Carter's Inc

NYSE:CRI

Earnings Call Transcript 2022-Q2

[Operator]

Welcome to Carter's Second Quarter Fiscal 2022 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President and Chief Operating Officer; and Sean McHugh, Vice President and Treasurer.

After today's prepared remarks, we will take questions as time allows. Carter's issued its second quarter fiscal 2022 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 presentations material 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 presentations 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 would like to turn the call over to Mr. Casey.

[Michael Casey, executive]

Thanks very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I'd like to share some thoughts on our business with you. Earlier this year, on our February earnings call, we reported a strong recovery from the pandemic in sales and a record level of earnings in 2021. Our progress last year indicated that consumers were also recovering well from the pandemic. The job market was improving, and wages and savings were rising. Children were returning to school, and people were traveling again, reconnecting with families and friends. More weddings were being celebrated, and the trend in births was improving.

On our February call, we also shared our outlook for growth with you. Our plan this year envisioned another good year of growth, building on the strong recovery and record earnings we achieved in 2021. In February, our year-to-date comparable retail sales in the United States were up 7%. The year was off to a good start.

On our more recent earnings call in April, we reaffirmed our outlook for growth this year. Among other things, we noted on that call that our second quarter was off to a slow start. Our plan envisioned a better contribution from the late Easter holiday in April. Our comparable retail sales in April were down 1%. And then in May and June, the trend in our retail sales weakened.

It is increasingly clear that the strength of the market has changed since the beginning of the year. The post-pandemic optimism we all experienced last year has been disrupted. There are new challenges weighing on the consumer and our results. Our best analysis suggests that the trend in our second quarter sales correlates to the declining trend in consumer confidence during that same time period.

In the second quarter, media reports highlighted the new and heavy burden on consumers weighed down by the surge in gas prices, a 41-year high in inflation affecting food prices, shortages of baby formula and rising interest rates. Our target consumers are parents of young children, men and women generally under the age of 40. It's fair to say that segment of the market has never before experienced the scope and impact of the recent collective disruption in their lives.

Earlier this week, the Conference Board reported that consumer confidence fell again in July to the lowest level since February of 2021. It was the third consecutive month of declining confidence in the state of the U.S. economy. In that same report, consumer expectations for the next 6 months fell to the lowest level in nearly a decade, suggesting weaker growth in the second half.

Our lower performance in the second quarter was largely related to our U.S. Retail segment. By comparison, our U.S. wholesale sales were slightly lower than last year and reflect a decrease in sales to off-price retailers. Our international sales grew 7% in the quarter. It is the only segment of our business that did not benefit from the government stimulus last year.

In our Retail segment, we had forecasted low single-digit growth in comparable sales in the quarter driven by the late Easter holiday and the strength of our spring and summer product offerings. Our actual comparable retail sales in the quarter were down 8%.

We achieved our pricing objectives in the quarter, which fully offset higher product costs, but unit volume declined. To date, we have seen no resistance to our high single-digit price increases this year, which equate to less than $1 per unit.

Customer satisfaction ratings on our value proposition remain high. With a stronger mix and level of inventories relative to last year, we expect to achieve our pricing objectives in the balance of the year.

In our U.S. eCommerce business, which has historically been our fastest-growing, highest-margin business, we saw a high single-digit decline in traffic to our websites. By comparison, traffic to our stores in the second quarter was only slightly lower than last year. We expected growth in eCommerce to be more challenging in the first half this year. We are comping up against a 43% increase in eCommerce sales last year, comping -- compared to the first half of 2019. We believe 2019 is a better base year for comparison. It was unaffected by the pandemic and related stimulus payments.

Relative to the pre-pandemic period, Carter's is a fundamentally stronger and more profitable company. Relative to 2019, our U.S. Retail earnings in the first half this year are up over 40%. And our consolidated earnings per share in the first half are up over 60% compared to the first half of 2019.

Our growth in profitability compared to 2019 reflects the structural improvements in our business made over the past 2 years, including the reduction of low-margin product choices, closure of less productive stores, investment in inventory management and pricing capabilities, reduction in promotions and improved price realization.

For the year, we're now projecting our U.S. Retail sales down about 10% to 2021. We are assuming the current run rate may continue through the balance of the year. Retail earnings are expected to be about 25% lower than the record profitability achieved last year, largely due to lower sales and expense deleverage.

Relative to 2019, we're projecting our Retail segment profitability this year up over 20%. For the balance of the year, our retail team has curtailed its inventory plans and reined in discretionary spending. We plan to continue leaning in and investing in the capabilities that provide a better experience for consumers shopping with us, including new stores located closer to their homes, the ease of shopping online and speed of delivering online purchases, including the convenience of same-day pickup and curbside pickup, which became popular during the pandemic. We believe these investments will strengthen our share of the market when the current burdens weighing on consumers subside and the post-pandemic recovery resumes.

Given our progress improving price realization, more attractive store opening opportunities are available to us. Nearly 70% of children's apparel is purchased in stores, and our stores are our largest source of new customer acquisition. We expect to open 100 or more stores net of closures in the United States by 2026, including 30 store openings and 19 closures this year.

Our new stores have been achieving our investment objectives and provide a high return on investment. Our stores increasingly provide a higher service level to consumers shopping online with us. Over 30% of our online transactions in the first half were fulfilled by our stores. Over the next 4 years, we expect our stores to support 40% or more of our online transactions. These are margin-accretive transactions.

Those who shop online and in our stores are our highest value customers. They have the highest satisfaction rates, shop more frequently and spend 3x more than those who shop only in our stores or online.

We are the largest specialty retailer of young children's apparel in North America and have the highest rated in-store and online shopping experience in kids' apparel. We believe our stores provide a better presentation -- the best presentation of our brands and inspire our wholesale customers to strengthen their presentation of our brands in their stores and online.

Our exclusive brands continue to be the strength of our U.S. Wholesale segment, growing to over 50% of total wholesale sales in the quarter. With the surge in gas prices, consumers may be consolidating shopping visits with retailers that provide one-stop shopping for essential core products. No other company in young children's apparel has the scope or depth of relationships that Carter's has built with the largest retailers in the world.

In the weeks ahead, we plan to relaunch our brand marketing with Target and Walmart during the back-to-school season. Our marketing team has worked collaboratively with Target and Walmart to refresh our branding in nearly 6,000 store locations and on Target.com and Walmart.com. Every week, over 100 million people shop in Target and Walmart stores. We expect that those shopping for young children's apparel will begin to see a stronger presentation of our Carter's brand in those stores in the second half this year.

We saw good demand for our Simple Joys brand in the second quarter driven in part by the timing of Amazon's Prime Day marketing event. In its recent Prime Day press release, Amazon highlighted our Simple Joys brand as one of its top-selling product offerings during its signature marketing event.

In the quarter, we saw lower demand in our core Carter's brand sold through department stores, clubs and off-price retailers. Some of our Carter's brand customers have been disproportionately affected by the shift in consumer demand to Target, Walmart and Amazon during the pandemic.

Since the pandemic began, we believe our customers have planned inventory commitments more conservatively given the challenging market conditions. By running leaner on inventories, many of our customers' margins are better than 2019. For the year, we now expect our Wholesale segment sales will be comparable to last year, with good mid-single-digit growth in our exclusive brands, offset by a mid-single-digit decrease in our Carter's brand.

We saw good growth in our International segment in the second quarter. Our growth was driven by our operations in Canada and Mexico and expansion in Brazil with our partner, Riachuelo. We have the #1 market share in young children's apparel in Canada, Mexico and now Brazil. The balance of our international sales are driven by wholesale relationships with nearly 40 retailers in over 90 countries, selling our brands through over 1,200 points of distribution and 100 websites globally.

Our operations in Canada contribute the largest component of our international sales and profitability. Canada is rolling out RFID capabilities in the second half this year. RFID enables better visibility to inventories, which enables us to provide a higher service level to online shoppers, including the same-day pickup of their purchase in our stores. It's a margin driver and enables higher sell-throughs and better price realization.

In Mexico, we are converting all of our stores to the co-branded model, replicating the successful strategy we executed initially in Canada years ago and then the United States. Over the next 5 years, we plan to triple our retail store square footage of Mexico by opening co-branded stores and converting our smaller single brand stores to the more productive co-branded store model.

For years, our Carter's brand did so well selling through Riachuelo department stores in Brazil that we partnered with them on a new growth strategy, which enables Riachuelo to open stand-alone Carter's stores. They expect to have some portion of 50 Carter's stores open by the end of the year. Brazil has been a fast-growing and profitable component of our International segment.

For the year, we now expect international sales to be comparable to 2021. Sales in Canada slowed in recent months similar to our experience in the United States, and some wholesale customers have adjusted their growth plans for the balance of the year. The stronger U.S. dollar is also expected to weigh on international growth this year. On a constant currency basis, we're forecasting low single-digit growth in international sales this year.

In our supply chain, on-time deliveries have improved, though not yet back to pre-pandemic levels. Fall deliveries this year are expected to be about 80% on time, the balance running, on average, a few weeks behind. That's the best performance we've seen since the pandemic began. Thankfully, the lockdowns in China this year have not had a material impact on the timing of production or shipments.

A year ago, we were only shipping 50% on time due to the supply chain delays both in factories and port congestion. Port congestion in the United States continues to cause delays. We have routed over 60% of our shipments from Asia to the East Coast this year to mitigate the risk of prolonged delays and labor disputes on the West Coast. The East Coast continue to be our preferred entry point given the closer proximity to our Georgia-based distribution centers.

We're encouraged by recent meetings with our largest suppliers in Asia. The common themes expressed by our suppliers suggest that capacity is opening up in Asia as global demand is weighed down by inflation. Input costs are trending lower. More containers are available to get product on its way to the United States. And ocean freight rates have trended lower every month over the past 6 months.

Their views are consistent with our data. Cotton prices and ocean freight rates are each down over 30% from recent highs. These are significant input costs. And together with available manufacturing capacity, we believe these improving trends may enable more stable product costs for Carter's beginning in the second half next year.

Inventories will be elevated this year for 2 primary reasons. We ordered product earlier to improve on-time deliveries for the back-to-school and holiday seasons, and we are packing and holding inventory given the slowdown in demand we've seen in recent months. Richard will share more about this margin preservation strategy with you this morning.

Based on changing market conditions and our second quarter results and third quarter trends, we have revised our outlook for the year. Our consolidated sales this year are now expected to be down about 5% given the trends in our Retail business and the risk of lower wholesale demand. Earnings per share are also expected to be down about 5% driven by lower-than-expected demand and higher inventory provisions.

Relative to the pre-pandemic period, earnings per share this year are expected to be up about 18% compared to 2019 given the structural improvements made to our business during the pandemic.

We expected a tougher comparison to the nonrecurring benefits of the unprecedented $3 trillion government stimulus in the first half of 2021. A good portion of that stimulus helped families with young children recover from the pandemic.

What we did not expect were the adverse effects of the absence of that stimulus, combined with a historic surge in gas prices, inflation and interest rates. We also did not expect the related and sharp decline in consumer confidence.

With time, we believe market conditions will improve. They always do. Over the past 15 years, Carter's has worked its way through the financial crisis, the Great Recession that followed, the cotton crisis and the pandemic.

In every case, our employees worldwide used those periods of disruption to strengthen our company and emerge stronger from them. Our employees enabled 31 consecutive years of sales growth prior to the pandemic, and they are committed to work their way through this latest challenge. With their support, we will continue to make Carter's the best-in-class in young children's apparel.

There are potential upsides to our latest forecast, which may be driven by a better mix and level of inventories relative to last year. A year ago, 50% of our fall and holiday product offerings arrived late. Last year, some of our product offerings arrived incomplete. We had ordered beautiful matching outfits, and many did not match. Many tops arrived without bottoms. Bottoms arrived without the matching tops. Some product offerings arrived so late, we missed the selling window. And some other product offerings never arrived at all.

By bringing product in earlier this year, we plan to provide a much better experience for consumers in the second half, which may drive higher sales than forecasted.

Baby apparel was the strongest performing product offering in the first half. Baby apparel is the largest component of our wholesale product offerings and a high-margin replenishment program for our largest customers.

Thankfully, birth trends are improving. The latest data available is through the first quarter this year when births in the United States grew 4%. That's the fourth consecutive quarter of growth in births, reversing a nearly 14-year decline in annual births in the United States.

With a near 40-year high in weddings expected this year, hopefully, family formations will follow, and the improving trend in births we began to see last year may continue this year and in the years to follow.

And we believe more children are returning to in-school learning this fall. That may also provide better back-to-school selling than forecasted.

In summary, we have risk adjusted our forecast to reflect what we experienced in recent months and what we now believe is possible this year. We will continue to focus on what we can control, and we plan to mitigate the risks related to the current market conditions.

Carter's has built a resilient business model focused on young children's apparel, which is a less discretionary product category. Our brands are focused on essential core products that consumers purchase frequently in the early years of a child's life. Carter's is not immune from the current market headwinds. But as we've seen in years past, we believe the strength of our brands and our multichannel business model may enable us to weather the latest storm better than most and recover more strongly from it.

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

[Richard Westenberger, executive]

Thank you, Mike. Good morning, everyone. I'll begin this morning on Page 2 of our materials with our GAAP P&L for the second quarter. Noteworthy on this page, our reported pretax income of $47 million reflects a $20 million charge related to the early extinguishment of debt. As we told you on our last call, we retired $500 million in pandemic-related financing in early April. The $20 million charge represents largely the early call premium and make whole interest as this debt was not set to mature until 2025.

We've treated these debt extinguishment costs as non-GAAP adjustments to our second quarter results. Beyond this item, we had no other adjustments to our GAAP results in the second quarter. Our first half GAAP P&L is included for your reference on Page 3.

A full summary of our non-GAAP adjustments for the second quarter and first half as compared to last year is included on Page 4. In last year's second quarter and first half, we had some modest charges related mostly to restructuring and COVID-related expenses.

The remainder of my remarks this morning will speak to our results on an as-adjusted basis.

On Page 5, we have an overview of our adjusted results for the second quarter. Our second quarter performance was clearly below our expectations, largely due to lower top line sales, which were $701 million, which was 6% or $46 million below last year.

The most significant driver of our lower year-over-year sales was our U.S. Retail segment, where sales declined $45 million versus last year. We attribute this decline in Retail to several factors. We had a challenging comparison to last year when the government was making extraordinary stimulus payments to consumers in response to the pandemic. And also, we saw a meaningful trend change in demand as we moved through May and June, corresponding to the spike in gas prices and the overall decline in consumer confidence.

We saw a slight decline this quarter in our U.S. Wholesale segment sales of 3%, which was largely offset by 7% growth in our International business. Our profitability in the quarter declined driven by the lower sales and higher inventory-related provisions. Our adjusted operating income was $75 million in the quarter, and adjusted EPS was $1.30. Q2 EPS decreased less versus last year than operating income did. EPS benefited from lower debt outstanding, a lower effective tax rate and a lower average share count due to our share repurchase activity, both in 2021 and this year.

We've summarized our first half performance on Page 6. We had a good first quarter, which exceeded our expectations, and now a second quarter, which was below what we thought possible a few months ago. It's worth noting that our profitability in the first half was up meaningfully over 60% versus the pre-pandemic period in 2019.

As Mike highlighted, we've made a number of structural improvements to how we manage the business, which we believe have strengthened the company. These improvements are proving even more important in an environment where overall market demand is lower than we expected it to be.

To provide a little more color on our second quarter performance, I'll turn to our adjusted Q2 P&L on Page 7. On the roughly $700 million in net sales in the quarter, our gross profit was just over $330 million, representing a gross margin rate of 47.3%. Of the $38 million decline in gross profit from last year, $23 million was from lower sales volume and $15 million was due to lower gross margin rate.

Gross margin was negatively affected by inventory provisions in the second quarter, which were $14 million higher than last year. Additionally, in the second quarter last year, we had favorable adjustments to inventory reserves, which did not repeat this year.

Importantly, we continued our progress in improving price realization in the quarter, offsetting the increase we saw in product costs. Additionally, like most in the industry, we've seen a significant increase in ocean freight rates to bring product into the United States from Asia. These rates were up nearly 90% over a year ago. There was a benefit in the quarter from spending less on airfreight, but the impact of the higher freight rates was more significant.

We're expecting that the impact of the higher ocean freight rates will moderate a bit in the second half. It was in the latter half of last year when we saw rates really begin to spike. We were also spending heavily on airfreight to expedite delayed product in the second half of last year, which we do not plan to repeat this year.

Overall, we're planning gross margin expansion versus 2021 in the back half of the year given the anticipated decrease in transportation costs, continued progress in price realization and an improved mix of our high-margin retail sales, especially in the fourth quarter.

Our spending in the second quarter was well controlled, down 1% compared to last year. While variable spending such as eCommerce fulfillment costs was lower, we deleveraged other costs because of the decline in net sales. Importantly, we've continued to invest in building our capabilities in areas such as pricing, marketing personalization and technology.

All of this translated to operating income in the quarter of $75 million. As I've mentioned, we had some favorable factors below the line. Our interest costs were lower as we retired the pandemic-related financing.

Our effective tax rate was 21.5%, which was 160 basis points below last year, which reflects our forecast that a greater proportion of our profitability will be outside the U.S. this year. We've also completed a meaningful amount of share repurchases in the first half of the year, retiring about 5% of the shares, which were outstanding as of the beginning of the year. So on the bottom line, adjusted earnings per share were $1.30 compared to $1.67 a year ago.

Our adjusted P&L for the first half is included on Page 8 for your reference.

Some highlights of our balance sheet and cash flow are summarized on Page 9.

Overall, our balance sheet is in fine shape. We continue to have substantial liquidity, roughly $1 billion with cash on hand and the vast majority of our $850 million revolving credit facility available to us.

We delevered our balance sheet significantly in the quarter by paying back the $500 million in pandemic-related financing, which, fortunately, we never needed. This debt repayment will save us nearly $30 million annually in cash interest costs. We'll have a full year benefit of these interest savings in our P&L next year.

Our Q2 ending inventory was in line with our plan, and I'll speak more about inventory in a moment. Our first half cash flow was lower than last year as a result of the factors summarized on the right side of this page.

For the full year, we're now expecting that we'll generate operating cash flow in the range of $125 million to $150 million. As demand and inventory levels normalize, we would expect that the business will return to its historical pattern of significant cash flow generation. For reference, in 2019, our operating cash flow was nearly $390 million.

Our share repurchase activity, which I've already mentioned, is summarized at the bottom of Page 9.

So on to inventory on Page 10. Our inventory at the end of the second quarter was $858 million, up 39% versus this time last year. While a meaningful increase, we had planned inventory to be up about 40% year-over-year. Despite sales being lower than planned, some production was delayed at the end of June, which benefited our quarter-end owned inventory balance.

Overall, about 75% of the growth in inventory was by design. We had intended to bring product in early because of the tremendous delays the entire industry faced last year in getting product to the U.S. from Asia. And product costs are up, as expected, and this is additive to our inventory balance.

Inventory management has always been a focus for us, and progress in this area has accelerated over the last couple of years as we have taken steps to respond to the historic disruptions of the pandemic. Our priority is to maximize the return on our investment in inventory. We've historically made only modest use of the off-price channel to deal with excess inventory, and we don't have plans to change that.

Given the lower outlook for consumer demand, which has unfolded thus far in 2022, we've taken meaningful steps to align our inventory commitments with our revised sales forecast. Where appropriate, we've canceled certain production planned for later this year.

In response to the pandemic and broad market disruption in 2020, we packed and held over $100 million of inventory, product which is now fully sold through at good margins. To a much lesser extent, we also designated some inventory as pack and hold last year.

We are reprising this strategy in 2022, largely for fall and winter product, previously earmarked for our retail stores and websites and for some wholesale customers.

For the portion of pack and hold inventory relating to wholesale, we made these decisions proactively and in collaboration with our wholesale customers. Our customers have been very supportive of these actions as they've seen the same trend change in consumer demand. These retailers are also actively working to better align their commitments with their revised outlooks for the second half.

While not without some cost and complexity, we have the wherewithal to hold this inventory and give ourselves the opportunity to earn a good return on this investment versus simply liquidating it at whatever price possible.

Our forecasts indicate that we've hit the peak year-over-year growth in inventory with lower growth expected in each of the third and fourth quarters.

Beginning on Page 12, we have some additional information on the performance of our individual businesses in the second quarter.

Overall, against last year's record performance, which was fueled in part by the significant government stimulus and recovery from the pandemic, our operating margin declined from 14.8% to 10.8%. We saw lower profitability in our Retail and Wholesale segments with some sales and profit growth achieved by our International business.

On Page 13, we have the same second quarter 2022 data, but the comparison is to the second quarter of 2019. While the current challenges in the retail marketplace are significant, Carter's is a stronger business than it was just a few years ago. We've benefited from those structural improvements that we've talked about, which have had an overall emphasis on improving profitability.

Our Retail and International businesses are more profitable than back in the pre-pandemic 2019 period. Wholesale's profitability was disproportionately affected by the inventory charges we have discussed.

Turning to Page 14, we have some additional color on each of our businesses and their performance in Q2. In Retail, sales decreased 11%. We've covered what we believe to be the drivers of our lower retail channel sales in the quarter, which are summarized again here on this page.

We saw lower sales in both our stores and eCommerce channels with a total decline in comparable sales of 8%. We had planned a low single-digit increase in retail comps for the quarter. We did not see a meaningful difference in our performance by geography, which further reinforced that the consumer has broadly pulled back on their spending.

We continued to make progress in improving our realized pricing in the quarter in our retail channels, which was an important objective because product costs were up, as expected, in the second quarter.

Given the fixed cost structure of the Retail business, we did not leverage spending in the quarter, which affected the operating margin for the Retail segment as did some higher costs related to marketing, transportation and retail share of the higher inventory provisions, which we took.

In Wholesale, sales were down 3% versus last year. Sales of the exclusive brands grew in total in the second quarter, continuing their momentum in this part of our business. We had lower sales in the core Carter's brand. Late arriving product continued to be an issue in Q2, which was compounded by the decline in consumer demand, which unfolded during the quarter.

Some shipments to customers, which had been planned for the second quarter, were deferred as we made decisions to pack and hold certain inventory, as I've discussed. Operating margin in Wholesale was affected by the same factors as in Retail, namely higher ocean freight rates and inventory provisions, offset somewhat by lower costs for airfreight and compensation.

International was a bright spot in the quarter. Sales grew 7% over last year. On a constant currency basis, international sales increased 10%. Our Canadian business held in well until the final weeks of the quarter when some of the same demand and inflation pressures began to weigh on traffic and comps. Despite this, we posted a high single-digit increase in total retail comp sales in Canada.

We saw particular growth in Q2 from our international partners' wholesale business. Our partners around the world continue to show strong recovery from the significant disruption they suffered during the pandemic.

We continue to see significant demand in particular in Brazil, where our partner there is rapidly expanding the presence of the Carter's brand in this market.

Turning now to some of our marketing initiatives, beginning on Page 15. In May, we announced a very unique collaboration with Hilary Duff, who is extremely popular among millennials. She has a tremendous following among young moms and more broadly across social media and the entertainment industry. As our Chief Mom Officer, Hilary has helped us in the annual refresh of our core baby essential products, My First Love, and just this week participated in a sneak peek of our holiday pajamas for our Christmas in July event.

This fall, she will unveil a beautiful collection of products on which she has collaborated with our talented internal team of designers and merchants. This collaboration with Hilary is a great example of the creativity and innovation of our marketing team in strengthening our connection with today's parents.

On the next page, we're approaching the back-to-school season, which is an important shopping period for both the Carter's and OshKosh brand. We're hopeful for our strong back-to-school season with more kids returning to in-person learning than in the last couple of years.

Our marketing features some great-looking kids wearing Carter's and OshKosh clothing, which generations of parents have come to trust for value, quality and style as they stock up for their kids return to the classroom.

On Page 17, as we've shared on past calls, Carter's plays a unique part in how families celebrate holidays and special occasions. Halloween and Christmas have been among the most searched terms on our website this summer. Our Christmas pajamas have become a holiday staple as families gather to celebrate together.

On the next page, we're continuing to see good demand for our eco-friendly Little Planet brand. This year will be a key year of growth for Little Planet. We will expand the brand to nearly 800 stores in the U.S. and Canada between our Carter's stores and the stores of some of our largest wholesale customers such as Target, Amazon and Kohl's.

On Page 19, we continue to lead the market in social media engagement with consumers. Our teams are constantly innovating in our social media efforts to keep our content fresh and interesting. Most recently, we've added videos featuring our merchants, highlighting new products as well as in-store shopping videos featuring our store associates. We've also featured Hilary Duff and some behind-the-scenes content from her recent photo shoot with us for fall and holiday.

On the next 2 pages, as you know, we've had tremendous success with the growth and performance of our exclusive brands, Just One You at Target and Child of Mine at Walmart. This fall, we'll be relaunching the brand marketing for these 2 brands in-store and online with these important retailers. Through this initiative, both Target and Walmart will more prominently feature Carter's, which is the best-selling brand in young children's apparel.

On Page 20, we have how the new branding will look at Target. This new Just One You branding will launch in nearly 2,000 Target doors and on Target.com in August.

And on Page 21, we have the new branding for Child of Mine. Consumers will see this new branding in nearly 4,000 Walmart doors and on Walmart.com also in August.

Overall, this effort reinforces the very unique and powerful distribution the Carter's brand enjoys in the wholesale channel. In addition to these roughly 6,000 Target and Walmart doors, consumers can find Carter's in an additional 13,000 retail doors across North America.

On Page 22, Amazon recently held its signature Prime Day event. As Mike mentioned, Amazon highlighted Simple Joys as one of the top performers on Prime Day. Our strategy at wholesale has always been to have a presence where parents are shopping, and we continue to grow Simple Joys on this important shopping destination.

On the next page, Kohl's continues to lead in its presentation of our core Carter's brand. We recently launched our annual refresh of our core baby assortment, My First Love, at Kohl's. We've been partnering with Kohl's on its digital marketing efforts, which are focused on attracting the valuable millennial customer. We've also increasingly partnered with social influencers to further increase awareness of the Carter's brand at Kohl's.

On the next page, Mike commented on our progress in developing the Carter's brand in Brazil with our partner Riachuelo. These photos show some of the beautiful new Carter's stores, which have opened recently in Brazil. We look forward to sharing our continued progress in this important market.

Turning now to our outlook for the balance of the year, beginning on Page 26. It's difficult to forecast our business in light of the current volatility in the market. As we've heard from Walmart earlier this week, consumers clearly continue to struggle with the high current prices of essentials like gas and food. This, combined with our experience in the second quarter, has led us to lower our outlook for sales and earnings for the balance of the year. As we've discussed, we've taken steps to better align our inventory commitments and discretionary spending with our revised outlook for top line sales.

On spending, we've reduced over $100 million of previously planned spend across the company for the balance of the year. There are a number of factors, which we find encouraging as we assess the performance that may be possible in the second half of the year. First, we expect our inventory position to be in much better shape than it was a year ago in both Retail and Wholesale. We believe we left a good amount of business on the table last year simply because we didn't have enough product on hand. This year, we expect to be in a much better position to support key holiday promotions and events.

We also don't expect to spend the historic amounts on airfreight, which we incurred last year to expedite delayed products. We believe the strength of our merchandising, branding and inventory management initiatives will facilitate continued progress in improving price realization in the second half.

Our forecasts reflect gross margin expansion and SG&A leverage in the second half of the year. And below the line, our second half forecast reflects lower interest expense and the benefit of our cumulative share repurchase activity.

Q4 will drive our earnings growth in the second half in part due to significant provisions for compensation and charitable giving made in last year's fourth quarter given our record performance in 2021.

In terms of our specific expectations on Page 27. For the third quarter, we expect sales in the range of $850 million to $865 million and operating income in the range of $90 million to $100 million and adjusted EPS of $1.50 to $1.70.

For the full year, we are projecting net sales of $3.25 billion to $3.30 billion. At the high end of this range, if we're successful in achieving our forecast, we would maintain roughly 95% of 2021's net sales.

We're expecting full year adjusted operating income in the range of $415 million to $440 million, which implies an adjusted operating margin in the range of 12.8% to 13.3%. And we're forecasting adjusted EPS in the range of $7.10 to $7.60.

While our comparisons to 2021 are not what we had originally planned, we've included the relevant 2019 comparables here, which show that we've made meaningful progress over the past several years in improving the profitability of Carter's.

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

[Operator]

[Operator Instructions] Our first question is for Tom Nikic with Wedbush.

[Tom Nikic, analyst]

I guess, first, at a high level, historically, your business has been really recession resilient and -- especially when you look back at the 2008, 2009 recession where you were pretty consistent and continued to grow sales and stuff like that. Kind of wondering what's different this time. Why do you seem to be more affected by macro factors and from the external environment, so some of the things in the external environment, whereas in the past, you tended to be more resilient?

[Michael Casey, executive]

Your recollection is correct. During the recession -- Great Recession, we had good solid mid-single-digit growth in both '08 and '09. 2010 was a record year of profitability for us. And I think what's different this year, I think everybody -- I'll speak for our -- at least for our market -- primary market in the United States. We saw last year in 2021 a very strong recovery from the pandemic. There was this post-pandemic optimism that the world was going to be better. There were some reports that say that our country potentially could have something equivalent to the post World War II recovery in the market in the world.

And so we saw our business rebound very strongly in 2021. Even the early part of this year, it was off to a very good start. Comps were up 7%. The year was underway.

I think what is different about this year relative to the last recession is the shock that consumers have with the historic gas prices. Did you ever think we'd be spending $5 to $7 a gallon for gas in the United States? And so -- and there's no indication that, that's going to get better in the balance of the year. And that, combined with the historic inflation -- and then think about our customer base. Can you ever recall a time in our country's history where there's been a shortage of baby formula?

So you had this kind of -- this combination of these factors weighing on the consumer that we began to see in May, June. It's continued in July, is that the consumers weighed down by these very abnormal factors that they've never experienced before. And that, coupled with we were entering what we all thought was a period of prosperity, a new time after a period of isolation for some portion of 2 years, that people were getting out and about again in 2021. The holidays for us in 2021 were terrific.

And so -- it's -- I think that's what we saw in May and June and, to some extent, continued in July, is that there's a bit of a shock that consumers, at least in the United States, have never experienced before. That, together with other global events. So I think there's a -- I think we're in a different environment today than we were during the last recession.

[Tom Nikic, analyst]

Understood. I filled up my gas tank for $4.07 a gallon yesterday. So hopefully, we're trending in the right direction there.

[Michael Casey, executive]

I hope so. Yes.

[Operator]

Our next question is from Warren Cheng with Evercore ISI.

[Warren Cheng, analyst]

Your exclusive partners, Walmart and Target, they've made some pretty well-publicized comments about some of the demand in inventory -- the traffic in inventory challenges they've seen, especially in June and July. Can you give us an update on how those challenges are affecting your business or why you seem to be more insulated? Because I did notice your exclusive guidance is still plus mid-single for the year.

[Michael Casey, executive]

Brian?

[Brian Lynch, executive]

Yes. Our exclusive brand business has been very good. And just overall -- just to give you some texture. Overall, Wholesale business, again, as Mike said, we're planning the full year comparable to last year. We're going to have growth with 4 of the top 6 accounts. We had originally planned it up mid-single digits, and our upfronts, our bookings were good. We had a mid-single-digit increase. But we did have some product delays, and the retail selling softened as we went through the quarter. The over-the-counter selling did soften at our top accounts sequentially as you went through the second quarter. So that created the need to proactively pack and hold inventory.

Our cancellations have generally been in line with our expectations. But the inventory at our accounts overall is in pretty good shape. It's up low single digits. We do not have an inventory issue at the exclusive brands. We obviously have great relationships with those folks, and we've read their public comments, but I feel like we're in good shape there. Even Walmart, our inventory is actually lower than last year.

So we had bookings to support the second half up mid-single digits. Now we're planning down low-single digits, but we'll have good growth for the year with the exclusive brands. And we're going to have -- I think even if you look at the second half, I think we'll have outsized growth in the third quarter because we're up against some significant lost sales we had in the third quarter last year when we had some shipping issues.

So we're optimistic that our improved shipping performance should help early fall selling this year. And I expect that we'll continue to have good strength with the exclusive brands. Their teams, very talented teams at those accounts and our teams have great relationships and manage that business very well.

[Michael Casey, executive]

Let me just add to that. It's important for you to know that at Target and Walmart, a very high percentage of the product offerings we sell into those 2 retailers is baby apparel. Our baby apparel business is over 50% of our total apparel sales, and that has been the strongest component of our business.

And in baby apparel, a good portion of what we do for Target and Walmart is on automatic replenishment. So as the register rings, it triggers an order that we send to those 2 retailers. If they turn off that replenishment, the shelves are empty. And that's not going to be a good experience for the consumers in the balance of the year.

So baby apparel, the essential core products, bodysuits, washcloths, towels, bibs, blankets, all the -- pajamas, all the things that a child grows through rapidly in those early years of life. So that's why I think we've done so well at Target, Walmart and Amazon because some very high percentage of the product offerings for those retailers is in baby apparel.

[Warren Cheng, analyst]

Got it. That's really helpful insight. And then my follow-up, can you help me better understand the divergence we're seeing between Retail and Wholesale segments this year? I better understand the first half. The things changed pretty quickly, so retail performed. But the guidance seems to imply kind of that same gap in the second half. So can you just give your thoughts there and then how to think about that progression of mix going forward?

[Brian Lynch, executive]

I think there's a few things. First of all, is timing. As I said, our direct-to-consumer business, we saw this impact pretty quickly when the gas and inflation took hold, as Mike said. So we saw that directly. Then in Wholesale, we were still shipping product, and we weren't talking about sell-throughs. As I said before, the over-the-county selling -- over-the-counter selling, I should say, at the wholesale accounts did decline sequentially during the quarter, and we have revised the second half.

So our Wholesale business, we had a good business in the first half overall, but the second half is going to be down mid-single digits. So there is diversity, but not as -- the gap isn't what it was in the first half.

And the other thing I would say is, again, we just talked about exclusive brands. It is a different business. We sell to people some of the key accounts we talk about, the biggest retailers in the country. There are such retailers that sell groceries and other items. And so I think there's a lower impact to them on traffic and other things than there are, for instance, in the department store channel or in some of the specialty channels.

[Michael Casey, executive]

I would say in the stores -- the stores actually had pretty good traffic. The best traffic to our stores, what we call our brand stores that are open closer to where consumers live in more densely populated areas. We still have about 30% of our stores in outlets.

And as we've seen in years past, when gas prices spike, traffic to our outlet stores declines. It settles down when the gas prices settle down. But the stores -- actually, we were encouraged by the traffic to our stores.

eCommerce was the one that surprised us. We started to see some weakness in the quarter in eCommerce traffic, which was down high single-digit. And I think part of that is due to the fact that the stimulus lapsed. There was stimulus in the market -- significant stimulus helping families with young children a year ago. So you have this wonderful environment ideal for an eCommerce environment that -- most of us were still working from home in the first half of last year, and you had the unexpected benefit of those stimulus payments, which drove very good growth in our eCommerce business.

[Operator]

Our next question is from Ike Boruchow with Wells Fargo Securities.

[Irwin Boruchow, analyst]

Two questions actually. I guess on the wholesale side, flat for the year. Exclusive's up mid-single digits. I guess just I'd love to get a little bit more color there. I would have thought that the exclusive brand, the Just One You and Child of Mine in the mass channel would have been under more pressure, but you're still forecasting pretty good decent growth there. So maybe just walk us through the puts and takes on Wholesale.

And then just a follow-up is on 4Q. So the 3Q guide looks pretty reasonable. When I look at the implied 4Q, it looks like margins are up 17%, 18%. It just looks like you're embedding a nice inflection in margin. And I'm just kind of curious on the differences between 3Q and 4Q to understand how that -- how we should think about the margin differences between the 2 quarters for the rest of the year.

[Michael Casey, executive]

Wholesale, Brian?

[Brian Lynch, executive]

Yes. Ike, it's Brian. I think a couple of things on Wholesale. As Mike shared before, exclusive brands, they continue to perform well. Those are our strongest businesses. I hesitate to say probably some of the strongest retailers out there, overall, they have been under pressure in certain components of their business as they reported.

I think if you think about our business, it is a little bit different. As Mike said, the majority of what we sell them is baby product. Our baby product has performed better than playwear and sleepwear and other products as you go through the year. And what we sell them, by and large, are essential core products. So we love the business to even be even better with them. And there have been some challenges, some inventory that we proactively work with them on a pack and hold as you -- pack and holding as you look through the back half of the year.

But overall, we've had good performance. And I think the 2 -- their companies and our group combined have done a really good job in inventory management and how we plan this business out. So it's not a significant challenge at this point. It's not easy, but we're excited about having growth this year.

And as we look forward into the future, we would expect exclusive brands to continue to be good growth vehicles for our company. And we're excited about the marketing changes that Richard shared. And we're going to have more prominent position, I think, on the floor, on how we communicate our brands and reinforcing to the consumer that these great brands are Carter's brands in 6,000 stores and on their websites.

[Michael Casey, executive]

Okay, Brian. Richard?

[Richard Westenberger, executive]

Yes. Ike, on the difference between Q3 and Q4, we are forecasting fourth quarter to be really the driver of earnings growth in the second half. There's a number of things contributing to that. We're planning on gross margin expansion in the fourth quarter in particular. That's driven by a few things.

We're forecasting good improvement in price realization. So product margin is expected to be higher. Q3 is a little bit on the gross margin line under a bit more pressure because of what Brian said around Wholesale is expected to have a very, very strong Q3 shipment period. So that flips around. And Retail is the bigger strength in the fourth quarter.

We have an ongoing benefit on the margin line from spending less on airfreight. We spent those historic amounts last year. Even though ocean freight continues to be a drag on margin, it becomes less of a drag as we move through the year, particularly in the fourth quarter, and then that mix of retail jumps up.

In particular, in the fourth quarter, we had some extraordinary spending a year ago, which we're not planning on repeating. We had such a strong 2021, a record year. We provided really extraordinary amounts for our people in recognition of that. So our -- the various categories, performance-based compensation, much less than a year ago in the fourth quarter.

We did some special things in marketing a year ago. Because of the upside we were experiencing, we don't plan on repeating some of that marketing spend. And then we made some special provisions for charitable giving that I don't think we'll provide at the same level for us.

So your observation is correct. Fourth quarter shows in our forecast as well as the stronger of the 2 periods. And then, of course, below the line, you have the ongoing benefits of the lower interest cost and the benefit of our cumulative share repurchase activity, which will benefit EPS.

[Irwin Boruchow, analyst]

Got it. Super helpful. And then, if I may, just any initial visibility into first half '23 order book or costs would also be interesting.

[Brian Lynch, executive]

Yes, Ike. Sure that -- I would say just given the uncertain macro environment, there have been corporate directives to remain lean on inventory with our top customers. Looking into spring '23, we're still booking spring. We have some of the early commitments, and the accounts have accepted our pricing. Our costs are going to be up, I think, mid- to high single digits, and we've raised pricing to match that and make sure that we cover those. And so we're still booking exclusive brands. They book a little bit later, but -- which has been a growth vehicle for us. They represent about half the business. And as I said, we're excited about the branding there.

But all in, first half, we'll have to see -- a little too early to call. I would say we could be under some pressure in the first half in Wholesale, primarily due to accounts that we sold the Carter's brand to. But it's kind of early to call it because we haven't finished booking. We haven't booked summer yet, and we haven't finished booking the exclusive brands. So that...

[Michael Casey, executive]

We'll know more in October. What we're encouraged by is that the wholesale customers continue to support our price increases, and I think they are supporting the price increases because they're seeing what we're seeing in terms of inflation into the first half of next year.

[Operator]

Our next question is from Jay Sole with UBS.

[Jay Sole, analyst]

Mike, I just want to follow up on the comment you made that -- you mentioned the comp for April. You said it slowed down in May and June, and then it continues here in July. Can you just give us an idea of maybe how much it slowed down in May and June? What you see here in July? And sort of what the guidance is based on? Is it based on sort of like the total second quarter trend? Or is it based on what you currently see here in July?

[Michael Casey, executive]

It's more of what we saw in May, June and July. It was double digit. It was like -- I'm rounding. It's down 10 at some -- 10 again in May, June and now July. So the trend continues. So as we're trying to build the models for the balance of the year, trying to ask ourselves, so when does this get better? What changes in the balance of the year? Are gas prices going to return to $2 to $3 a gallon? And then with the recent news on the contraction in GDP. So we just said we -- for purposes of sharing with you what we believe is possible in the balance of the year, we are assuming, in Retail at least, that the current trends in our business continue because that's what we're seeing.

This is not the time to be bullish on forecast. We're going to tell you how we're trending. We'll assume those trends continue in the balance of the year. That said, I will tell you, Jay, that there is some optimism on our retail team as they reflect on the quality and the level of inventory going into the back half of the year. And that's true with back-to-school. So we're starting to get some early read on back-to-school. And it's early, but -- it's early and good. And so we'll see whether or not the forecast is conservative, but it's appropriately conservative given the trends that we've seen since May.

It's been a meaningful slowdown in traffic, and we are assuming that continues through the balance of the year. That said, there are a number of upsides we've shared with you this morning that may produce better results than we're sharing with you today in terms of the forecast.

[Jay Sole, analyst]

Got it. And then if I can follow up on one more. You mentioned that the supply chain situation has improved. 80% of the fall goods have arrived on time. Does that mean that -- also that the lead times are shorter? Or is it just -- it's still taking longer, except things are arriving on-time on that longer rate? And then secondly, what has to happen to get back to 100% or to get back to where you were pre-pandemic?

[Michael Casey, executive]

Well, I think what we're dealing with from our suppliers, they've been dealing with some level of absenteeism due to -- still people are getting infected in Asia. And -- but the trend is improving. And how long will it take to get back to it? In good years, we'd probably be shipping some portion 95% on time. As a matter of fact, the First Love that Richard referenced, our -- the core of our baby product offering that launched in May, that shipped over 90% on time. So there are pockets of what I would say significant improvement.

And so we're dealing with some factory delays, and they -- there was some impact of the China lockdowns. Our suppliers would say it was not significant, but it wasn't as if there were some component parts that they relied on from China that were running late. And I'd say more of the issue is on still the port congestion. And I think with the world slowing down, that will continue to get better.

[Operator]

Thank you. And ladies and gentlemen, with that, we conclude our Q&A session. I will pass the call to Mr. Casey for his final thoughts.

[Michael Casey, executive]

Well, thank you all very much for joining us this morning. We look forward [indiscernible] October.

[Operator]

And this concludes today's conference call. Thank you for participating, and you may now disconnect.