Carter's Inc

NYSE:CRI

Earnings Call Transcript 2020-Q3

[Operator]

Hello, and welcome to Carter's Third Quarter 2020 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer.

After today's prepared remarks, we will take questions as time allows. Carter's issued its Third Quarter 2020 Earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted to the Investor Relations section of the Company's website at ir.carters.com.

Before we begin, let me remind you that statements made on this conference call and in the Company's presentation materials about the Company's outlook, plans and future performance are forward-looking statements. Actual results may differ materially from those projected. For a discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the Company's most recent annual and quarterly reports filed with the Securities and Exchange Commission and the presentation materials posted on the Company's website.

On this call, the Company will reference 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, Chairman and CEO]

Thank you very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I like to share some thoughts on our business with you.

Carter's is making good progress, recovering from the market disruption caused by the pandemic. Thanks to the support of our employees worldwide. We exceeded our sales and earnings goals in the third quarter. We achieved a record gross profit margin in the quarter with improved price realization and fewer and better promotions. We reduced our spending and inventories below prior year levels.

We also strengthened cash flow and liquidity in the quarter and gained market share. With respect to business trends, we got off to a good start in July with sales running more than 90% of prior year sales. We had substantially all of our stores opened heading into the 4th of July weekend and retail sales over that holiday shopping period comped up 7%.

In August, we saw sales trend to about 87% of prior year sales as schools delayed reopening. With children starting their school year learning virtually at home, there was less of a need to shop for back-to-school outfits. September was the largest month so far this year in sales and earnings contribution. September sales ramped up to 95% of prior year sales. That's the best performance we've seen since the pandemic began to impact us in March.

Our Labor Day holiday sales were the strongest in the past three years, with comparable retail sales up 15% during that shopping period. And in October, sales are trending over 90% of prior year sales.

With respect to product performance, we continue to see good demand for our baby apparel and sleepwear product offerings. Our baby apparel and sleepwear contribute about 70% of our total apparel sales. We own five times the share of our nearest competitors in each of these product markets.

Our playwear sales improved in July as families prepared for the beginning of a new school year. Sales dipped in August when it became clear that schools would not reopen and then rebounded in September as consumers shopped for cooler weather outfitting.

We launched our Little Baby Basics product offering in late June to coincide with the store reopenings. This is the core of our baby product offerings and the best-selling newborn apparel in the United States. It's a high-margin replenishment program and one of our strongest performing launches in recent years. Replenishment trends since the launch are much better than last year.

In the third quarter, our retail sales improved to 97% of third quarter sales last year. That's the strongest recovery in sales relative to our Wholesale and International segments. Understandably, the pandemic has accelerated the shift to online purchases. With fewer store visits, we reduced our hours of store operations by over 20% in the quarter. On a per hour basis, our store sales were better than last year.

Though store traffic was lower, we saw higher conversion rates and higher units purchased per transaction. We believe those better metrics reflect the strength of our product offerings, our compelling value proposition, and a high service level provided by our store associates.

Our stores that historically benefited from tourism, including international guests, saw the largest decline in traffic. These stores only represent about 11% of our U.S. stores, but drove about 40% of the decline in comparable sales in the quarter. Until tourism and cross-border travel resumed to pre-pandemic levels, these stores will likely underperform our other stores.

Thankfully, what we saw in lower store performance in the quarter was largely offset by stronger growth in eCommerce sales. Given the mix and level of eCommerce inventories, we were less promotional than last year, and as a result, we and eCommerce profitability in the quarter.

Similar to our store experience, online demand from international customers continues to trend lower than last year. The biggest declines in demand were from Brazil, Argentina and Europe. Historically, these were three of our best sources of international demand on our U.S. websites. These markets were particularly hard hit by the pandemic and stronger dollar.

We continue to benefit from significant investments made in recent years in our online shopping experience. Our websites were relaunched in the third quarter last year and improved the presentation of our product offerings, ease of search and navigation, and speed of checkout experience.

In the third quarter, our stores fulfilled 24% of our eCommerce orders. We've invested in technology that helps us optimize the profitability and speed of delivering those purchases. To improve the convenience of shopping with us, we now offer same-day pickup and curbside pickup services in over 600 of our stores in the United States.

These new omni-channel services are margin accretive relative to shipping from our distribution center to the consumer's home. Our omni-channel customers, those who enjoy both the online and in-store experience, are our highest value customers with annual spending more than twice that of our single-channel customer.

Going forward, we expect our stores will play an important role supporting our eCommerce customers. Currently, about 85% of our stores in the United States are located in open air centers, which we believe gives us an advantage relative to our mall-based competitors. Open Air centers provide a better, more convenient experience for same-day pickup and curbside pickup of online purchases.

We plan to continue opening stores located in more densely populated areas and plan to close stores in more remote and declining centers. We currently plan to open less than 100 co-branded stores over the next five years. We also plan to close about 25% of our stores as leases expire.

Nearly 60% of those closures may occur by the end of next year. 80% of those closures are planned by the end of 2022. These are generally older, lower margin stores in declining centers and less likely to support our focus on high-value omni-channel customers.

Carter's is an attractive tenant. Our brands are viewed as traffic drivers and bring families with young children into the shopping centers. As other retailers struggle and downsize, new and more attractive real estate opportunities become available to us. It's a buyer's market, and we plan to pursue those better opportunities in better centers that provide convenience for our consumers and a high-return on investment for our shareholders.

Our Wholesale business also showed good progress recovering from store closures earlier this year. Sales in the third quarter were about 86% of prior year sales. The operating margin on those sales was better than last year. In the third quarter, we had growth with three of our top five wholesale customers. We continue to see good growth with our exclusive brands with sales collectively, up 10%.

eCommerce demand for our brands through our wholesale customers was up over 40% in the third quarter, including triple-digit growth rates with some of our exclusive brands. The trend in online demand improved each month in the quarter.

Together with our wholesale customers, the online purchase of our brands is up over 50% year-to-date. Within the next few weeks, we expect to achieve a new milestone for our company with annual online purchases of our brands exceeding $1 billion this year.

Our Carter's brand wholesale sales were down about 25% in the quarter, driven by retailers cautiously planning for second half sales and our decision earlier this year to curtail fall and holiday inventory commitments. Generally speaking, most of our wholesale customers are lean on inventories, seeing better sell-throughs, higher margins and in a chase mode, given better-than-expected demand for our brands.

Given the pandemic related uncertainty in consumer demand, we believe operating with leaner inventories as a better strategy through the balance of this year, even if it comes at the expense of fewer sales. Our decision to run lean around inventories may impact second half wholesale sales by as much as $50 million or less than 3% of our total second half sales.

One benefit of running leaner on inventories this year is fewer low-margin sales to off-price retailers. Our sales to off-price retailers were down 18% in the quarter and down over 50% year-to-date.

We use our stores and websites in the United States and Canada to sell-through excess inventories, which were caused by store closures and related wholesale order cancellations earlier this year. As a result, we offer consumers a compelling value through our stores and websites and avoided losses that would have been incurred, selling the excess inventory to off-price retailers.

International sales in the quarter were about 90% of last year's sales and contributed over 13% of our total company sales, which is comparable to last year. The strength of our International segment is in our direct-to-consumer business, which represented over two-thirds of our international sales in the quarter.

We saw high single-digit growth in our retail sales, driven by a nearly 70% increase in eCommerce sales in Canada and Mexico. Many of our international wholesale relationships are with several smaller retailers, representing our brands throughout the world. These retailers have historically been a good source of sales and profitability.

They've been particularly hard hit by the pandemic, stronger dollar and other local market challenges. We currently expect that sales to these wholesale customers will be the slowest to recover from the global pandemic. Just for context, these customers contributed less than 2% of our company's annual sales in 2019.

We expect a better recovery with our multinational retailers including Walmart, Costco and Amazon. Amazon is seeing good performance from its expansion of our Simple Joys brand in Europe this past year. That should be a good source of growth for us in the years ahead.

With respect to our supply chain, our team did an excellent job working with our suppliers to reduce our exposure to excess inventories. Inventories at the end of September were down over 10% compared to last year.

As we shared with you in July, we're seeing delays in the receipt of products from Asia. We believe those delays were caused by reduced capacity by carriers earlier this year when demand slowed due to store closures. The delays also reflect inadequate capacity to support the surge in demand when stores reopened this summer and the precautions being taken to keep manufacturing and transportation workers protected from the coronavirus.

Thankfully, our wholesale customers are lean on inventories and in need of fresh product. They have been very supportive and recognized that the delays are a function of the market disruption. As we head into the holidays, the flow of products has improved, and we do not expect shipping delays to have a material impact on fourth quarter sales.

We're also managing the exposure to freight surcharges imposed by inbound and outbound carriers due to the surge in eCommerce sales and constrained capacity. Our best analysis suggests these surcharges may impact fourth quarter earnings by about $2 million.

With lower input costs and excess manufacturing capacity in Asia, our supply chain team has negotiated lower product costs for spring 2021. Demand for that product offering is planned comparable to last year, and the related shipments began later this quarter.

In summary, we're making good progress recovering from the disruption caused by the pandemic. We've endured a historically challenging market this past year with the unprecedented scope and duration of store closures, record unemployment and a highly contagious and deadly virus. Thankfully, we have 20,000 Carter's employees who have demonstrated an extraordinary resilience and commitment to helping their families and their company through this crisis. Their good work is reflected in the strong performance we reported this morning.

We expect the road ahead will be bumpy. That said, we believe we have a strong product offering and good marketing plans as we head into the final weeks of the year. No one knows how long the market disruption will last, what we do know is that the fundamental strength of our brands and business model should help us continue to weather the storm.

We own the largest share of the young children's apparel markets in the United States and Canada with twice the share of our nearest competitors. Children's apparel is a less discretionary purchase. We focus on essential core products bought in multiple quantities on a frequent basis in those early years of a child's life. Our average price points are less than $10, providing a great value to consumers in a weaker economic environment.

We are the largest supplier of children's apparel to the largest retailers in the United States. We are also the largest young children's apparel specialty retailer with one of the strongest and most profitable eCommerce platforms in children's apparel. Wherever you're shopping for young children, you'll likely see a strong presentation of our brands.

I want to thank all of our employees who are focused on delivering a strong finish to this year. I'm grateful for their commitment to strengthen our brands and to serve the needs of families with young children. Over the next few months, we will refresh our growth plans based on our experiences this year. Based on our current estimates, we are planning good growth in sales and earnings next year.

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

[Richard Westenberger, EVP and CFO]

Thank you, Mike. Good morning, everyone. I'll begin on Page 2 with our GAAP income statement for the third quarter. As Mike noted, our third quarter results were meaningfully better than we had planned. Net sales in the quarter were $865 million, down 8% from last year. Reported operating income was $114 million, an increase of 35%. And reported EPS was $1.85 compared to $1.34 a year ago, representing growth of 38%.

Our third quarter and year-to-date results for both 2020 and 2019 contained unusual items, which we've detailed on Page 3. We've treated these items as non-GAAP adjustments to our reported results to enable greater comparability. My remarks today will speak to our results on an adjusted basis, which excludes these unusual items.

Moving to Page 4 on our adjusted P&L for the third quarter. Net sales declined 8% to $865 million, which is a meaningful improvement over the 30% decline we saw in the second quarter. We continue to see strong demand online with our U.S. eCommerce business achieving a 17% comp and eCommerce comps in Canada up nearly 60%.

While gross profit dollars declined 5% due to lower sales, gross margin rate improved by 180 basis points versus last year to 44.4%. This represented record quarterly gross margin and was driven by improved price realization and continued progress in reducing excess inventory.

Royalty income was roughly comparable to last year at $9 million. Spending was very well managed during the quarter. Adjusted SG&A declined to $24 million or 8% across a broad range of expense categories. Adjusted operating income grew 4% to $120 million and adjusted operating margin expanded 160 basis points to 13.8%, driven by our strong gross margin performance and management of spending.

Below line, we had higher net interest expense than last year due to the $500 million in new senior notes, which we issued earlier this year. We had other income of approximately $3 million in the quarter, largely foreign currency gains. And our effective tax rate was about 19% in the quarter, up from about 18% last year. Average share count declined 2%, driven by share repurchases in 2019. Recall that we suspended share repurchases earlier this year as part of our liquidity improvement initiatives.

So on the bottom line, adjusted EPS grew 5% to $1.96, up from $1.87 last year. Turning to Page 5 with some balance sheet and cash flow highlights. Our balance sheet and liquidity remained very strong. Total liquidity at the end of the third quarter was nearly $1.6 billion, with over $800 million of cash on hand and virtually all of the borrowing capacity under our $750 million credit facility available to us. With all of the uncertainty of the current environment, we believe that having substantial liquidity, as we clearly do, is a strategic advantage for Carter's.

As Mike said, we ended the quarter with inventories 11% lower than the year ago. We believe the quality of our inventory is high overall. We've made good progress in reducing excess inventory, although we're still working through some excess spring product, particularly in our stores. We're currently planning net inventories at the end of the year to be roughly comparable with a year ago.

Our Q3 accounts receivable balance declined 10% compared to last year, which reflects lower wholesale sales. Accounts payable were $473 million at quarter end compared to $206 million a year ago. This increase reflects the successful extension of payment terms and rent deferrals. We continue to receive strong support from our vendors and landlords as we collectively manage through the disruptions caused by the pandemic.

Long-term debt was $1 billion, up from $770 million in the third quarter of last year, which reflects our successful senior notes financing transaction in May and lower revolver borrowings. In the third quarter, we repaid $244 million, which represented all of the outstanding which represented all of the outstanding borrowings under our credit facility.

When considering our meaningful cash position, net debt at the end of the third quarter was $158 million compared to over $600 million at the end of Q3 last year. Based on our current outlook, we believe we will have ample liquidity for the foreseeable future as our business continues to recover from the pandemic.

Despite year-to-date net income, which is lower than last year, our operating cash flow was very strong at $320 million compared to $73 million last year. This increase reflects improved working capital, including lower inventory and the successful extension of vendor payment terms, which I've described.

Turning to Page 7 with a summary of our business segment results for the third quarter. While sales were down, profitability in each of our business segments improved in the third quarter, and our consolidated adjusted operating margin expanded by 160 basis points over last year.

Turning to Page 8. With third quarter results for our U.S. retail segment, total segment sales declined 3% compared to last year. As Mike mentioned, we saw good demand over the 4th of July and Labor Day holiday selling periods. For the quarter, total retail comparable sales declined 3.5%, reflecting strong eCommerce growth of 17% and lower store sales.

September, which is the largest month of the year in our business, had particularly strong performance, with comparable store sales down only slightly versus last year. Store traffic continued to be a challenge for us and the broader industry. Consumers are understandably cautious, especially as we see virus counts rising again in many areas of the country. Our store traffic in the third quarter exceeded the industry benchmark, which we follow.

While traffic was down, we saw improved conversion and higher transaction values in our stores in the third quarter. The adjusted operating margin of our retail segment improved by 50 basis points to 11.4%, driven by improved price realization, especially online, and our improved inventory position and good control of spending.

Turning to Page 9. Consumers continued to take advantage of our omni-channel capabilities in the third quarter. We've worked to optimize our stores to make it convenient for customers to arrive and quickly pick up their online orders. Many customers are also taking advantage of curbside pickup, which is a new capability for us.

Overall, the synergy and integration between our eCommerce and the successful extension of vendor payment terms, which borrowings under our credit facility. When considering our meaningful cash business and our nationwide network of convenient and easy to shop stores continue to grow.

On Page 10, all of our recent marketing efforts continue to be highly integrated with our presence on social media. In the third quarter, we built on our leadership position by adding more followers on Instagram and Facebook than our largest peers in children's apparel combined.

On Page 11, we had particularly high engagement in September with two specific promotional events. With the pandemic, many families weren't able to take their usual end of summer vacation around Labor Day. Recognizing this, we held the promotion to give away staycation packages to families. This promotion generated the highest ever social engagement for the Carter's brand.

We also held a special celebration of the 125th birthday of the OshKosh B'gosh brand , which included the release of Special Limited edition vintage overalls in sizes for the entire family. This promotion proved very productive as we sold out of the kid sizes of these special overalls within a few weeks.

Turning to Page 12. Another family tradition which has gone virtual is the announcement that a new baby is on the way. During our Baby Love event in September, we gave away 10,000 Carter's body suits with the message 2021 Looking Bright to celebrate the happy news of a new baby set to arrive in 2021.

Moving to Page 13. Since the pandemic began, we've been providing families with ideas for activities while they spend more time at home. We recently initiated a twice a week e-mail series for parents with toddlers and babies with new ideas and tips for fall. These communications have continued to deepen our relationships with our customers and reinforce that no brand understands parenthood better than Carter's.

On the next page, it seems clear that we will all be living with the reality of social distancing for a while longer. Like so many other things, the tradition of kids visiting Santa will be different this year, realizing that we've collaborated with the innovative and popular cameo platform in order to deliver personalized virtual messages from Santa to thousands of children for Christmas.

On the next several pages, we've included examples of some of our marketing for the holidays. Maybe this year, more than most families are looking forward to being together in celebrating the holidays. On Page 15, we've seen strong demand for our holiday products, Halloween, Thanksgiving and Christmas products are all exceeding expectations and last year's performance metrics.

On Page 16, Carter's is known for our pajamas, especially Christmas PJs with sizes for everyone in the family. On Page 17, we also have extensive offerings for special outfitting for dress applications for the holidays. And this year, on Page 18, we have toys from Skip Hop and Carter's. In the majority of our stores, we will introduce special Santa's toy shops for the holiday season.

Moving to Page 19 with a recap of U.S. wholesale results for the third quarter. While net sales were lower than last year, our sales were meaningfully better than we had expected. The upside to our forecast was due to several factors. We saw some earlier demand for fall product from several retailers, replenishment demand for Little Baby Basics was strong and the impact of the delay in the arrival of product, which we mentioned on our last call, was less severe than we had forecasted.

All of our wholesale customers are investing in and growing their online businesses, which has translated into strong demand for our brands. Demand for our exclusive brands at Target, Walmart and Amazon was strong in the third quarter with combined sales growing 10% over last year.

Our Skip Hop brand grew nicely in the wholesale channel this quarter. With consumer spending more time at home, Skip Hop's Home Gear, Playtime and Bath Time products have proven very popular.

As Mike said, sales of the Carter's brand were down in the quarter, in part due to the fact that in the early days of the pandemic, we proactively canceled a good amount of fall and winter inventory commitments and given that many customers have understandably chosen to run leaner on inventory in the current environment.

Shipments to the off-price channel declined meaningfully in the third quarter as we're more effectively using our own retail channels to clear excess inventory. U.S. Wholesale adjusted segment income was $67 million in the third quarter compared to $73 million a year ago. Adjusted segment margin improved by 140 basis points to 22.3%, reflecting lower inventory related charges which were partially offset by higher bad debt expense.

On Page 20, we launched our core Little Baby Basics collection annually. This year, we did so in late June, which is somewhat later than normal. These products are the everyday essentials at every parent of a newborn needs. We're seeing very strong performance of Little Baby Basics this year.

We sell these signature products in multiple channels, including at some of our largest wholesale accounts such as Kohl's and Macy's. Performance in our own stores on carters.com and in our International business has also been strong.

Beginning on Page 21, we've included a few slides that highlight our exclusive brands, which are available at Target, Walmart and Amazon. But just one new brand continues to enjoy good momentum. Target has invested in several digital campaigns highlighting Just One You. These campaigns have increased awareness of the brand among new and existing guests at Target.

Sleepwear for infant and toddlers has been a particularly productive category with plans for continued momentum in the fourth quarter with Christmas pajamas and a broad assortment of sibling dressing products.

On Page 22, on the Child of Mine brand at Walmart. In the third quarter, eCommerce sales of Child of Mine more than doubled over last year. Here too, investments in brand marketing have driven good productivity and momentum in Child of Mine, which we expect will continue into the holiday selling period.

Finally, on Page 23, our Simple Joys brand continues to resonate with consumers. We have a strong partnership with Amazon and Simple Joys and Simple Joys has grown to be one of our largest brands. We participated in another successful Prime Day recently, where we posted a significant increase in sales. The Simple Joys assortment has expanded over the past few years and now includes Baby, Toddler and Pajamas up to size eight as well as shoes and accessories.

Moving to Page 24 and third quarter results for our International segment. International net sales declined 10% to $114 million. This decrease was principally driven by lower wholesale shipments to markets outside of North America due in part to the stronger U.S. dollar as well as the disruptions caused by the global pandemic.

Canada delivered a very good quarter overall, with retail comparable sales growing 7%. Online demand continued to be strong with eCommerce comps up 58%. Store comps in Canada were down a bit, but the arrival of colder weather and good back-to-school demand helped boost sales.

Net sales in our Mexico business were down year-over-year, reflecting a weaker peso and lower wholesale sales. We're making good progress in the retail portion of the business in Mexico. Our new larger co-branded stores are performing well and eCommerce, which we launched late last year, continues to post strong growth.

International adjusted operating margin expanded 270 basis points to 15.8%, driven by strong performance in Canada that was partially offset by a lower contribution from our partners business.

On Page 25, we've included a photo of one of our newest of one of our newest stores in Mexico. The store is our sixth larger format co-branded store. Initial consumer reaction has been very positive. In Q3, this store has quickly become one of our best-performing locations in Mexico.

Page 26, we've included pictures from the first three stand-alone Carter's stores in Brazil, two in São Paulo and one in Rio de Janeiro. These stores are operated by Riachuelo, our exclusive partner in Brazil.

As many of you know, we've had a strong following by Brazilian consumers shopping with us in the United States over the years, so establishing a direct presence in this important market is a good step forward. Early reaction from consumers to these new stores has been very positive.

Turning to Page 27 with our outlook for the balance of the year. As with last quarter and given the ongoing market disruption caused by the pandemic, we're not providing sales and earnings guidance today. We expect that COVID-19 will continue to have a significant impact on our operations in the fourth quarter.

We're assuming that store traffic will continue to be lower than last year, and we're mindful of the risk of the resurgence of COVID-19 in key markets in North America. We expect that online demand will continue to be strong in the fourth quarter, and we're planning for continued gross margin expansion.

We're tracking several other risks over the balance of the fourth quarter, including the broader macroeconomic environment including unemployment and consumer confidence as well as developments related to possible additional economic stimulus and the upcoming elections.

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

[Operator]

[Operator Instructions] Our first question is coming from Paul Lejuez with Citigroup. Please go ahead.

[Paul Lejuez, Citigroup]

Can you talk about what's happening at point-of-sale at the big three retailers you're partnered with on the Wholesale business? Just in terms of what's happening in POS versus the rest of the business, the rest of the wholesale business? I'm trying to get a sense of sell-through versus sell-in and what that might imply for when business might stabilize? Just if you could comment on that.

[Michael Casey, Chairman and CEO]

Sure. I'd say sales of the top three, the ones that you're referencing, has been brisk. I think, by and large, many of our wholesale customers are lean on inventories, in part because we, earlier this year, when the pandemic hit, curtailed our inventory commitments for fall and holiday. We did not do that for the exclusive brands. We did do that in the core Carter's Wholesale business. But with respect to Target, Walmart, Amazon sell-throughs, point-of-sale, over-the-counter, sales have been brisk, and we expect it will continue to be through the balance of the year.

[Paul Lejuez, Citigroup]

And Mike, did I hear you say that you're planning your spring demand to be flat versus last year. Is that at a company-wide level? Maybe if you could talk about how you're thinking about demand in Retail versus Wholesale for spring?

[Michael Casey, Chairman and CEO]

Sure. That's relative to spring '20 and that's the Carter's brand, we're planning the Carter's brand spring '21 comparable to spring '20. So there's some indication based on that demand that things may stabilize. Time will tell. I think a lot depends on how we get through the holidays. We have two important months ahead of us. And I think of some retailers, I remember our top-to-top meetings earlier this year in January. It was clear some retailers did not have the holiday performance that they had expected. So, they planned holidays '20 more conservatively, and that's a better place to be to be leaner on inventories.

At least what we're getting a signal for spring '21 that there might some be some stabilization and that perhaps they may have recognized they went a little too lean on spring '20. So, we'll see. But the next two months are important for many retailers, just to see if they can get -- to continue to see good momentum in their online businesses. I'm sure you follow Shopper Track, but Shopper Track trends for soft goods, for apparel, it's been down over 30%, sometimes closer to 40%. So store traffic has been tough. eCommerce business has been very, very good for us and for our wholesale customers.

[Paul Lejuez, Citigroup]

Right. Aren't you lapping really big declines in spring of '20? So to plan the business down, just wondering, do you risk not having enough inventory if things do bounce back?

[Michael Casey, Chairman and CEO]

Yes. Yes, that is a risk. Yes, it sure is. And we decided earlier this year to run leaner on inventories. I think it's a much healthier model when you're lean on inventories. You're seeing better sell-throughs. You're seeing better price realization. You're seeing less product on the clearance rack at the back of the store at the end of the season. So at least near term, with the uncertainty in the market, we're going to continue to run lean on inventory.

[Operator]

Our next question comes from David Buckley with Bank of America. Please go ahead.

[David Buckley, Bank of America]

I want to ask about the better profitability across all channels, the improvements in gross margin and expense management. Looking to fourth quarter and into next year, how much of this do you view as sustainable, particularly as sales trends continue to recover?

[Richard Westenberger, EVP and CFO]

I'd say we're focused on improving the profitability of the business that we have, David. There's uncertainty around the level of consumer demand. I think that uncertainty and the volatility on the top line may continue, to Mike's point, into next year. So our focus has been improving profitability really throughout the P&L. So, we're extremely encouraged by the improvement in gross margin. I'd say the single biggest contributor to that improved gross margin is the fact that we're improving our price realization in our own retail operation.

Most of that's coming from eCommerce, which had become extremely promotional as a channel for us over the last few years. So, we've reversed that. And it goes hand-in-hand with that leaner inventory position. I think we've got the confidence of the beauty of our products, the quality of our brands to get paid a bit more for that, and that's what we're seeing in the P&L. So, we're certainly planning for continued progress on gross margin. We've also had a strong focus on spending management, and that discipline will continue as well.

[Paul Lejuez, Citigroup]

That's great. Just given the higher profitability, can you guys also discuss how eCom performed as 3Q progressed? How it started fourth quarter? And then what type of channel mix shift are you anticipating for the fourth quarter there?

[Michael Casey, Chairman and CEO]

Yes. eComm has done very well. It's strong sales and profitability, higher price realization through fewer promotions, so we feel really good about that business. Comps remain strong in Q2 and when stores started to open up early in Q3, it continued to do well. August was a little softer because we really didn't have that back-to-school event, but it rebounded strongly in September. So we've got good eCommerce business, it continues to be strong in the fourth quarter, and we're optimistic going forward.

[Operator]

We will go next to Susan Anderson with B. Riley. Please go ahead.

[Susan Anderson, B. Riley]

Nice job managing the quarter. On the U.S. wholesale segment, it looks like sales were still fairly significantly down the department store channel. I guess I'm curious how much of that is still due to weak demand there versus inventory constraints? And are you expecting it to continue to improve sequentially? And then just really quick on eCommerce, I think you said 24% was shipped from stores. Maybe if you could talk about the EBIT margin difference between shipping online orders from the DC versus the stores?

[Michael Casey, Chairman and CEO]

The wholesale performance reflects more curtailment of inventories that ranked that higher than conservative planning by our wholesale customers. They wish we had more inventory but we cut fall in holiday inventories for our wholesale customers back some portion of 30% or more earlier this year. Glad we did. Glad we did. And then the margin differential on shipping from the stores versus the DCs?

[Richard Westenberger, EVP and CFO]

It's better. I don't think we're going to parse it out in DC based on that, but it's better all the way around. It's better from a customer experience point of view. We're seeing some capacity constraints in the small parcel channel. So consumers are able to get that product from our stores more rapidly. It makes more effective use of the store-based inventory. So, we're pleased to see the adoption from consumers and I think from an operational and execution point of view, getting better at it every day.

[Michael Casey, Chairman and CEO]

It's a meaningful new capability. So the most expensive way to support the eCommerce customers shipping it from our distribution center to their home. We've got 850 beautiful stores from Maine to Hawaii, and we're leveraging those stores to improve the speed of delivery and the profitability of fulfilling those eCommerce orders. And it also makes a better use of the inventory in those stores. So you can -- we have technology that can identify where there might be some extra inventory, and that inventory is best used to support that eCommerce order. So this is fairly new capability, and what we refer to as omni-channel capabilities, leveraging the stores to provide a better experience for the e-commerce customers. Those are margin accretive activities.

[Operator]

Next, we will move to Ike Boruchow with Wells Fargo. Please go ahead.

[Ire Boruchow]

I wanted to focus on -- hey, Mike, just on the wholesale channel. I think, Mike, you talked about like leaving sales on the table for Q4, which I totally understand with the inventory, but I think you talked about $50 million. Can you maybe give a little context behind the $50 million? Is that all off price? Is that all low margin revenue? Just would like to understand what that revenue actually looks like.

[Brian Lynch, President]

Ike, it's Brian. Just to -- this has been a question we've heard a good amount about. So I just want to clarify. The Q3 shipments of our brand, the Carter's brand, were meaningfully lower. The exclusive brands were higher. And the reason for that, if you look back in March, we had relationships with all of these retailers. Outside of the three exclusive brands, most folks called us and said, we don't need the summer product. We're going to cancel our orders. And we had a decision to make at that time. So we then proactively canceled about 30% of the fall orders that they had given us.

And so that is across the board. And so, the relationships are very good. Our wholesale partners are very pleased with our product performance, product's selling really well. The challenge is they don't have enough of it. And that is a proactive step that we took that caused that because we had a lot of uncertainty going forward. So we did have lower off-price sales because we've been managing the inventory better, and we're moving that product through our own retail stores. But as far as the rest of the wholesale customers, the main issue really is they don't have as much of our inventory as they would like because we proactively took steps to reduce it given the unknowns for fall and winter.

[Michael Casey, Chairman and CEO]

Yes. That part of the business, Ike, that's a high-margin component of our business, the core Carter's wholesale business is a very good margin business for us. And we intentionally decided to reduce the risk of having too much inventory in the second half of the year. We're encouraged by it. That's an opportunity for next year. So, it's a much better place to be when you're seeing very good sell-throughs. Everybody's lean on inventory. They wish they had ordered more, and they'll have an opportunity to order more for the second half of next year now.

[Ire Boruchow]

Well, I guess just to wrap that up. I mean, I guess my question is. I know you're not giving guidance on wholesale, but $50 million is about 15% of rev. So should your wholesale business in Q4 look kind of similar to what it did in Q3, down 15%, but with better margins potentially? Just trying to understand how your bookings look and how we should be expecting your wholesale business to look in Q4.

[Richard Westenberger, EVP and CFO]

Yes. I don't think we want to be precise around segment guidance for the quarter. I think the complexion of what's driving the business is what Mike and Brian have described. We have great momentum in the exclusive brands. We expect that, that will continue. We'll see good demand from those retailers. I think the Carter's brand will be down for the reasons that have been described that we cut back on inventory, which from a risk mitigation point of view, in the early days of the pandemic was absolutely the right strategy.

And I'd say those retailers are also hungry for inventory as well. They're coming to us and asking for additional product. In some cases, we're able to support it. And as I said in my remarks, the replenishment demand for Little Baby Basics currently is really strong in the wholesale channel. And those are some of the folks who buy the core Mother Ship Carter's brand.

[Operator]

Our next question is coming from Jim Chartier with Monness, Crespi & Hardt. Please go ahead.

[James Chartier]

Like, I just wanted to kind of follow up onto comment about flat spring 2021. Is that just for the Carter's brand at wholesale? Or is that for overall Carter's including retail?

[Michael Casey, Chairman and CEO]

Carter's, the flagship, Carter's brand wholesale.

[James Chartier]

Okay. And so, is it reasonable to assume that the exclusive brands are planned up given the momentum that you've seen in that business?

[Michael Casey, Chairman and CEO]

Well, their order cycle is a bit different. We'll share more of that with you in February. We're expecting continued good growth with the exclusive brands.

[James Chartier]

And I guess how does spring flow or shift between first and second quarter? And is summer 2021 looking flattish as well? Or is that -- I expect it to be better than that.

[Michael Casey, Chairman and CEO]

Yes. We'll share more of that with you in February, but some of spring does start to go in December this year. That's just the normal cycle. They like to get some fresh product on the floor during the holidays and going into January. So, some of that spring does go in the fourth quarter.

[James Chartier]

Okay. And then the $50 million wholesale impact. Is that more pronounced in third quarter than fourth quarter? Or is it more pronounced in fourth quarter?

[Michael Casey, Chairman and CEO]

Well, I think fall is the bigger season than holiday. So I would say, more pronounced in the third quarter.

[James Chartier]

Okay. And then lastly, on our playwear, it seems like back-to-school, big impact on playwear in third quarter. Should that business improve in fourth quarter just because you don't have -- you're less dependent on back-to-school to drive that business?

[Michael Casey, Chairman and CEO]

Yes. So, it's back-to-school is behind us. That's -- it's -- we saw that dip in August. That was the worst of it. And then in September, as people realize kids weren't going back-to-school, they shift into other product categories. And we have the benefit. For the first time in three years, we had the benefit of the cooler weather rolling through, and that is always a stimulus in our business. Any time weather turns from warm to cool and then in the spring from cool to warm, that's a reason to get out and shop. So we saw that in a meaningful way in September.

[James Chartier]

Right. And then on the store closures, are those store closures EBITDA accretive to the business overall?

[Michael Casey, Chairman and CEO]

I'd say they're low-margin stores. I'd say low single-digit operating margin. We're opening up stores with operating margins closer to 20% and closing the low single-digit operating margin. It's just that because -- in years past, we'd say, as long as it's cash flow breakeven or better, why close them. But you got to look at where the arrow is pointing and the consumer loves these co-branded stores, the performance of the stand-alone Carter's and OshKosh stores, we made a year or so ago to exit those stores.

A lot of times when we're closing a store because a better center has opened up in an adjacent market, so we're often asked. Why are we opening stores when people are closing stores? We open up stores because we make a lot of money in those new stores. And consumers love seeing our stores. It's a beautiful brand experience. So we'll open stores closer to the consumer, co-brand stores in better centers with better margins, and we're going to close when leases either come up for renewal or there's a kickout provision that gives us an opportunity to make a decision as to whether or not we're going to reinvest in that center or exit it.

And we're more inclined -- in light of everything we're going through, we're more inclined to exit some portion of 200 or more stores. About 80% of those will happen over the next couple of years. So our focus is fewer, better, more profitable stores located close to the consumer that have a higher likelihood of serving those omni-channel consumers, those who love to shop online and swing by the store and pick up the product.

[Operator]

Next, we will move to Jay Sole with UBS. Please go ahead.

[Jay Sole, UBS]

Mike, would it be possible to elaborate on why you're saying October was up over 90% of prior year sales when September was at 95%? And maybe is there something going on there that can explain the trend?

[Michael Casey, Chairman and CEO]

Sure. It's an experience we've had over the years. Any time you see a surge in demand, like we did in September with the cool weather, there's a lull. And so when weather like here in Atlanta returned to like 80, 85 degrees, you're not thinking so much about long sleeve, long bottom outfitting. So, it's a normal type of experience that when you see a surge like we did in September, you see a lull immediately after that. But we feel good about the fourth quarter. I think we have a handle on the fourth quarter.

[Jay Sole, UBS]

And maybe can you just describe for us, what's the normal contribution of October to 4Q, like on a percentage basis? And how much -- how important is November, December?

[Michael Casey, Chairman and CEO]

I'd say September is the largest in terms of sales and earnings contribution. October will be smaller than that. I think November and December combined are more important than October, for sure just given the holidays.

[Jay Sole, UBS]

Got it. And then maybe is it possible just with sell-through at wholesale being good and inventories being lean, is it -- can you paint some scenarios -- is it possible, maybe there could be a pull forward of inventory into the channel in November and December, what retailers want you to do that? Could you do that? So maybe just frame some range of scenarios for that possibility?

[Michael Casey, Chairman and CEO]

I would actually say, we have seen our customers saying, hey, if you got it, bring it in, bring it in, we're happy to take it. That's true this year. It's been true for years. Depending on the sell through, if we have the product, we're happy to ship it to them earlier. And my guess is we'll see some of that this year.

[Jay Sole, UBS]

Got it. And then just one last one for me. Mike, you talked about less sales to off-price this year. Is that like a strategy that you continue to want to deemphasize that channel? Or is that something where next year you could see wanting to refill and replenish that channel as well with the rest of the retail partners?

[Michael Casey, Chairman and CEO]

It's one of the learnings we've had this year that we could better leverage our stores, our beautiful stores throughout the country, including Canada. Canada was a huge help to us moving through some of the excess that was created when stores closed for several weeks. So no, there's no plan, hey, let's go back and sell a lot of low markets and stuff to the off-price retailers next year. That is not -- we like the strategy that we put in place in '20, and we hope that continues in years ahead.

[Operator]

Our next question comes from Steve Marotta with CL King & Associates. Please go ahead.

[Steven Marotta]

Good morning, Mike and Richard. Third quarter SG&A as a percent of sales was roughly even with last year, which is pretty remarkable given the sales decline as well as the massive shift in distribution channel mix, towards e-commerce and digital. Is there anything in the quarter, from a discretionary standpoint, that was withheld? And I guess the underlying question is, given seasonality aside, can we think about this as a bit of a run rate from an SG&A standpoint? And then I have one quick follow-up.

[Richard Westenberger, EVP and CFO]

Sure, Steve. I would say there were a lot of things at work in SG&A in the third quarter. We had favorability across virtually every line item within the spending accounts. We were favorable on those selling expenses that you might expect to be favorable just given where the top line was. So stores expenses were lower. We pulled back on marketing. I think our marketing team has done a great job, kind of more real-time reading the mood and the sentiment of the consumer. If they're not out listening and not in a mood to shop, we've been able to kind of pull back on marketing, and we did that in the quarter.

Distribution expenses were lower. Where we saw some higher expenses would make sense to, I think relative to eCommerce fulfillment costs were up. That tracks to the 17% comp that we did. And then I'd say across most of the G&A accounts, most of the administrative areas, we saw favorability as well. We had asked the organization to curtail spending just given the business got a little choppy in the middle of the quarter. So the teams did a fine job pulling back on spending where they could.

We also have favorability at the moment as it relates to our various performance-based compensation provisions, just given how the years unfolded. Those are much lower than they were a year ago. I wouldn't expect the run rate to be the same in the fourth quarter, mainly because we've chosen to lean into some investment spending, first and foremost, because we have the ability to do so. We're not concerned about liquidity. I think we've been effective over the years where we could lean forward and make some investments, which we think will yield long-term benefit. That's what we're spending on.

If you strip that out, I'd say the run rate on spending is probably in the neighborhood of what we were down in Q3. But if you layer in these additional investments, the comparability year-over-year won't be quite as favorable. And they're across a few different areas. We've chosen to continue to invest in the website. We're going to relaunch our mobile app, which given the rise of prominence and usage of mobile devices or eCommerce shopping. We've been kind of overdue to do that. So we think that's a great long-term investment.

We've chosen to make some investments in our primary distribution center in terms of the speed and efficiency of our eCommerce deliveries. We are going to invest more in marketing in the fourth quarter. So, as we've been able to pull back on some of the brand erosive promotions, we're putting that back into brand marketing, which has proven very effective for us. And then I'd say, importantly, we've chosen to restore some of the compensation provisions that were curtailed earlier in the year in response -- the initial response to the pandemic. We have restored wages and such across the organization, which we think is appropriate given the business that we're driving and given the outstanding performance of our employees.

[Steven Marotta]

That's very helpful. So what I heard was it's not -- wouldn't be a big surprise to have SG&A deleverage in the fourth quarter?

[Richard Westenberger, EVP and CFO]

Correct.

[Steven Marotta]

I got you. And one quick follow-up is, as it relates to royalty income, it was down significantly in the second quarter on a year-over-year basis, relatively flattish in the third quarter. Can you talk about that differential and how we could think about the line item going forward?

[Richard Westenberger, EVP and CFO]

Yes. I think we -- to your point, year-to-date, it's down much more considerably than it was in third quarter. I think we've started to anniversary now some of the structural changes or strategic changes that we've made in some of those relationships. So the Genuine Kids agreement that we had with Target for a number of years, that was a significant source of the decline in the earlier quarters. That starts to normalize a bit and then some of the categories that we had in-sourced. So, that's now sales and margin for us relative to royalty income. I think we're starting to overlap some of that as well.

I think there have been some market disruptions for a number of our license partners where they've had difficulty getting their product out of China and Asia. They're subject to some of the same kind of transportation and delivery issues that we've seen with our apparel products and then just the disruption in wholesale channel. When they sell those products to their wholesale customers, we earn a royalty. Hopefully, as the market starts to recover, the roughly stream to us, will continue to improve.

[Operator]

Our next question is coming from Warren Cheng with Evercore ISI. Please go ahead.

[Warren Cheng, Evercore ISI]

I just wanted to ask a question on the strong digital growth you're seeing, both owned and partner. Do you have the customer data to see how much of that is channel shift? So the sales that used to flow through your own stores, your partner stores, and how much of that is new customers coming out of the brand?

[Michael Casey, Chairman and CEO]

You're refereeing ongoing growth, Warren?

[Warren Cheng, Evercore ISI]

Yes, I'm referencing the online growth both your own eCommerce and you mentioned some really good growth numbers out of your partner eCommerce stores -- or your partner eCommerce business, especially with your exclusives?

[Michael Casey, Chairman and CEO]

Yes. So, I think it's a shift to the consumer from stores to online. Particularly during the pandemic, I think people are more comfortable shopping at home. They're going to follow a Shopper Track, we do. And it's -- traffic in these stores has been down. And thankfully, the people who are coming into our stores are coming to buy, not coming to shop.

The units per transaction, the average transaction value is higher. And so -- but more and more people are shopping online because of the convenience and because of the -- I'll speak for our own kind of eCommerce capabilities, the beauty of the product presentation, the ease of navigation and search capabilities, the ease of checkout. Richard commented on the relaunch of our app, which will happen in the fourth quarter.

So I just think that is a -- it's going to be with us for a while. That's where consumers are shopping. And they enjoy the convenience of shopping. It is interesting to me, in the kids apparel market, still about some portion of 70% of children's apparel is bought in stores. So, I think it's just the nature of young children's apparel.

You want to go in. You find out you're expecting a child. You want to go in with your family and enjoy that experience of shopping for that first wardrobe for your beautiful new baby in the store. And my guess is our e commerce penetration, I think, was close to 40% in the third quarter. My guess is it will be probably close to 40% for the fourth quarter, and that's about 10 points higher than it was a year ago.

As we move through '21, hopefully, there's a vaccine, the fears related to the virus subside and we'll start to see store traffic improve again. But we're very fortunate that we have, I would say, one of the most successful and certainly one of the most profitable eCommerce platforms in kids apparel and that will help us some on other things to weather the storm until it settles down.

[Warren Cheng, Evercore ISI]

Got it. And then my follow-up is just on the exclusive programs. What is the price and volume trends? What are the price and volume trends been for that side of the business? And is there an opportunity to add more breadth to those offerings across categories or age groups?

[Brian Lynch, President]

Well, I think in terms of breadth, we have added, to the exclusive brands, we've got more online product for those accounts. And we've expanded, I think we said earlier the year, we've expanded in the toddler for target, Walmart and Amazon. Those businesses are doing really well. And then we're looking at bigger sizes, starting with sleeper. So there has been increase in the SKU base for what we sell those accounts as that business has grown and deserves a broader array of our products.

[Operator]

And that will conclude today's question-and-answer session. Mr. Casey, at this time, I will turn the conference back to you for any final remarks.

[Michael Casey, Chairman and CEO]

Thanks very much. Thank you all for joining us on the call this morning. Appreciate your support this past year. From all of us here at Carter's, we wish you and your families a happy and healthy holiday season together.

We look forward to updating you again on our progress in February. Goodbye, everybody.

[Operator]

Thank you. This concludes today's call. Thank you for your participation. You may now disconnect.