Carter's Inc

NYSE:CRI

Earnings Call Transcript 2021-Q2

[Operator]

Welcome to the Carter's Second Quarter 2021 Earnings Conference Call.

On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer. [Operator Instructions]

Carter's issued its second quarter 2021 earnings press release earlier this morning. A copy of the release and the 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 the company 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 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.

[Michael Casey, Chairman and 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. Earlier today, we reported record levels of sales and earnings in our second quarter. We continue to see a good recovery from the pandemic-related disruption last year, with strong double-digit growth in each of our Retail, Wholesale and International segments. Profitability is meaningfully higher than last year and significantly better than our pre-pandemic performance.

Earnings in the second quarter were up over 70% compared to our second quarter 2019 earnings. Over the past year, we made structural changes in our business to help us weather the pandemic and emerge stronger from it. We focused our product offerings on fewer and better choices. We dropped low-margin styles and reduced product choices by over 20%. We then increased the mix of higher margin, longer life cycle product choices, including our new sustainable Little Planet brand and Bold Basics product offering.

We ran leaner on inventories and reduced low-margin clearance and off-price sales. With a better mix of inventory, our marketing focused more on brand building and less on promotions. We strengthened our e-commerce capabilities during the pandemic last year to improve the experience for our high-margin online customers, including curbside pickup, same-day pickup and ship-from-store capabilities.

We launched a new mobile app and invested in RFID capabilities that we believe will improve inventory accuracy, sell-throughs and margins. And we doubled our store closure plan to edit out lower-margin stores that have a low penetration of omni-channel sales. The collective benefit of fewer better product choices, fewer better higher-margin stores, a better mix of high-margin e-commerce customers, leaner inventories and fewer and better promotions drove a meaningful improvement in price realization and profitability in the second quarter and first half this year.

Given our strong first half performance and expected continued benefit of structural changes to our business, we have raised our sales and earnings forecast for 2021. In the second half, we expect sales and gross profit will be higher than previously planned. Given the positive trends in our business, we're planning higher levels of spending in the second half to expedite deliveries from Asia, to support higher demand for our brands and to overcome pandemic-related delays in production.

We're also increasing our investments in eCommerce capabilities, brand marketing and employee compensation, which was curtailed during -- last year during the height of the pandemic. These investments are expected to enable a strong finish to this year, and more importantly, get us off to a good start in 2022.

If we're successful with our balance of year plan, we will achieve a record level of profitability this year and build a stronger foundation to grow on in the years ahead.

In terms of sales trends, the second quarter got off to a good start as warmer weather arrived in more parts of the country, and consumers began to update their children's spring and summer outfits. We saw better-than-expected demand in each month of the quarter. The third quarter has also gotten off to a good start. Our Retail segment was the largest contributor to our second quarter sales and earnings. The collective benefit of a stronger product offering, higher margin e-commerce sales and fewer low-margin stores enabled us to achieve the highest second quarter retail operating margin in over 10 years.

eCommerce continued to be our highest margin business in the quarter with penetration growing to 38% of our retail sales, up from 27% prior to the pandemic. Our store sales and earnings meaningfully outperformed our expectations in the quarter driven by higher units and better price realization. Comparisons to our 2020 results are less meaningful given the COVID-related store closures last year. Compared to the second quarter of 2019, retail sales were higher despite nearly 60 fewer stores.

We're on track to close over 100 low margin stores this year. We estimate that the store closures will reduce our retail sales by nearly $90 million this year compared to 2019 but will improve profitability by over $5 million. We continue to see a meaningful lift in the profitability of our stores located in markets adjacent to the stores that we closed. Those transferred sales flow through a very high margin given the fixed cost structure of our store model.

We paused our store opening plan during the pandemic and are only opening 1 store this year. Our real estate team is evaluating new store opportunities in the top 20 U.S. markets. We expect to resume opening stores beginning next year. We'll share those plans with you after they're firmed up later this year.

We continue to see more customers taking advantage of our omni-channel capabilities. 90% of our stores are located in outdoor shopping centers, which makes it more convenient for consumers to shop online and pick up their purchases at our stores. Over 30% of our online orders in the quarter were supported by our stores compared to less than 12% last year. We're focused on providing a higher service level to our omni-channel customers because they are our highest value customers. They shop more frequently and spend nearly 3x more than our single-channel customers.

Our retail and marketing teams are focused on the upcoming back-to-school shopping season. We recently launched a highly creative OshKosh brand campaign focused on back-to-school outfitting. Richard will share some of that visual content with you this morning. We expect to see a very good recovery in our back-to-school sales this year. We saw good growth in our wholesale segment in the second quarter driven by our flagship Carter's brand. Collectively, our exclusive brands had good growth on top of the surge in demand last year during COVID-related store closures. Our exclusive brands contributed nearly 50% of our second quarter wholesale sales. We also saw good growth with our OshKosh and Skip Hop brands.

Many of our wholesale customers are also seeing the benefits that we are seeing by running leaner on inventory commitments, driving higher sell-throughs with less end-of-season clearance sales and better margins. For the year, we're expecting good double-digit growth in wholesale sales and earnings, and growth with 9 of our top 10 customers. Together with our wholesale customers, our global eCommerce sales grew to over $0.5 billion in the first half this year, up over 60% compared to 2019. No other company in children's apparel has the breadth and depth of eCommerce distribution that Carter's has, working with the largest online retailers in the United States.

We were recently honored by Target as their vendor of the year, recognizing Carter's for its performance during the pandemic. We launched our exclusive brand with Target 20 years ago. It has been a significant source of growth for us. It provided a good model to launch our exclusive brands for Walmart and Amazon and enabled us to extend the reach of our brands to 3 of the most successful retailers in the world.

Together with our wholesale customers, we saw growth in each of our age segments from a newborn to a 10-year-old child. A high percentage of our sales through our wholesale customers are Baby apparel. Our Carter's brand is a traffic driver for the national retailers. It's the brand consumers expect to see when shopping for their new baby. Carter's is the best-selling brand in children's apparel. It's the most recommended brand by moms for moms and has the highest level of social media engagement in kids apparel. The latest U.S. market data suggests Carter's was the fastest-growing brand in young children's apparel in the second quarter.

Our sales growth in the second quarter was driven by baby apparel with sales up over 30%. Thankfully, the forecasted decline in births this year has moderated. Earlier estimates had suggested 300,000 to 500,000 fewer children would be born this year in the United States due to the pandemic. Births were estimated to decrease as much as 8% to 14% versus 2020. The latest data from the CDC reflects births this year are down only 5%. With the continued benefit of government stimulus, including the enhanced child tax credit, we may see a moderation in the decline in births. That would be good for our country and our company.

We also saw good growth in our toddler and kid size apparel. The early read on back-to-school products like graphic tees, denim, uniforms is good. Casual and comfortable styling continues to outperform special occasion fitting. That said, with more people traveling, even the fancier outfits are picking up as parents are reconnecting with family and friends. Thankfully, with broader access and acceptance of the vaccines, schools are expected to reopen this fall, and we believe we are well positioned to benefit from that positive outlook.

Our International segment was also a good contributor to our growth in the quarter. International sales nearly doubled, recovering nicely from the pandemic-related disruption last year. Our operations in Canada and Mexico had good growth despite COVID-related store closures. More than half of our stores in Canada were closed for most of the second quarter due to government mandates. Thankfully, those restrictions ended on June 30, and business has been brisk since reopening.

We also saw good growth with our international wholesale partners, including Amazon. eCommerce sales through our international segment grew by nearly 70% in the first half of this year driven by Canada and Amazon. The drivers of our growth in international markets include new omni-channel capabilities launched in Canada earlier this year. Consumers in Canada are responding very positively to the convenience of shopping online and picking up their purchases in our stores. We are the largest specialty retailer of children's apparel in Canada with more than 3x the share of our nearest competitor.

In Mexico, we plan to replicate the success we've achieved through our co-branded store model in the United States and Canada. Over the next 5 years, we plan to convert all of our stores in Mexico to the co-branded model. Mexico also launched eCommerce capabilities last year, and it's off to a good start, better than we had planned.

Our Simple Joys brand sold internationally through Amazon, is expected to be a meaningful source of growth for us in the years ahead. Our wholesale relationships with retailers in Brazil and the Middle East are also expected to be good contributors to our growth.

With respect to our supply chain, we continue to be challenged by 2- to 3-week delays in the receipt of product from Asia. This is a macro challenge affecting many retailers. Transportation-related delays have improved relative to the first quarter, but COVID-related factory delays have continued to impact deliveries as infections from the virus appear to be outpacing access to vaccines in Asia. We expect late deliveries will continue in the balance of the year, and we've reflected that risk in our forecasts. To mitigate that exposure, we are expediting deliveries at a higher cost. To the extent possible, we are also moving production schedules up to mitigate pandemic-related delays in Asia and the West Coast ports. Thankfully, our wholesale customers are lean on inventories, and seeing good demand for our brands. To date, we have not seen any meaningful order cancellations due to late deliveries, but it's a higher risk than usual.

Our freight costs will be higher this year, but they are being offset by better sell-throughs of our product offerings, fewer promotions, better price realization and higher margins. We've had the benefit of lower product costs this year, but our suppliers are seeing inflation in cotton and polyester prices, which will impact our product costs beginning with our spring 2022 product offerings. We have raised our prices for spring 2022 to maintain product margins next year. Those price increases have been agreed to by our wholesale customers given the macro environment.

It is our intention to continue improving margins through SKU productivity, marketing effectiveness, store rationalization and better price realization.

In summary, we've had a good first half, and we are now projecting a much stronger-than-expected recovery from the pandemic. Carter's continues to lead the market because of the strength of our brands, unparalleled market distribution in over 19,000 store locations and nearly 20,000 employees worldwide working to provide the very best value and experience in young children's apparel.

I want to thank all of our employees who contributed to the record sales and earnings we're reporting today, and their commitment to achieve our growth objectives this year.

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

[Richard Westenberger, EVP and Chief Financial Officer]

Thank you, Mike. Good morning, everyone. I'll begin on Page 2 with our GAAP income statement for the second quarter. Net sales were $746 million, up 45% from last year. Reported operating income was $108 million compared to $21 million last year, and reported EPS was $1.62 compared to $0.19 a year ago. Last year's second quarter results were heavily affected in the early days of the pandemic by store closures, which began in mid-March and continued through the balance of the second quarter, and the suspension of shipments to many of our wholesale customers.

Our second quarter results for 2021 and 2020 included unusual items, which are summarized on Page 3. We've treated these items as non-GAAP adjustments to our reported results to enable greater comparability and provide insight into the underlying performance of the business. My remarks today will speak to our results on an adjusted basis, which excludes these unusual items.

On Page 4, we've summarized some highlights of our second quarter performance over the past 3 years. Given the significant disruption to our business and the broader marketplace in last year's second quarter, we expected to post good growth over 2020, which we delivered. As the chart indicates, we also delivered growth over our 2019 performance, especially in profitability. Certainly, the recovery from the pandemic has been a significant contributor to our performance, but we've also made some fundamental improvements to our business, many of which Mike just enumerated. We believe these factors will continue to drive our business going forward.

Moving to Page 5 and our adjusted P&L for the second quarter. Building on the 45% increase in net sales, gross profit grew at an even greater rate 57%, to $369 million. Gross margin improved 370 basis points to 49.4%, a fifth consecutive quarterly record for us. For reference, this year's second quarter gross margin was 540 basis points over what we achieved in 2019.

The expansion in our gross margin over last year was driven by strong product performance and strong wholesale customer and retail consumer demand. We were less promotional in our U.S. retail business. And saw a good recovery in demand for our core Carter's brand in the wholesale channel. Product margins in the quarter were also helped by lower product costs. These benefits were offset somewhat by higher transportation costs incurred in response to the supply chain disruptions that many companies are experiencing currently. Royalty income nearly doubled to $7 million, driven by recovery in demand across our domestic and international licensees.

Adjusted SG&A increased 34% to $265 million, reflecting higher store payroll expenses given store closures a year ago, the restoration of compensation provisions, which were curtailed a year ago, and higher marketing spend. Spending was lighter than we had planned, some portion of which was due to timing and will shift into the second half of the year.

Given the strong growth in net sales, SG&A leveraged 300 basis points to 35.5% of sales. Adjusted operating income nearly tripled from $41 million to $110 million, and adjusted operating margin improved 680 basis points to 14.8%, reflecting our gross margin expansion and expense leverage. On the bottom line, adjusted EPS was $1.67, up meaningfully from $0.54 in last year's second quarter.

Moving to Page 6. Our balance sheet continues to be in great shape. Our liquidity remains strong. We ended the quarter with over $1 billion in cash on hand, and our total liquidity was nearly $2 billion when considering the availability under our credit facility. Accounts receivable were fairly consistent year-over-year. As expected, we saw a significant growth in wholesale sales. Most of our customers have returned to their pre-pandemic terms. And we've had good payment trends.

Quarter-end net inventories declined 8% to $620 million. The quality of our inventory is very good, given strong demand and meaningfully lower excess inventory versus this time last year. We're projecting that inventory will grow year-over-year through the balance of the year, in part because of how constrained second half inventory was a year ago. And also, we're trying to bring in inventory earlier where we can, given the disruptions we've experienced in the supply chain.

We're expecting year-end net inventory to be up in the high single digits over the end of last year due to our efforts to accelerate product receipts and to support good planned demand in the first part of next year.

Our long-term debt is down over $240 million versus last year when we were partially drawn on our revolver. Those borrowings were repaid in the second half of last year.

Given our strong first half performance, cash flow from operations was $50 million. This was down from last year when our working capital initiatives in response to the pandemic yielded unusually strong cash flow, particularly for the first part of the year.

As we announced on our last call, our Board of Directors approved the resumption of our quarterly dividend, which was paid at $0.40 per share in the second quarter. Given our strong liquidity and our improving outlook for the business, we continue to evaluate additional opportunities to return capital, including share repurchases over time.

Turning to Page 8 with a summary of our business segment performance in the second quarter. Each of our segments grew net sales and profit dollars, and we saw substantial operating margin expansion in both the U.S. Retail and International segments. In U.S. Wholesale, we saw improved profitability in several aspects of the business, including improved product margins and favorable mix with strong sales of the Carter's brand. These gains were offset by higher transportation costs to expedite delayed product from Asia.

Corporate expenses as a percentage of net sales increased slightly to 3.8%, reflecting higher compensation provisions and consulting fees in support of our productivity initiatives. Overall, our consolidated adjusted operating margin expanded to 14.8%.

Now for some additional information on each of our segment's performance in the second quarter, beginning with U.S. Retail on Page 9. We posted strong sales in our Retail segment above our expectations. Our outperformance was driven by our stores and improved price realization. As expected, eCommerce sales were down versus last year, given the surge in online consumer demand, especially in the early part of the pandemic. As Mike noted, we have continued to make progress in improving the quality of our store portfolio and have closed nearly 90 stores year-to-date. Profitability in the Retail segment improved substantially. Gross margin and operating margin expanded due to the improvements in how we've been managing the business, including improved inventory management and lower promotional activity.

Now turning to Page 10. An important event in the quarter was the refresh of our core baby assortment. Previously, these products had carried the Little Baby Basics names. This year, we've rebranded these offerings as My First Love in order to better capture the joy and emotion, which accompany the arrival of a new child. These products are made with 100% Oko-Tex certified cotton, which certifies that the manufacturing processes for our products eliminate exposure to potentially harmful chemicals. We launched the My First love collection in June with a first of its kind live digital shopping event on carters.com, featuring styles curated by Bachelor alum and mom, Jade Roper Tolbert. We're seeing strong consumer response to this year's launch in all of our channels.

Turning to Page 11. One of the most significant contributors to retail growth over the past several years has been our Age Up strategy. The extension of our age and size ranges under the Carter's brand has been very well received by consumers and has allowed us to extend the length of our customer relationships and increase their lifetime value to us. As shown on the slide, our Age Up product offering is comprised of differentiated and complementary assortments, including Carter's and OshKosh branded product.

Turning to Page 12. In addition to Carter's, the other great children's apparel brand in our portfolio is OshKosh B'gosh. We acquired OshKosh in 2005 as a strategic and complementary brand, given its focus on playwear with its sweet spot in the toddler age range. Since then, we have integrated the brand in all of our channels, stores, online and wholesale in the U.S., Canada and Mexico. This iconic brand has over 125 years of rich history with a well-deserved reputation for quality and value.

We have photos in our archives of John F. Kennedy and Ronald Reagan visiting OshKosh facilities. This is a brand whose history is intertwined with that of our country. Over the past few years, we've made some significant changes to OshKosh, improving the focus and productivity of its assortments and updating the aesthetic to be even more unique and differentiated in the market. We're currently on track to achieve the best year yet in OshKosh profitability. Today, consumers rank OshKosh as one of the most recommended and durable childrenswear brands, and one which they are proud to give as a gift.

Turning to Page 13. Building on this iconic heritage, our marketing team has developed a very creative new brand campaign for OshKosh. The Today is Someday campaign, spotlights notable trailblazers as children. In the first series of ads, young versions of Mariah Carey, Muhammad Ali and Outkast all share messages of confidence and determination and encouraging the next generation to dream boldly about who they will become someday, all while wearing their OshKosh outfits. The campaign is off to a strong start, generating outstanding impressions and consumer touchpoints since its launch.

Moving to Page 14. As we told you on our last call, we recently launched Little Planet by Carter's. This brand has an overall emphasis on organic materials and sustainability, both of which are increasingly important to today's consumers. On Page 14, we have a photo of a new in-store presentation of Little Planet, which we've introduced in select stores in addition to its beautiful online presence. Little Planet is also available in over 400 Target stores nationwide, and we're planning to launch the brand on Amazon in spring 2022. Our data suggests that Little Planet is attracting a largely new customer to Carter's. And in the second half, we've allocated additional marketing spend to support Little Planet's continued growth and introduction to new customers.

Page 15 highlights another important investment that we're making in our retail business. We're currently implementing an RFID technology solution in our U.S. stores. This technology is intended to improve our in-store inventory accuracy and support our growing omni-channel demand by making a broader range of in-store inventory available to consumers shopping online and opting for in-store pickup. Additionally, it's expected to increase efficiency across numerous tasks in the store, better leveraging store labor and freeing up our associates to spend more time interacting with customers.

Ultimately, we believe RFID will be an important tool in our objective to run a higher-margin retail business through better inventory management. We expect to complete the RFID rollout this fall, realizing some benefits beginning in the fourth quarter and more meaningful contributions in 2022 and beyond.

Moving to Page 16, and our U.S. Wholesale business. As expected, we posted strong sales growth in this part of our business in the second quarter. A year ago, many of our wholesale customers canceled or deferred their orders as their stores closed in response to the pandemic. While sales were strong across wholesale, the largest contributor to growth was increased demand for our core margin-rich Carter's brand. Our My First Love assortment launched at wholesale in June, and we're seeing good performance and strong replenishment demand in this channel. Overall segment profit increased to $41 million in the quarter, albeit at a lower margin rate as transportation costs were elevated and given favorable changes in inventory reserves, which occurred in last year's second quarter.

On Page 17, our Simple Joys brand sold on Amazon continues to be an important presence for Carter's online. Amazon shifted its meaningful Prime Day event back into the summer months this year, Simple Joys was featured prominently on the Amazon Prime Day banner page, along with other leading brands such as Keurig and Levi's. Over the 2-day June prime event, sales of Simple Joys increased 70% over last year.

Page 18 features some of our recent marketing efforts with Kohl's, one of our most significant customers of the core Carter's brand in the wholesale channel. Over the years, Kohl's has been a strong partner in presenting perhaps the broadest product assortment and one of the most compelling in-store presentations of the Carter's brand. This year, our marketing focused on launching the My First Love collection as part of Kohl's Baby sale in June. In addition to terrific in-store presentation, this year's marketing also leveraged digital channels and leading social media influencers to showcase the beauty of this core baby offering and to drive traffic to Kohl's.

Turning to Page 19, and second quarter results for our International segment. We saw strong growth in our International business in the second quarter, where sales nearly doubled to $91 million. Canada was the largest contributor to our growth as sales in this market increased 75% over last year. A good portion of our store base in Canada was closed for much of the second quarter due to the reimposition of government safety mandates. Despite this, our stores outperformed our expectations, driven by strong consumer demand and improved price realization. eCommerce was also strong in Canada with strong demand while the stores were closed as well as increasing utilization of the new omni-channel capabilities now in place in this market.

Business in Mexico and with our international partners also performed well in the second quarter. Profitability in the International segment increased significantly over the loss posted last year driven by strong sales growth, improved product margin and expense leverage.

On Page 20, our partnership with Riachuelo in Brazil continues to expand. This new store recently opened in Rio de Janeiro. Riachuelo currently distributes the Carter's brand in 260 of its own department stores and has opened 7 stand-alone Carter's stores in Brazil. Riachuelo is planning on having approximately 25 Carter's stores in Brazil by the end of 2021. Riachuelo is also planning to develop the eCommerce channel later this year. Despite the significant COVID disruptions in Brazil, demand for the Carter's brand in this important market has been very strong.

On Page 21, one of our most important international markets is the Middle East. This region has been particularly hard hit in the past couple of years with lower oil prices and also by the impact of COVID. But now with the price of oil having increased and the world beginning to open up, the outlook in this part of the world is improving. Our partner recently opened this beautiful new Carter's store in the United Arab Emirates. Our partner has nearly 40 stores in the Middle East, and the UAE is home to the largest freestanding Carter's store outside of North America. Many stores in this market are some of the most productive Carter's stores in the world.

On Page 22, as announced in a separate press release issued this morning, we have published our first Corporate Social Responsibility Report. As we've mentioned on past calls, we've stepped up our focus on all things ESG. And in this inaugural report, we provide a good overview of our commitments across a number of areas, including our sourcing activities, stewardship of the environment and workforce diversity.

On Pages 23 and 24, we summarized our adjusted results for the first half of the year. It's been a great start to 2021 with sales in the first 6 months up 31%, significant gross margin expansion and SG&A leverage. Our first half adjusted operating margin was 15.6% compared to low single-digits last year.

I'll note that our first half 2021 sales and earnings performance exceeded what we achieved prior to the pandemic in 2019. It's also worth noting the strong improvement in our adjusted EBITDA in the first half of the year. This performance obviously reflects the broader recovery in the marketplace after the historic disruptions of a year ago, but also the fundamental changes and improvements to how we run the business as we've been sharing with you.

Now turning to our outlook for the balance of the year, beginning on Page 26. On balance, we're optimistic about our prospects for the second half of the year. We've raised our forecast for second half demand, even though there remains a good deal of uncertainty and risk in the marketplace. We believe a number of factors will drive our second half, and we've summarized some of them on this slide. As we've been discussing, we believe we've made some fundamental changes to how we run the business, and we intend to continue these disciplines going forward in areas such as assortment and SKU productivity, marketing efficiency and inventory management. These changes have enabled the very strong gross margin performance we have posted the last number of quarters. There are a number of issues, though, many outside of our control that we continue to monitor closely.

In recent days and weeks, the Delta COVID variant has emerged as a significant threat to the ongoing recovery of the country and world from the pandemic. Infections and hospitalizations have been rising. The impact on key aspects of our business is unknown, such as kids returning to school, which we expect will contribute to a very good back-to-school -- to very good back-to-school apparel sales. We've mentioned factory and transportation delays, and we expect these issues may persist through the second half. We've already incurred significant and unusual expense to expedite delivery of our product to the United States.

As we've demonstrated over the last 18 months or so, we intend to continue to actively manage through whatever the situation turns out to be, and we're well positioned to do so.

Turning to Page 27. We're fortunate, given our very strong first half performance, to be able to continue to invest in the business, especially when our sense is many others are retrenching. While our demand forecast for the second half has increased, we will have higher spending relative to our previous expectations. Some of the spending represents investments for the long term, including on technology such as continuing to enhance our eCommerce and digital capabilities, upgrading our point-of-sale system in stores and adding new capabilities around pricing, data and analytics and RFID. We will also spend more on marketing in the second half, some spend related to the OshKosh brand campaign, and higher spend on digital marketing, which has proven very effective for us. We're also increasing our provisions for performance and other compensation for our employees, which were curtailed a year ago in response to the pandemic. It's a competitive market out there, and this is 1 element of retaining and motivating our outstanding team.

Other spending is related to business continuity. We will spend much more than typical on transportation costs. Market rates have increased substantially through COVID, and we're spending extraordinary amounts on expediting delayed product. This additional spending and some differences in the timing of revenue will affect the comparability of this year's second half to 2020. It's important to look at the year in total, given these comparability issues, and we expect 2021 will turn out to represent extraordinary performance for Carter's.

Moving to Page 28, and our specific thoughts on the outlook for the third quarter and full year. For third quarter, we're expecting net sales of approximately $960 million, adjusted operating income of approximately $110 million and adjusted EPS of approximately $1.60. Today, we're raising our sales and earnings outlook for the full year. We're now projecting net sales growth of approximately 15%, up from our previous view of 10%. We've meaningfully increased our expectation for earnings growth. Adjusted operating income is now expected to be approximately $475 million, up from our previous view of about $400 million. If we achieve our forecast, this would represent record operating income and a very strong operating margin of about 13.5%. Adjusted EPS is expected to grow approximately 75%, up from our prior view of plus 40%.

So finally, on Page 29, here's a graphical depiction of our expected performance, dropping in our guidance for full year 2021. We're not forecasting that we will get fully back to 2019's level of net sales, and that's all right with us. With our focus on profitability, we're not repeating low margin sales from last year through the off-price channel or from low-margin stores, which are being closed. Achievement of this forecast would represent a terrific year for us, and we're focused on executing a very strong second half of the year.

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

[Operator]

[Operator Instructions] Our first question comes from Susan Anderson with B. Riley.

[Susan Anderson, B. Riley]

Really nice job on the quarter. Good to see the rebound in the business there. I'm curious maybe if you can give a little bit more color on back-to-school this year. Everyone is talking about a record back-to-school. Are you expecting it to get back to normal in terms of timing, which maybe is why you're seeing the earlier wholesale demand? And then also, are there any early reads so far in July? Or any impact you've seen so far from the child tax credit?

[Michael Casey, Chairman and Chief Executive Officer]

Yes. We're expecting to see a very good back-to-school season to be comparable, if not better than 2019, and we're prepared for that. So -- and then as it relates to the child tax credit, we did see sales pick up mid-July relative to our plan. I would say it was a relatively short-lived and it was obviously a smaller benefit than stimulus check that was received earlier this year. But we saw business pick up, and it picked up for a week or so and then settled back down closer to our plan.

So the nice thing about the enhanced child tax credit. Those are 6 monthly payments in the balance of this year. And then the second half of the annual benefit would be paid early part of next year. So we'll continue to see whether or not that continues to benefit us in each of the months in the balance of the year. But it's a meaningful benefit for families with young children. For children under the age of 6, I think the payment -- the tax credit improved by some portion of about 80% to about $3,600 a year for children under the age of 6. So it should be good for families with young children and might be a potentially good benefit for us.

[Susan Anderson, B. Riley]

Okay. Great. And if I could just add one more. I'm curious how you're thinking now about the longer-term operating margins with the performance in the quarter and your expectations for the year, are those -- I guess I'm curious how much of those margins are sustainable longer term? And does that change your longer-term outlook on the operating margins?

[Michael Casey, Chairman and Chief Executive Officer]

It does. What we shared with you earlier this year that we were targeting an operating margin of around 13% by 2025. We'll exceed that margin goal this year. So in the balance of the year, we'll revisit what our longer-term potential is based on the structural changes that we've made in the business. Our objective would be is to build on the strong margin performance that we're expecting this year.

[Operator]

Our next question comes from Jim Chartier with Monness.

[Jim Chartier, Monness]

I just wanted to touch on kind of the fourth quarter expectation. It looks like sales implied down on a 2-year basis, about 10% versus up 1% or 2% in second and third quarter. So any color you could give there would be great.

[Richard Westenberger, EVP and Chief Financial Officer]

Jim, as I mentioned, there's a number of issues affecting comparability and it is a different business now comparing back to 2020, and it's a different business comparing back to 2019 as well. So you had in 2020, you had a 53rd week, which would have fallen in the fourth quarter, that was over $30 million of revenue. There were issues in the timing of wholesale, that's perhaps more of a Q3 issue. And then an issue for the entire second half is just -- we're operating less retail stores than we had a year ago. Those were largely marginally profitable or unprofitable stores. And so we're better off from a profit point of view, but we will be short of those sales and how we report revenue here for the second half.

[Jim Chartier, Monness]

Okay. And then any inventory constraints that impacted second quarter? And then does that situation get better for you over the balance of the year?

[Michael Casey, Chairman and Chief Executive Officer]

Wouldn't say meaningfully. So we probably would estimate there was some portion of about $15 million in sales that we would have otherwise had if the inventory position was better, and more than half of that will go in the third quarter.

[Jim Chartier, Monness]

Okay. And then lastly on share repurchases here, just curious what balance sheet metrics or other things you're waiting for to start repurchasing shares again?

[Richard Westenberger, EVP and Chief Financial Officer]

Well, it's a topic that we continually discuss with our Board. I think as we have moved through this year, our confidence has increased regarding the sustainability of the business, the durability of the business, the resilience of our operations. We are in a very good liquidity position. But there's still a lot of uncertainties, and that's why we've been cautious to date, given that we're not through the pandemic 100%, yet. This more recent rebound of the virus around the country and around the world has some pause for thought for us. But we'd like to be more constructive than not. We feel good about our liquidity. We think this is a business that's going to generate substantial free cash flow going forward, and that would be our intent to revisit it shortly.

[Operator]

Our next question comes from Ike Boruchow with Wells Fargo.

[Unidentified Analyst]

This is Will on for Ike. Just a question on gross margin next quarter and in 4Q. Can you just talk a little bit about and frame up how we should think about gross margin for the back half of the year?

[Richard Westenberger, EVP and Chief Financial Officer]

I'd say we're forecasting bottom line gross margin down a bit in both Q3 and Q4, and that's largely related to the transportation costs that I mentioned. We're -- we don't spend a lot of air freight typically in this business, and we're spending several years' worth of air freight based on our forecast, given the delays in production. So that will weigh on gross margin. I would say some of the more fundamental building blocks, though, continue to be a positive story. We expect to continue to make progress with price realization. Product costs are expected to be down largely through the second half of the year. So more on a product margin point of view, I think that will continue to show expansion. But we'll give some of that back in the form of these really higher-than-typical transportation costs.

[Unidentified Analyst]

So you're expecting -- are you expecting margins to kind of revert back to pre-pandemic levels? Or you think they'll be a little bit a bit higher than that, gross margin?

[Richard Westenberger, EVP and Chief Financial Officer]

I think they're going to be down year-over-year, as I said, for Q3 and Q4. I think in terms of longer-term outlook, I think we feel good about the outlook for gross margin. We are intending to cover product cost inflation, which we see on the horizon. We mentioned on our last call, we're seeing some inflationary pressures in product costs for spring of 2022. That's what we have visibility to at this point. We're planning on covering those with pricing increases. I think the progress we've made over the last year has given us increasing confidence that we have the ability to do that. So we're not expecting deterioration from that front. I think in terms of transportation costs, what we'd like to be out of the business of spending a lot on airfreight, which we, obviously, are this year. Hopefully, that would go back to something at a more historical level. I think it has yet to be determined how other inflation and transportation costs may play out. I think the increases that we're seeing in oceangoing freight, those may persist with us for a while, certainly into 2022, whether additional capacity comes online. That's what's happened in the past is that we've seen spikes in oceangoing rates. And then additional ships are brought online, additional capacity comes into the marketplace and those rates come back down. But we'll have to see how that plays out over time.

[Unidentified Analyst]

And if I could just squeeze one more in. What are you guys seeing in terms of traffic to stores? I mean how -- are you seeing it recover to pre-pandemic levels? Where are we in terms of foot traffic and that you're seeing coming to brick-and-mortar stores?

[Brian Lynch, President]

Yes. It's -- again, it's not comparable to 2020 because we were closed. So if you look at versus 2019, our traffic is still lower than '19. It is recovering. It's getting better every month as we move forward, and we expect to have that continue to improve as we go through the balance of the year. But we're optimistic on what we're seeing. Again, it's getting better virtually every week, but it is not at 2019 levels yet.

[Michael Casey, Chairman and Chief Executive Officer]

I'd say largely, the weakest part is the international customers...correct just with travel. Our largest markets are in California, Texas, Florida, New York and New Jersey. Those are obviously big international tourist destinations. And then we have some of the largest outlets in those states. And so that's been the weakest part. To Brian's point, traffic every month seems to be improving both from more domestic shop stores, consumers and those international guests but International continues to weigh on the business.

[Operator]

[Operator Instructions] Our next question comes from Paul Lejuez with Citi.

[Kelly Crago, Citigroup Inc]

This is Kelly Crago on for Paul. Just looking at 3Q guidance, it looks like you're expecting an EBIT margin around 11% to 12%, which means your EBIT margin would be down versus 2019 levels. While in 2Q, it was up pretty significantly, I think, over 600 basis points. That's a pretty big delta despite the top line looking pretty similar. So could you just help us understand the drivers of that delta? How much was the supply chain freight headwinds impacting your business in the second quarter? And what does that look like in the third and fourth? And then how much of that is coming from higher SG&A?

[Richard Westenberger, EVP and Chief Financial Officer]

Well, it's substantial. The issue that you just went through, Kelly. As I mentioned, the transportation costs, which affect the gross margin line, that will affect Q3 and Q4. I would say some of the additional investment spending will weigh on the P&L as well. Now we think that's a good long-term trade for us. That's spending across a lot of different areas. It's technology, it's marketing, it's restoration of some of these compensation provisions, which were abnormally low a year ago. And I would say spending was abnormally low a year ago. And even in -- back to 2019, some of those provisions were not quite as fulsome as we would like them to have been. So those will all affect the comparisons and the operating margin. But we think they're good long-term trades. And I think that spending will serve us well over time. And again, I think given the comparability issues that I mentioned, it's important to look at the full year. The full year is going to be an extraordinary year for us.

[Michael Casey, Chairman and Chief Executive Officer]

Yes. Kelly, I would just add to that. I'm looking at the way you would. So in the second half, our operating margin will decrease to about 12% from the 13%, and let's call it, 13.5% we had in 2019, so 1.5 points on nearly $2 billion in second half revenues. That's $30 million of margin erosion. And the freight costs alone -- the increase in freight costs alone, including the air freight to support the demand we're seeing for the brands, to get the product here, to expedite deliveries from Asia, to overcome the pandemic-related production delays. The freight costs alone will be up about $50 million versus 2020.

[Kelly Crago, Citigroup Inc]

Got it. And just secondly, I'm curious about your pricing strategy for spring '22. How much are the price increases that you're expecting to implement? And will that be on like-for-like product? And if so, what parts of the assortment do you see the most opportunity?

[Michael Casey, Chairman and Chief Executive Officer]

The cost increases for spring '22, largely driven by fabric prices, higher cotton, higher polyester input costs, will be mid-single digits. Keep in mind, mid-single-digit increases for us in product costs, unit costs are some portion of around $0.20. So our price increases will be mid-single-digit price increases. So it still offers significant value to the consumer. But in light of the -- what's going on with inflation, that we'll start to see product cost increase in the first half of next year.

[Operator]

Our next question comes from Steve Marotta with CL King.

[Steve Marotta, CL King]

Mike, I want to just ask a follow-up to that question, mid-single-digit product costs in the first half of '22. There'll be price increases that partially offset that. Do you think the promotional environment will be similar so that price realization ultimately will be similar to what we're seeing in the first half of next year versus the first half of '20 is similar to what we're seeing in the current environment?

[Michael Casey, Chairman and Chief Executive Officer]

Yes. I'll tell you, from our experience, Steve, every good retailer is focused on improving their margins, improving price realization, running leaner on inventories, chasing demand as opposed to backing up with excess inventory that sits on the clearance rack at lower prices and lower margins. So will it be a more promotional environment in the second half next year? All depends on the strength of the product offering in the market and how you bought the inventory. So we're going to continue to run leaner on inventories, be conservative on the buys, conservative on the forecast and be more in a chase mode. It's a much healthier business. And we see that with some of our better wholesale customers that they're leaner, they're seeing better sell-throughs, higher price realization, better margins. So I think good companies will do their best to have this -- make sure the pendulum does not swing back to backing up with inventory. So the promotional environment is largely driven by how you bought the inventories. So I just think that overall, I think the market is much healthier. It's a much healthier position, healthier in terms of the quality of the business, quality of the sales.

[Steve Marotta, CL King]

That's helpful. Richard, is the incremental air freight in the second half of this current year aimed more at supporting your wholesale customers or more aimed at supporting DTC?

[Richard Westenberger, EVP and Chief Financial Officer]

I would say it has to do with both businesses. It's probably a bit more weighted towards wholesale than our direct business. But expediting product to support given the magnitude of the delays we're seeing, the production delays, it's necessary to support both segments of the business.

[Operator]

Our next question comes from Carla Casella with JPMorgan.

[Carla Casella, JPMorgan]

Just a question on CapEx. Did you say how much your total CapEx is for the tech investments, and kind of where your maintenance CapEx stands at this point?

[Richard Westenberger, EVP and Chief Financial Officer]

Well, CapEx for the full year is projected to be around $50 million. That's up from around -- from memory, about $30 million a year ago. I would say at least half of that relates to technology projects, both in our retail -- in our retail stores and enterprise technology. Then there's a good chunk that relates to distribution. Our distribution centers, which I would say is more maintenance CapEx related. Some additional investment around conveyor equipment and such to improve our eCommerce operations. But I would say at least half of the CapEx annually is related to technology projects.

[Carla Casella, JPMorgan]

Okay. Great. And have you made up all of the rent payments that had been deferred last year, any other costs that had been deferred during the pandemic?

[Richard Westenberger, EVP and Chief Financial Officer]

I would say largely, we have. There's perhaps some rent agreements that deferred rent was tacked on to the end of the rent agreement. But for the most part, I think we've caught up.

[Carla Casella, JPMorgan]

Okay. And then just one more question on the sales timing. You mentioned the Amazon shift. I'm wondering if there's been any other shift in terms of timing of back-to-school. Are people buying differently? And did you quantify the amount of shift from Amazon Prime Day moving back into the quarter?

[Richard Westenberger, EVP and Chief Financial Officer]

We didn't, specifically on Amazon. We go to some lengths to not speak too specifically about individual customer relationships.

[Carla Casella, JPMorgan]

Okay. And timing of back-to-school, though in general, are people buying earlier or later? Any thoughts there?

[Brian Lynch, President]

Back-to-school, we're off to a strong start. We're optimistic. These families, the children did not go back last year. So they were running around in pajamas, and last year's stuff in the house. So it's a wardrobe replacement for the kids. We're optimistic at this point. We'll see what happens if they're going to be going back. But I would say our back-to-school business has been very strong. It started early, particularly with our OshKosh brand. With basic tees, shorts, denim, uniforms, those businesses are very strong out of the gate. Even in the South, I think in Atlanta here, the public school children go back-to-school next week. So it is -- we are right in the midst of it. And I would say that it's strong.

[Michael Casey, Chairman and Chief Executive Officer]

Yes. Southeast has been our strongest region in recent weeks.

[Operator]

There are no additional questions at this time. I'd like to now turn it back to Mr. Mike Casey for closing remarks.

[Michael Casey, Chairman and Chief Executive Officer]

Okay. Well, thank you. Thank you all for joining us this morning. We look forward to updating you again on our progress in October. Goodbye, everybody.

[Operator]

Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.