the end of the quarter was substantial, $1.5 billion in total. We had $1 billion of cash on hand and approximately $500 million in available borrowing capacity under our $750 million revolving credit facility. Our Q2 accounts receivable balance declined 1% compared to last year. We believe the quality of our receivables is high. The majority of the Q2 balance is comprised of receivables from retailers whose operations have been less affected to date by COVID-19.

Quarter end net inventory declined 4% compared to last year, which was substantially better than we had previously forecasted. As discussed, our sales were higher than anticipated. We've also made good progress working through excess inventory. In our last update we told you we were tracking to about $110 million of inventory, we were planning on packing and holding for sale next year. Principally because of accelerated demand from some of our wholesale customers this balance is now approximately $70 million. We believe our inventory quality at the end of the second quarter is high, with known issues appropriately reserved. Given our improved inventory position, our reserves for inventory were approximately $10 million lower than at the end of the first quarter. Based on our current outlook for the business and given the significant steps we took to reduce second half inventory commitments, we are planning that net inventories will be lower year-over-year at the end of both the third and the fourth quarters.

Accounts payable were approximately $460 million at quarter-end compared to $233 million a year ago. This increase reflects the successful extension of payment terms and rent deferrals. We've received excellent support from our vendors and our landlords as we've managed through the extraordinary challenges presented by this pandemic. Long-term debt increased to approximately $1.2 billion, up from approximately $600 million in last year's second quarter. In May, we executed a very successful financing transaction, raising $500 million in new senior notes. These notes carry a coupon of 5.5% and mature in 2025.

Factoring in our significant cash position, our net debt was $232 million actually down compared to the end of second quarter last year. While our forecast did not indicate the need for incremental financing, we thought it was prudent, given the uncertainties surrounding the pandemic to take advantage of the opportunity to further bolster our liquidity. We saw excellent demand for our transaction and we achieved essentially an investment grade covenant package. We used the proceeds of the new notes to pay down a good portion of the outstanding balance on our revolver. As we told you on our last update, we've received strong support from our bank group, which approved waivers of financial covenants under our revolver for the balance of 2020 and relaxed covenants for most of next year. Based on our current outlook, we anticipate that we will have more than adequate liquidity to manage our operations and importantly, we'll be able to continue to invest while our business and the broader marketplace begin to recover from COVID-19. First half operating cash flow was strong at nearly $240 million, up from $104 million last year as our working capital and liquidity initiatives have more than offset lower earnings.

Now moving to Page 7 with a summary of our segment results for the second quarter, as we've said our consolidated sales were down about $220 million. This was actually just about the decline we posted in store sales, which was offset by over $100 million of growth in U.S. e-commerce sales. Wholesale and international segment sales also declined in the quarter. Consolidated profitability was down just over $20 million, with a 70 basis point decline in our consolidated, adjusted operating margin. We saw operating margin declines in the U.S. retail and international segments and operating margin expansion in U.S. wholesale, which I'll describe more fully in a moment. Corporate expenses were well managed during the quarter, down $8 million versus last year and unchanged at 3.6% of consolidated sales.

Turning to second quarter results for the U.S. retail segment on Page 8. Total segment sales declined 25% compared to last year, reflecting the significant disruption from store closures in the second quarter. After closing all of our stores in mid-March for the safety of our customers and employees, we began to gradually reopen stores in early May. Reopenings accelerated in June and we ended Q2 with approximately 97% of our stores open for business. We saw good demand in stores once they reopened. After reopening stores collectively comped up 8% in the second quarter with strong conversion and higher transaction values more than offsetting declines in traffic. We had particularly good momentum later in the quarter with June retail comps up over 18%. As we said, e-commerce demand was very strong in the quarter, with comparable sales increasing 101% over last year.

During the quarter we saw significant acceleration in omni-channel activity, including orders picked up by customers in store and orders shipped to consumer’s homes from our stores. U.S. retail adjusted segment income is $33 million in the second quarter compared to $50 million last year, that's lower overall profitability. It was principally due to the store closures and expense deleverage. As Mike commented, we saw a meaningful improvement in the profitability of e-commerce in the second quarter, driven by the significant increase in sales, improved price realization, and expense leverage.

On Page 9, as our stores have reopened we've been focused on providing the safest possible environment for our customers and employees. We're practicing good social distancing and have increased our cleaning protocols. Like most other major retailers, we've also adopted a masks for all approach in our stores. On Page 10, we've been leveraging our existing and new omni-channel capabilities. In the second quarter, we've fulfilled approximately 13% of online orders through our stores. This metric was as high as 30% at certain points during the quarter. The ability to leverage our stores provided a much needed capacity boost as we constrained activity in our principal e-commerce distribution center. We continued to see an increasing proportion of customers who want to pick up their online orders the same day by visiting their local store. We've also begun to make curbside pickup available at our stores, which is obviously of great appeal given the current environment. The service is currently available in approximately 500 stores.

On Page 11 in recent months we've all become familiar with the reality and the need to wear masks. Our design, merchandising, and supply chain teams have collaborated to develop a line of face masks for children. This work was performed on an extremely accelerated timeline, and these products have become instant bestsellers. We've received very, very favorable feedback from consumers, particularly regarding said quality and value with a price point of $3. On the next several pages we have updates on some of our recent marketing activities, our marketing team has been working overtime in finding new and innovative ways to connect more closely and in a more meaningful way with our customers. We leaned into brand building moments in our marketing during Q2 knowing that families were craving emotional connection, moments of joy and support, especially in these troubled times. We believe that the Carter's and OshKosh brands occupy a unique place in the hearts and minds of parents. This was a competitive advantage for our company and one which we intend to develop further throughout 2020 and beyond.

As you'll see, our efforts are focused on the digital space, specifically creating virtual communities of families with young children. My Page 12, we've recapped our recent partnership with Kelly Clarkson, who joined us in hosting a virtual baby shower for moms whose showers were canceled because of COVID. This was all part of our declaration of May as the month of mom. We also partnered with some other leading brands, including Huggies, Coles and Johnson & Johnson, to create an event which resulted in 1.3 billion earned media impressions and which was featured on the Kelly Clarkson show on July 14th.

On Page 13, we also leveraged the strength and heritage of the OshKosh brand in the second quarter. OshKosh has a long history of standing for fun and play. As we previewed with you on our last call, we held Camp OshKosh online from mid-June through early July, this was a virtual camp with a variety of different activities for kids. This event was another way to support families after distance learning for the school year ended and given the many in-person camps have been canceled around the country. This event also had a celebrity time with actress Molly Sims serving as our host. Camp OshKosh drove incredible engagement from our fans and all of this events online content was created by our own employees working from home.

On Page 14, we wanted to highlight our company's response to the tragic event in Minnesota and the resulting social unrest we've seen across the nation in recent weeks. Our messaging here on social media emphasizes our support for diversity and inclusion and states our absolute commitment to fighting racism. In recent weeks, we've also engaged our employees in a number of discussions reinforcing our commitment to diversity and inclusiveness as a company. It has been very positive and constructive conversations which have reinforced our winning company culture and which have provided us with valuable insights as we seek to make our company even better.

On Page 15, June was Pride Month. Our social media postings celebrated Pride, and we're consistent with our company's stated mission to serve the needs of all families with young children. We also feature some beautiful products, part of our Pride inspired collection. Now turning to Page 16 for a recap of U.S. wholesale results for the second quarter, net sales declined to 34%, which reflects the fact that many of our wholesale customers closed their stores for much of the second quarter and canceled or delayed planned shipments from us. In Q2, we saw continued good demand for our exclusive brands sold by Amazon, Target, and Walmart. These retailers, along with several other of our customers were able to keep their stores open during the pandemic. Much like in our own retail business, many of our wholesale customers saw strong demand in their online businesses in the second quarter while their stores were closed.

We were able to support strong wholesale online demand for our products, which we've estimated grew over 100% in Q2. U.S. wholesale adjusted segment income was $29 million in the second quarter, compared to $35 million a year ago. Segment margin was 19%, up 360 basis points compared to 15.4% last year. This improvement was driven by lower inventory related charges as our current and projected excess inventory positions have improved and we have lowered sales to off price retailers.

Moving to Page 17 and second quarter results for our international segment. International net sales were $47 million compared to $82 million in the second quarter of last year. Similar to the U.S. the decline in sales was due to store closures in Canada and Mexico, and lower wholesale shipments both as a result of the worldwide pandemic. We saw good growth in online sales in both Canada and Mexico. E-commerce is a new business for us in Mexico and we've seen consumer demand in this channel ramp up much more rapidly than we had anticipated. The pace of store reopenings in Canada lagged the U.S. somewhat, while Canadian stores have now re-opened and we've seen a good rebound in store sales since reopening.

Beyond our businesses in Canada and Mexico, the rest of our international business largely relates to wholesale relationships around the world. Business with our multinational wholesale customers such as Walmart, Costco, and Amazon has been good. As in the U.S., these retailers have been able to keep their businesses up and running around the world. The remainder of our business with our international partners has been under more pressure as these largely smaller retailers have been challenged by economic conditions in their individual markets, including managing through the effects of a stronger U.S. dollar. Our international segment posted a loss of $3 million in the second quarter compared to income of $4 million last year, largely due to the effects of the pandemic related store closures.

On Page 18, 2020 was intended to be another good year of investment in the business. When the extent of the potential disruption from COVID-19 became clear, we revisited our planned spending. We scaled back spending on some projects and deferred others entirely. Given the strength of our performance in the second quarter and our improved outlook for liquidity, we believe we have an opportunity to lean into our investment agenda a bit more than we had envisioned a few months ago. We believe our ability to invest in the business is a competitive advantage with so many others having to cut back right now. Some of the key areas of investment are summarized on this page. They range from continuing to develop our marketing, e-commerce, and omni-channel capabilities to accelerating work around further optimizing our cost structure and long-term distribution capacity.

And finally, on Page 19 given the continued uncertainty surrounding the pandemic, we're not providing specific financial guidance this morning. It's important to remember that the second half has historically been the most significant part of the year in terms of overall sales and profit contribution. We expect that COVID-19 will continue to have a significant impact on our operations in the second half. We expect that we will be profitable in the third and fourth quarters, albeit not at the same levels as last year. And we're monitoring a number of risks right now. Most notably, we're watching trends and consumer traffic to our stores, especially given the backdrop of increased COVID-19 cases around the country. We're also mindful of overall economic conditions, including unemployment and consumer confidence, which may fluctuate as we move through the second half of the year.

In the appendix of the presentation, we've included information on our year-to-date performance and some other supplemental schedules which we hope you'll find helpful. And with these remarks, we're ready to take your questions.

[Operator]

Thank you. [Operator Instructions]. Our first question comes from David Buckley with the Bank of America.

[David Buckley, Bank of America]

Good morning guys, thanks for taking my question. First off, how are sales with your exclusive brands in 2Q compared to the rest of the wholesale channel? And then could you discuss in a little bit more detail the improved profitability in the wholesale channel during 2Q, how much was due to lower sales to off-price, and just how should we think about margins in the channel for the remainder of the year?

[Michael Casey, Chairman and CEO]

Yeah, as far as exclusive brands in Q2 our sales to exclusive branded customers are actually higher in Q2 than they were last year. So the remainder of the account base was obviously lower. Our Skip Hop products were comparable to last year. In terms of margin, we had good margin performance overall. There was also an inventory adjustment made which positively impacted the margins.

[David Buckley, Bank of America]

Okay, and then just have you -- what have you seen in states with recent surge in virus cases, have you seen the material drop off in store performance in those states?

[Michael Casey, Chairman and CEO]

Your connection isn’t 100% clear, but your question in terms are we seeing a drop off in states where there's been a surge in the corona virus, yes. No, doubt about it.

[David Buckley, Bank of America]

Okay, thank you.

[Michael Casey, Chairman and CEO]

Thank you, David.

[Operator]

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

[Kelly Crago, Citi]

Hi, this is Kelly on for Paul. Thanks for taking our question. I just want to dig a little more about how you're thinking about the back half of the year, the 50% of your wholesale business with your largest customers are you planning that up in the back half of the year and then when we think about the other 50% of the wholesale business, just how much should we expect that to be down? And then just what are some of the other assumptions you're making about the back half year in order to have a profitable second half of the year? Thank you.

[Michael Casey, Chairman and CEO]

It's like collectively we're expecting a growth with our exclusive brands in the balance of the year. Other wholesale customers who had closed doors in the second quarter we expect that they will be more conservative on their buys in the second half. We've been more conservative on buying inventory for them in the second half. So you should assume the other non-exclusive relationship, exclusive brand, the wholesale customers the demand from them we expect will be lower in the second half. We'll comment on how much lower because there's a lot of year still ahead of us. But we're assuming in our models that demand from wholesale customers other than Target, Walmart, and Amazon likely will be lower in the second half, including off price retailers.

[Richard Westenberger, EVP and CFO]

Kelly, to that I would add that we're expecting that the stores will continue to be under pressure. I think we've been appropriately conservative around assumptions around store traffic and comps in the stores. We've assumed continued good momentum in e-commerce. So we'll see if we attract good growth in e-commerce sales and then importantly, we're planning for gross margin expansion year-over-year in second half as we continue to make progress on pricing and working through our excess inventory. Those are probably the major building blocks.

[Kelly Crago, Citi]

Got it, thank you. And then just when we think about the product costs this spring, do you expect to recognize the AUC benefit in spring next year or do you plan to reinvest in price to take share?

[Michael Casey, Chairman and CEO]

Our expectations to product cost for spring will be lower. We have no plans to lower prices in spring.

[Kelly Crago, Citi]

Got it. Thank you.

[Operator]

Our next question comes from Ike Boruchow with Wells Fargo.

[Ike Boruchow, Wells Fargo]

Hey, good morning everyone. Good performance in a tough market. Just a couple from me, I guess the July commentary of 90% of last year, so revenue down 10, is there some more color you guys could give us just maybe by channel what exactly has transpired over the initial couple of weeks of July to get you to that 90% of last year volume overall?

[Brian Lynch, President]

I think I had shared we've got a couple of days left in our fiscal month of July and the good news is we have a strong retail comp at this point, it grew up about 3%, three comp with a couple of days to go. Our online demand continues to be strong double-digits. Our store sales are down. As Mike said they've slowed where we've got some COVID hot spots and we've got about I think about 12 or 13 stores that we had to reclose based on COVID primarily in California. But at this point in time, we've got three comp in July.

[Ike Boruchow, Wells Fargo]

Got it, that's helpful. And then maybe for Michael or Richard, when you look out now into 2024 it's interesting and helpful to hear about the larger amount of store closings, so 115 to 200. I guess when you guys had given us your last longer-term view by 2024 you were expecting e-com to reach about 42% of DTC sales. I imagine that mix is now forecasted to be higher given the ramp and closures. But could you now kind of give us more of an updated view on where e-com penetration could ultimately reach?

[Michael Casey, Chairman and CEO]

Well, we hit that 20 -- we will likely hit that 2024 number this year with the store closures. But my guess is it will be -- when things settle down my guess is that e-commerce penetration will be over 40%. There is still as I shared with you in the remarks, last year about 80% of children's apparel was bought in stores. Only about 20% online. We love the accelerated growth in online. But when it comes to children's apparel people love to go to the stores, particularly our stores. It's all the things you need for a newborn to about a 10 year old child. All the essentials, essential core products in those early years of life. So stores will continue to be important. But as we look at the next few years, particularly, we have a number of leases coming up for renewal and we have to make a decision, do we reinvest for some portion of 5 to 10 years, do we invest in capital expenditures, refresh all the point of sale or do we let those leases expire and search for better locations, better co-tenancy. And so over the next few years, my guess is we'll probably close probably some portion of 80% or more of those 200 stores.

So as leases expire the analysis we've done, there's no need to accelerate closures. But with a kick out provisions, our average lease terms are less than two and a half years. So we'll take advantage of those early exit options and we'll exit more stores than we envisioned we would before the COVID experience. But with the acceleration in online demand for our brands and a more favorable real estate market going forward, we're inclined to exit some of our older store locations, ones that don't lend themselves to omni-channel services, being able to pick up the product the same day after you've ordered it online, and we will search for better real estate opportunities.

[Ike Boruchow, Wells Fargo]

Thanks, Mike.

[Michael Casey, Chairman and CEO]

You're welcome.

[Operator]

Thank you. Our next question comes from Susan Anderson with B. Riley.

[Susan Anderson, B. Riley FBR]

Good morning. Thanks for taking my question. Nice job on the quarter. I was wondering how you're thinking about back to school if schools do not reopen or maybe only reopened 50%. Maybe on the flip side though the daycare is open and that helps the non-school age children in your customer base. And then also it's kind of curious how big July normally is versus June and assuming it must be bigger given that these are normally would start to see back to school pickup?

[Brian Lynch, President]

Yeah, back to school I would say, I think Mike commented that we are off to a little slower start, as you'd expect. It's very early but we are off to a slower start. Many of the schools in fact most I think are going to go virtual so that event where mom needs new clothes for that event is a pressing need, is not there right now. So we'll see how it goes. We did cut our fall and back to school receipts. We also shifted out our product flows because we had sensed this was going to happen and we shipped out our marketing. We really haven't started back to school marketing yet. I think it's the next couple of weeks we'll kick that in. So I think it's going to be a little slower. Our actual back to school clothing and uniforms, it's a smaller business for us than our competitors. About 50% of our business is in baby so have less impact on us but that's what I think. Near-term there could be some impact on some of our playwear categories and in the OshKosh brand particularly. It's probably a situation where the demand is going to come more based on the weather changes than the actual back to school shopping event. As you remember in spring, when the weather turned we saw a big surge in demand late May, June and even through July. So I think it's going to be more of a when does the fall weather change and get cooler versus that impetus to run out and buy a bunch of back to school clothes sitting here in July and August.

[Michael Casey, Chairman and CEO]

And so just as a reminder, over 50% of our annual sales are in baby apparel. So all the everyday essentials, bodysuits, wash clothes, towels, bibs, blankets, sleepwear, is huge part of our business. So that business we expect will continue to be in good demand. As Brian said back to school, it can be school uniforms never a big part of our business. But as the weather turns, just like it did earlier this year and just like we've seen over many, many years, when the weather turns, when people start to think about long sleeves, long pants outfitting, we typically see a surge in demand for our brands. And I'd say in recent years, back to school for us it's kind of been a deluded experience. It spreads over multiple weeks, if not months. But when the weather turns, we typically see a surge in demand. So when we update you again in October, we'll have full visibility to hopefully have a better visibility to how we did when the weather turned.

[Susan Anderson, B. Riley FBR]

Great, that's helpful. And then just on I guess market share in the quarter, do you think that you guys gained in the quarter I think a lot of smaller children's brands maybe had to have been shut down in the quarter and then we've seen obviously a lot of department stores shut some doors so maybe their private label is not as prevalent but do you think there is opportunity also looking forward to take some of that market share that's been taken out of the system?

[Michael Casey, Chairman and CEO]

So the latest data we have through the end of May suggest that we improved our market share positions through May. Again, not surprisingly because no one has. No one in young children's apparel has the relationship we have with the major retailers of young children's apparel. Walmart, Target, Amazon three of our largest customers, Coles, one of our largest customers, even though Coles and Macy's closed their stores just as we did in the second quarter, those stores were repurposed. They were shipping online purchases from their stores and the online demand from Coles, Macy's and others was robust, even though they were closed. No one has those relationships like we do with the major retailers. So not surprisingly we gain share. And to your point, going forward my guess with more store closures, more of a shift to online customers, and competitors exiting stores we believe that's an opportunity for us to gain more share in the market.

[Richard Westenberger, EVP and CFO]

The only think I had to add, that we've had a strong number one share in baby and in toddler. And based on our age up strategy, which we started to pursue about a year and a half ago for the first time that last 12 months through May. We've gained and we now have the number one market share in the kids segment, the five to seven year old child. So we're excited about that age-up strategy seems to be working well for us and we continued to increase the lifetime value of our customers on both a four and a seven year basis.

[Susan Anderson, B. Riley FBR]

Great, that sounds good. Thanks so much, you guys. Good luck for the rest of the year.

[Michael Casey, Chairman and CEO]

Thank you very much.

[Operator]

Thank you. Our next question comes from John Morris with Davidson.

[John Morris, D.A Davidson]

Thanks. Mike congratulations, in such a tough environment as well. E-commerce growth, as one would imagine in this kind of environment, doing really well. But we think one of the really interesting things to track and try to get a read on is the new customer growth. And I'm wondering if you can share with us, if you track that, if you have intelligence on and you can share with us the potential or what you've seen with new customer growth on e-commerce through this period, I think that would be a really good way to underscore the strength of the brand, do you have any metrics on that?

[Richard Westenberger, EVP and CFO]

Yeah, I don't hopefully give specific metrics. I can tell you that since the stores closed our online customers were up about 67% in the quarter. And of that, the two biggest changes were a number one new customer, some new customers that did not shop with us before. And then also kind of leads to folks that only bought in stores before that shifted their spending to online. So we're happy with the performance, I would say. I would concur with you that most importantly, the growth in new customers online was very encouraging.

[John Morris, D.A Davidson]

Okay, that's great. And my follow up back on the gross margin strength, again, really impressive performance that it was actually up year-over-year. You pointed to a couple of different factors here that have contributed to that, price integrity. But you also mentioned the inventory adjustment. I'm just wondering if you can bucket for me the different factors and somehow quantify the contribution or rank the contribution in terms of what has led to that gross margin strength in the quarter?

[Richard Westenberger, EVP and CFO]

I'm sure I'll try without being overly specific. So there are a lot of puts and takes in the gross margin line this quarter. I'd say one of the big positives is just the improvement in e-commerce margins. So that's a significant effect in the quarter. It's driven by the fact that we had higher realized pricing, bit of a rationalization of the ineffective promotions that we've perhaps had a year ago. That's probably the single biggest driver, the next big positive would be the fact that our inventory position has improved, the fact that sales were so meaningfully above our forecast, and the quality of our inventory has improved. We were able to move through a good portion of what we had reserved for those. Those are the two big positive effects. I'd say there's a reasonably significant negative mix effect that's on the gross profit line, gross margin line as well. That's principally due to the fact that we had far less retail store sales, which are historically very high gross margin sales. We have a bigger mix of the exclusive brand sales and wholesale. Those are great operating margin sales. They are not as robust on the gross margin line. So I'd say those are, John, the principal effects on gross margin for the quarter.

[John Morris, D.A Davidson]

Thanks, Richard. Thanks, everybody. Good luck for back to school fall.

[Michael Casey, Chairman and CEO]

Thank you.

[Operator]

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

[Jim Chartier, Monness, Crespi, Hardt]

Good morning, thanks for taking my questions. Just following up on the gross margin question. Richard, given healthy inventory, lower off price sales, lower product costs. Any reason we shouldn't expect gross margin up in the back half of the year?

[Richard Westenberger, EVP and CFO]

Now, Jim right now, we're planning gross margin expansion year-over-year in second half.

[Jim Chartier, Monness, Crespi, Hardt]

Great. And then could you comment, where you're seeing sell through at your wholesale customers, excluding Walmart and Target since their stores have reopened?

[Michael Casey, Chairman and CEO]

Let’s say it's been robust. I'd say, for a number of them they're chasing demand and wish we had more inventory to share with them. So we would say with the reopening similar experience that we had, I think demand has been robust.

Q - Jim Chartier

Great and then finally, the transition to fall the last couple of years seems to have been a bit challenging, some of it I think due to weather. But anything you guys have done from a product perspective to maybe improve your performance during the transition to the full product? Thanks.

[Richard Westenberger, EVP and CFO]

Yeah, I think a couple of things. One based on strategy and one based on the COVID situation. We shifted our policy. So we really felt that the last several years with the consumer buying trends and the heat that we brought in too much fall too early it wasn't appropriate and the selling was soft. So we shifted the fall receipts, we cut fall receipts and shifted them out. Our inventory, our fall inventory is in stores right now is down more than 50% from where it was last year. So we've extended the life of spring. We have plenty of spring goods, as you can imagine, and they're selling really well. So we're really planning on selling kind of a spring summer mix through Labor Day this year and taking the pressure off, having to sell traditionally fall weight goods in July and August. And I think that the fall product that we are going to bring in is more transitional in nature as we responded to the selling trends over the last few years. So we're optimistic that we'll do better. That said, we did cut the inventories back and we will plan it conservatively and we'll see how the other demand goes as we move through the fall season.

Q - Jim Chartier

Great, thanks for the color.

[Operator]

Our next question comes from Jay Sole with UBS.

[Jay Sole, UBS]

Great. Thank you so much. I want to follow up on the gross margin question. Richard, could you maybe just give us an idea what the difference in gross margin is between retail store sale and e-commerce sale and what it was in Q2?

[Richard Westenberger, EVP and CFO]

Well, I'd say historically there was a fairly significant delta because the shipping costs to the consumer are reflected in the gross margin line. That was the case a year ago, that spread has narrowed significantly because of the improvement in gross margin in the e-commerce business. I'd say they're relatively consistent for the second quarter of this year. In the past, there was a lot more daylight between the two.

[Jay Sole, UBS]

So I guess with more of the omni-channel sales happening in Q2 buy online, ship to store, I assume that lowers the shipping costs which helps improve the gross margins, how do you project that going forward, I mean, as the environment normalizes, hopefully you think people continue to use those options to fulfill their order or does it go back to where the shipping cost that maybe you saw it last year?

[Michael Casey, Chairman and CEO]

So, I think the trend was positive before COVID, its accelerated because of COVID. I don't know whether it's our stores or restaurants. I think people have gotten comfortable placing their orders online, swinging by, and picking up what they need. So my guess is that trend will continue. Again, we saw a surge in it. Every quarter we'll update you on what we're seeing but we're encouraging that because we want people to order online, swing by the store, its margin accretive when they pick up the order in store. And when they come to the store, now that they're reopened, more often than not, they see something in the store that catches their eye and they increase the total purchase. So this is why we've invested it over the past few years to add these capabilities, including curbside. Curbside was accelerated because of the COVID situation our retail team did an excellent job putting in new procedures to it to provide that experience for people who might have a child or two sitting in the backseat instead of having to get them out of the car seat and make their way into the stores. They give us a call and we're happy to run the product out to the curb so they can pick up what they need and go on their way.

[Jay Sole, UBS]

Very interesting. Thanks, Mike.

[Michael Casey, Chairman and CEO]

You're welcome.

[Operator]

Thank you. Our next question comes from Warren Cheng with Evercore ISI.

[Warren Cheng, Evercore ISI]

Hey, good morning. I just want to ask the follow up question on the focus and curbside and ship to store capabilities that really ramped up in the last few months. So first, how much of that factor into your decision of that store closure plan from 150 to 200? And second are there any metrics you can share in your productivity or comps to give us an idea, those stores that are getting a lot of curbside pickup, how much is it boosting the productivity of the stores?

[Michael Casey, Chairman and CEO]

Yeah well, I will tell you on the first, part of the analysis that we did, the stores that are being closed have a very low penetration of omni-channel sales. So whether they're an outlet store located 45 minutes away from where most people live, people are inclined to swing by and pick up the product, than have it shipped to their door. So the omni-channel service capabilities that the acceleration of that did weigh into stores that we will close. Those that have low omni-channel penetration are more likely to be closed. And then the productivity and comps of where it's offered, its additive. There's no question its additive.

[Warren Cheng, Evercore ISI]

Okay, got it thank you. And just one clarification, you mentioned it could be buyer's market coming up in the pandemic for some of these real estate opportunities. But your new store plan was unchanged, is that -- are those opportunities just not yet factored into the plan?

[Michael Casey, Chairman and CEO]

So, it's early. Just at this point, I don’t see any reason to take up the store opening plan. I think it's important for you to know, there will continue to be new opportunities for us to open stores. Consumers love shopping in our stores and in many cases where we're closing stores it's because a newer, better center has opened in an adjacent market with better potency, better access for consumers, and many of these stores that we're closing are older stores. And it's certainly not the same experience in a new store location. So for now, the game plan is to continue to open stores thoughtfully over time. We actually slowed down the pace of store openings this year. And just to see how the things settle in the post COVID environment.

[Warren Cheng, Evercore ISI]

Thank you. Good luck.

[Michael Casey, Chairman and CEO]

Thanks very much.

[Operator]

Thank you. Our final question will come from William Reuter with Bank of America.

[William Reuter, Bank of America]

Good morning. I just have two. The first is with regard to the accelerated store closures. Will this only be when leases expire or do you expect that some of these you may pay to get out of the leases and I guess could this be a meaningful amount of money?

[Richard Westenberger, EVP and CFO]

No, but it'll be the former. It's when leases expire or there's a kick out option available to us. We've done the analysis. There's no need for us to accelerate store closures well in advance of the lease expiry date. We'll do it when the leases expire.

[William Reuter, Bank of America]

Okay, that's good to hear. And then secondarily, you were very cautious with regard to issuing debt this year to improve your liquidity. But things kind of seem okay. At what point would you consider share repurchases or other dividends, etcetera that essentially reduce your liquidity?

[Richard Westenberger, EVP and CFO]

Sure, Bill I would say first of all we have a good portion of the year ahead of us. We have to see how the second half plays out. We do have some restrictions right now under our bank agreements that would prohibit us from distributing capital for dividends or share repurchases. If we're in such a great position as we get into next year and we have just loads of excess capital that's a discussion that we could pursue again with our bank partners and see if it would be prudent. But at the moment, we're not envisioning that we would be distributing capital until we get into next year and have a better read on the business.

[William Reuter, Bank of America]

Makes sense. Alright, thanks a lot.

[Richard Westenberger, EVP and CFO]

Thank you.

[Operator]

Thank you. I would like to turn it back to Mr. Casey for closing comments.

[Michael Casey, Chairman and CEO]

Thanks very much. Thank you all for joining us on the call this morning. We look forward to updating you again on our progress in October. Until then stay safe. Best wishes to all of you and to your families. Goodbye everybody.