Carter's Inc

NYSE:CRI

Earnings Call Transcript 2021-Q3

[Operator]

Welcome to the Carter’s Third Quarter 2021 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer. After today’s prepared remarks, we’ll take questions as time allows.

Carter’s issued its third quarter 2021 earnings press release earlier this morning. A copy of the release and presentation materials for today’s call have been posted on the Investor Relations section of the company’s website at ir.carters.com. Before we begin, let me remind you that statements made on this conference call and in the company’s presentation materials about the company’s outlook, plans and future performance are forward-looking statements.

Actual results may differ materially from those projected. For a discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the company’s most recent annual and quarterly reports filed with the Securities and Exchange Commission, and the presentation materials posted on the company’s website.

On this call, the company will reference 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 Chief Executive Officer]

Thanks very much. Good morning, everyone. Thank you for joining us on the call. Before we walk you through the presentation on our website, I’d like to share some thoughts on our business with you. We’re in the final week, so the much stronger year in recovery than we had forecasted earlier this year. Our fourth quarter is off to a good start, whether it’s turning cooler, Christmas shopping’s underway and we’re seeing strong demand for our brands across all channels of distribution.

For the past 20 months, we’ve worked our way through a hopefully once in a lifetime global pandemic. We were faced with store closures and school closures, travel restrictions and lockdowns, high unemployment and shipping delays. Like other challenges and years past the financial crisis back in 2008, the great recession that followed and the cotton crisis in 2011, Carter’s employees use these periods of disruption to strengthen our company and emerge stronger from them. Forecasting sales this year at about 98% of the pre-pandemic level in 2019. Over the past two years, we’ve intentionally edited out lower margin sales.

We focused our product offerings on fewer, better and higher margin choices and reduced skews by about 20%. We then increased the mix of higher margin, longer lifecycle products, including our new organic brand Little Planet and our Bold Basics product offering. We ran leaner on inventories and reduced low-margin clearance and off-price sales.

Relative to 2019, our sales forecast this year reflects the closure of over 100 low margin retail stores, a $50 million reduction in clearance sales, a nearly 50% reduction in low margin off-price sales and lower demand from international guests who historically were drawn to our low margin clearance sales. By focusing on higher margin products, closing low margin stores, running leaner on inventories and focusing our marketing investments on brand building versus promotions, we significantly improved price realization and margins this year.

Given the collective benefit of structural changes made to our business over the past two years, we are raising our earnings guidance this morning and projecting a record level of profitability for the year. We believe the fundamental changes made to our business are producing earnings and margins, which are sustainable. Earlier this year, we shared our longer-term growth objectives with you. That was projections are now being revised based on the progress we’ve made this year.

We’ll firm up our revised growth objectives in the balance of the year and share them with you early next year. Those projections will reflect the benefits from improvements in our business, any emerging macro factors that may be helpful to us. There are multiple signs as a robust recovery in the post-pandemic period. Americans at all income levels have more savings than the pre-pandemic period. Wages are rising, not from government mandates, but through supply and demand. There are more job openings today than people seeking jobs. In Carter’s is seeing a favorable trend in job applications.

The latest CDC data reflects an increase in births in the second quarter. Growth trends are far better than projected this year. And weddings many postponed during the pandemic are projected to increase to a near 40-year high next year. It is expected that some portion of the spending plan proposed by Congress will be approved. Meaningful portion of that proposed legislation is focused on helping lower and middle income families, including enhanced child tax credits, childcare and universal pre-k for three and four-year-old children.

This proposed legislation is focused on reversing a 13-year decline in U.S. births, which would be good for our country and our company. And improvement in birth trends could be a catalyst for Carter’s. Like every year there are challenges we will continue to work our way through. We expect to be challenged by the lingering effects of the pandemic in the months ahead, including supply chain disruption and inflation. Production and transportation delays have increased since we updated June and July.

In recent years, we reduced our exposure to China due to tariffs and other rising costs. We shifted production to Cambodia and Vietnam given their higher capacity for growth and lower costs. Cambodia and Vietnam now produce over 50% of our unit volume. By comparison, we source less than 10% of our products from China. We believe that this shift in production will serve as well in the years ahead. That said Cambodia and Vietnam have lagged China in terms of vaccination rates and on-time production. With broader access to vaccines in the months ahead, we expect on-time performance to improve next year.

Transportation delays have weighed on the growth that was otherwise possible this year. Bottlenecks in the U.S. ports affected our third quarter sales and have increased the risk of wholesale order cancellations in the balance of this year. We’ve reflected that risk in our fourth quarter forecast. To put the current challenge in perspective, we’ve seen up to 20-day delays, getting our products through the West Coast ports. There’s been a 30% increase in shipping container volume this year by comparison, trucking capacity is up only 8%.

Thankfully jobless claims are at a pandemic low. With more people getting back to work backlogs at the U.S. ports and on-time deliveries are expected to improve. In recent months, we’ve invested in unprecedented level of airfreight to expedite the receipt of essential core products to serve the needs of families with young children. We focus that effort on product offerings for our largest wholesale customers who supported our brands during the most challenging periods of the pandemic.

With only eight weeks ago before Christmas, the selling windows are shortening. We are proactively engaging our wholesale customers and together deciding what products to ship in the balance of the year, which products should be packed and held over to next year and what orders should be canceled. Transportation delays may moderate in the months ahead. Historically, the peak shipping volume is from July to October. The post holiday shipping period may give the dock workers and truck drivers time to catch up as we head into the spring season next year.

Transportation rates will be higher heading into 2022, we have negotiated and locked in higher, but very favorable freight rates with our suppliers and have largely avoided the abnormally high spot market rates for ocean containers. Inflation will impact our product cost next year. Our suppliers are raising their prices to help offset higher cotton and polyester prices. We’re planning a mid-single digit percentage cost increase for our spring and summer product offerings. We’ve raised our prices by a similar percentage and our wholesale customers have agreed to those increases.

Put it in perspective, a mid-single digit wholesale price increase is about $0.30 per unit. Based on our market analysis, we believe we will be competitive on pricing next year, and we’ll continue to offer a compelling value to families with young children. For the year, we expect our retail business will drive nearly half the growth in our total sales. Our stores are expected to be the highest contributor to our annual revenue this year with store sales projected to exceed $1.1 billion.

So a very strong recovery and back to school sales in good demand for our older age segment product offerings. The profitability of our stores is forecasted to grow by over 30% relative to 2019 on nearly $150 million less revenue, driven by our reduction in skews, closure of low margin stores, leaner inventories, fewer clearance sales and improved price realization. Carter’s has the largest e-commerce platform focused exclusively on young children’s apparel. Our U.S. e-commerce penetration is forecasted to be nearly 40% this year up from less than 32% in 2019.

Relative to 2019, our e-commerce business has been our fastest growing and highest margin business. We’ve invested significantly in technology in recent years that has provided consumers with the convenience of shopping online, the ease of same day pickup of those orders in our stores and access to the full scope of our product offerings with easy online shopping in our stores. With our investment in RFID capabilities, we’re expecting higher productivity of inventory and faster shipping by leveraging over 70% of our stores to fulfill online orders.

Increasingly, our stores are providing a higher service level to our margin rich online customers. Year-to-date, nearly 30% of our online orders were fulfilled by our stores. Consumers who shop both online with us and in our stores are our highest value customers. They spend nearly 3 times more a year than our single channel customers. Carter’s is a traffic driver for shopping centers. Given the consumer staple nature of our business with children rapidly outgrowing their outfits in the early years of life, our brands drive frequent visits by families with young children.

We’ve seen the benefit of a more favorable rental market in our lease negotiations this past year. Our average remaining lease term is less than 2.5 years, which gives us the flexibility to negotiate better rates or exit the site. We renegotiated over 25% of our leases this year and over 70% of those renewals were at a lower cost.

Given the more favorable rental market, our real estate team is pursuing opportunities to open more stores than previously planned. Our focus will continue to be exiting low margin stores upon lease expiration and opening higher margin stores and centers located in densely populated areas with good co-tenancy, a high return on investment and the flexibility to exit if our investment objectives are not met. We’ll firm up our store opening plan in the balance of this year and share the revised growth plan with you in February.

Our wholesale business is forecasted to be are the second largest contributor to the sales, to our sales this year. The largest component of our wholesale sales and earnings growth is expected from our flagship Carter’s brand, which was affected by store closures last year. Demand from our wholesale customers this year exceeded our ability to support that to me and because of supply chain delays.

That said, we believe we’ll have the inventory needed to support our growth objectives this year. Our total wholesale sales this year are not expected to be back to the 2019 level. Some of our wholesale customers were more conservative with inventory commitments due to pandemic related uncertainties. That said with leaner inventories, these retailers are experiencing higher sell-throughs and margins this year.

Relative to 2020, we’re forecasting higher wholesale margins and nearly 20% earnings growth for our wholesale segment this year. Our wholesale margins will be affected by higher airfreight costs in the second half. Going forward, our annual freight costs are expected to be a fraction of the nearly $40 million investment we’re planning this year. We are the largest supplier to the largest and most successful retailers in North America. No other company and children’s apparel has the scope of distribution we’ve built over the past 20 years with our brand sold in over 19,000 store locations and on the largest most successful online platforms. Together with our wholesale customers, the online sales of our brands this year have exceeded $1 billion up over 50% compared to 2019.

We’re also seeing a strong recovery in our international sales and profitability. International sales are projected to exceed 13% of our annual sales this year, which would be a record level of sales and profitability. Our operations in Canada are expected to contribute the largest component of our international sales and earnings. We have the largest share of the children’s apparel market in Canada more than twice this year of our nearest competitor.

Despite extensive COVID-related store closures in the first half, our sales in Canada are projected up 16% this year, including over 10% growth in store sales and nearly 30% growth in e-commerce sales. In Mexico, we are executing the same strategy that served us well in Canada and the United States. We are converting all of our stores in Mexico to the more productive and more profitable co-branded model with the very best of our Carter’s OshKosh and Skip Hop brands.

Like Canada, we built a multi-channel model in Mexico with e-commerce and wholesale distribution capabilities. Wholesale distribution is an important component of our international growth strategy. Our brands are sold in over 90 countries through wholesale relationships, including Amazon, Walmart, and Costco. We expect our international e-commerce sales to exceed $100 million this year more than double the pre-pandemic period.

In summary, we’re emerging from the pandemic, a stronger and more profitable company. We’ve made substantive and sustainable structural changes to our business, which we believe will enable us to build off a higher level of profitability in the years ahead. Carter’s is the best-in-class in the young children’s apparel. Our brands have withstood the test of time in many market disruptions over the past 100 years.

We’ve served the needs of multiple generations of families with young children and believe we’re well-positioned to benefit from the post-pandemic market recovery. I want to thank our nearly 20,000 employees worldwide who have made our strong recovery possible this year and their commitment to ensure that Carter’s continues to provide the very best value and experience in young children’s apparel.

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

[Richard Westenberger]

Thank you, Mike. Good morning, everyone. I’ll begin on Page 2 with our GAAP income statement for the third quarter. Net sales were $891 million up 3% from last year. Reported operating income was $124 million up 9% and reported EPS was $1.93 up 4% compared to a $1.85 a year ago.

Our third quarter results for 2021 and 2020 included unusual items, which we summarized on Page 3. We’ve treated these items as non-GAAP adjustments to our reported results to enable greater comparability and insight into the underlying performance of the business. The adjustments were not meaningful and this year’s third quarter. Last year’s adjustments totaled $6 million in pre-tax expenses. As I speak to our results on an adjusted basis today, these unusual items are excluded.

Page 4 summarizes our third quarter performance over the past three years. As Mike noted, while we saw a strong demand for our brands in the third quarter. Top line sales performance was constrained by delays across the global supply chain. These delays had particular impact on our U.S. wholesale business, where we’ve estimated we achieved about $70 million less in sales than we had planned.

Despite this challenge better than planned gross margin and expense management enabled us to exceed our earnings objectives. For the third quarter, we posted record gross margin rate and gross profit dollars. Our adjusted operating margin was also strong at nearly 14%. As shown in the chart, despite lower revenue, we exceeded our 2019 pre-pandemic profit performance in 2021. Given our strong liquidity and improved profitability we resumed share repurchases in the third quarter when including dividends paid are cumulative return of capital to shareholders through the third quarter was $145 million.

Moving to Page 5 and our adjusted P&L for the third quarter, building on the 3% growth in net sales gross profit grew 7% to $409 million and gross margin improved by 150 basis points to 45.9% both records as I’ve mentioned. Our gross margin expansion was driven by strong consumer demand and less promotional activity, which resulted in improved price realization. These benefits were partly offset by higher freight charges, particularly air freight and the unfavorable comparison to last year’s third quarter release of inventory reserve.

Royalty income was down about $1 million. Last year’s third quarter was particularly strong as shipments of licensed products surged as stores reopened. On a year-to-date basis, royalty income has grown by 13%. Adjusted SG&A increased 7% to $293 million. Compensation provisions, which were significantly curtailed a year ago in response to the pandemic were higher as was spending on brand marketing and technology initiatives.

Spending was lower than we had planned and was well controlled. The organization did a good job cutting back and deferring spending, where possible, especially as the outlook for delays and the receipt of inventory became more pronounced. Adjusted operating income was $124 million, up 4% compared to last year and adjusted operating margin improved 10 basis points to 13.9%.

Below the line, there were a couple of factors which reduced the flow-through of year-over-year growth and operating income. First, we had a modest FX related loss in the quarter compared to an FX gain a year ago. Second, our effective tax rate was higher than last year, 21.6% compared to 19% in last year’s third quarter. This increase reflects a greater mix of U.S.-based income and higher non-deductible compensation expense relative to last year.

For the full year, we’re forecasting an effective tax rate of approximately 23% versus around 19% last year. Our average share count was consistent year-over-year, while we executed meaningful share repurchases in the quarter, it takes some time for that benefit to be reflected in the average share count used in calculating EPS. So on the bottom line, adjusted earnings per share were $1.93 compared to $1.96 in last year’s third quarter.

Moving to Page 6 with a recap of our balance sheet and cash flow. Our balance sheet and liquidity remained very strong. We ended the quarter with nearly $950 million in cash and total liquidity of $1.7 billion, when including available borrowing capacity under our credit facility.

Quarter end net inventories were 12% higher than last year. At quarter end, we had $272 million of in-transit inventory and increase of over 100% versus a year ago. As we’ve said, production and transportation delays in the supply chain have been extensive in our business, as they have been for many others as well. We believe our inventory quality is very good and we’re well reserved for known issues. We’re projecting that year-end inventories will also be up low double digits, reflecting plans to bring in product earlier to offset potential transportation delays and given good demand planned in the first half of next year.

Year-to-date cash flow from operations was $7 million compared to $319 million last year. Last year was a very unusual year, given the significant extension of vendor payment terms and rent deferrals. This year’s cash flow is benefiting from our growth and earnings, but the changes in working capital, including higher inventory are working against us.

As the business continues to recover from the pandemic, we expect to return closer to our historical profile of generating significant operating and free cash flow. As a reminder, our operating cash flow in 2019 was nearly $400 million. We resumed share repurchases in Q3, buying back $110 million of our stock, share repurchases under our current trading plan have continued in the fourth quarter, bringing cumulative repurchases in 2021 to just over $190 million. This brings our cumulative return of capital year-to-date, including dividends to over $200 million.

Turning to Page 8 with a summary of our business segment performance in the third quarter. Our U.S. Retail and International segments delivered top line growth and good margin expansion, particularly our U.S. Retail business. Our U.S. Wholesale business was disproportionately affected by the late receipt of product and higher freight costs. Both of which weighed on sales and especially segment operating income.

The increase in corporate expenses is largely attributable to higher compensation expense, given our strong performance this year and the comparison to last year, when many aspects of compensation had been curtailed. All in, our consolidated adjusted operating margin improved to 13.9%.

Our year-to-date performance is summarized on Page 9. We’ve had very strong growth in book sales and earnings in 2021, as the business has rebounded. Year-to-date sales are up 19% and our profitability is up significantly with adjusted operating income growth of 171% and our adjusted operating margin expanding to 15%. Year-to-date profitability in all of our business segments is up meaningfully.

Now moving to some individual business segment highlights for the quarter, beginning in U.S. Retail on Page 10. Our retail team did a great job managing through the quarter, delivering sales growth and even more significant profit improvement. Delays in inventory receipts also affected our retail business. The team was able to creatively and effectively manage with the inventory available to them and create compelling product presentation and promotional strategies that drove these great results.

Net sales in our U.S. Retail segment grew 4% with comparable sales growing, nearly 6%. The school’s resuming in-class instruction this year, we saw a nice recovery in back to school demand. We achieved the double-digit comp over the Labor Day selling period, with strong growth in our Big Kid sizes and playware product categories.

U.S. Retail profitability improved meaningfully in the third quarter. Our Retail team continued to make good progress and expanding gross margin through more effective pricing promotion and inventory management. Additionally, the strong retail comp sales performance in the quarter allowed us to leverage the fixed costs of the business. Regarding fixed costs, our store optimization program has allowed us to eliminate about $30 million of annual costs related to low margin stores, which we’ve now closed.

On Page 11, we have several significant technology initiatives underway in Retail currently, two of which we’ve summarized here. First, we’re in the process of replacing our point of sale system in the stores. This initiative includes both new software and the replacement of legacy hardware in the stores. This new POS is expected to drive a number of benefits, including a significant reduction in checkout times.

Our initial experience has indicated, it is as much as 50% faster. The new POS will also better integrate the store and e-commerce experiences for consumers. And ultimately enable some of the innovative initiatives we’re planning and marketing, including personalization. These marketing personalization capabilities are intended to drive stronger, more enduring and more profitable relationships with our customers.

On our last call, we told you about our RFID initiative. We’ve completed the initial deployment of RFID tagged inventory to our stores and have conducted extensive training with our Retail team. It will take into next year for all of our store inventory to be tagged, but we will start to realize some of the benefits of this technology right away, including improved visibility to store level inventory, which will enable greater store fulfillment of online orders. Our Retail field team is very excited about this new technology and what it will mean in terms of better serving customers, in addition to the numerous operational and profitability benefits we believe it will drive over time.

Now turning to Page 12 and some of our Carter’s marketing in the third quarter. One of our core strategies is to Win in Baby. Baby is the core of the Carter’s brand and we enjoyed significant credibility with consumers, having served generations of families with young children, especially those with new babies. We understand the challenges, which come with welcoming a new baby. Our research has told us that most new parents are looking for reassurance that they’re on the right track.

Our marketing team recently created the Made For This Carter’s brand campaign. This highly emotional smart features a mother, now a grandmother, speaking to her daughter who has just had her first child. We’ve received great feedback and engagement from consumers so far. We’ve included the link to the video and encourage you to watch it. Our marketing team recommends that you have some tissues nearby when you do.

Our Carter’s marketing also increasingly speaks to consumer shopping for older children. Our objective with [indiscernible] is to meet the needs of parents shopping for up to about a ten-year-old child and to increase the lifetime connection and value of our customer relationships.

Sales of these older age range products have driven meaningful sales growth in our Retail business in recent quarters. And we’re our fastest growing product segments in the third quarter.

Turning to Page 13 in the OshKosh brand, back to school is a key selling period for OshKosh. As expected with the return of in-person learning in most of the country, we had planned for a good back to school season and that’s what we delivered, especially with OshKosh. As we told you on our last call, we kicked off back to school with a new OshKosh brand campaign, Someday is Today featuring icons, Mariah Carey, Muhammad Ali, and outcast.

This campaign resulted in $2.5 billion earned media impressions and a strong lift across all key brand metrics. As a fast follow to the campaign, we’ve partnered with leading fashion house Kith to present its first ever kids’ brand collaboration, [indiscernible] OshKosh’s iconic heritage and timelessness with Kith modern aesthetic and edge and pop culture to reintroduce the brand to parents in a whole new life.

Turning to Page 14, holiday is underway and we’re pleased with early demands so far. Given the challenges of last year, including the COVID surge late in the year, which kept many families apart for the holidays. We think consumers are in a celebratory mood this year. And our holiday messaging this year will emphasize families celebrating together.

And this spirit on Page 15, in addition to beautiful holiday products, we’re continuing to develop new and innovative ways to draw consumers to our stores and to our award-winning website. Throughout the holiday season with exclusive giveaways and child and parent focused experiences.

First up is a one of its kind collaboration with Vistaprint, where customers can order their annual holiday cards with a backdrop showcasing Carter’s signature PJ prints. Family dressing, especially in Carter’s iconic Christmas pajamas has been a very strong trend in our business for the last several years and this Vistaprint collaboration is a new way to extend and enhance this touch point with consumers.

On Page 16, we’re continuing to leverage social media as a key way to connect with parents. We’ve recently expanded into new social channels, such as TikTok, and we’ve increased our video content as we continue to increase our relevance to in connection with today’s parents, especially, those from Gen Z. This strategy continues to pay dividends as we captured over 70% of kids apparel, social engagement on Instagram in Q3 and continued to grow our community of parents.

Moving to Page 17, in our U.S. Wholesale business. Wholesale segment net sales were $294 million compared to $302 million in last year’s third quarter, a decline of 3%. We’ve talked a lot about late inventory receipts and wholesale was our most effective business in this regard. The baby category is heavily penetrated in our Wholesale business and much of this product is manufactured in Cambodia and Vietnam. Two countries heavily affected by COVID. As such, inventory availability was particularly acute in this part of our business.

Because of these inventory issues, we realized about $70 million less than Wholesale sales in the third quarter than we had planned with these orders rolling from Q3 into the fourth quarter. Fortunately, the majority of this $70 million has now shipped. Our customers remain hungry for inventory. And today, we’ve not seen any meaningful customer order cancellations.

The risk of order cancellations remains elevated though, particularly if delays a fall, winter and holiday product persist or worsen, as we move deeper into the fourth quarter. Relative to our previous forecast, we have increased our estimate of shipments previously planned to occur in the fourth quarter, which will be affected by late arriving product. We’re expecting fourth quarter Wholesale sales will be up mid to high single digits over the last year.

Our supply chain in Wholesale teams have worked around the clock for many months now and a very adverse circumstances in order to serve our customers in the most complete and efficient manner possible. Bright spots in the third quarter included good overall sales growth with our exclusive brands and strong replenishment demand for our core My First Love baby products under the Carter’s brand and the replenishment components of the exclusive brands businesses.

Adjusted segment income was $40 million compared to $67 million in last year’s quarter. Segment margin was 13.7%, down from 22.3% last year. This lower profitability is due to a number of factors as summarized on this page. One very notable driver has been the very significant expenditures for air freight in the Wholesale segment, which were about $15 million in the third quarter.

As Mike mentioned, this was a significant multiple of what we spend in any given year. As I mentioned, year-to-date performance of all of our business segments, including Wholesale has been strong. Year-to-date, Wholesale margins are up 360 basis points over last year and for the full year, we’re forecasting higher earnings and margin expansion in the U.S. Wholesale segment.

Moving to Pages 18 and 19, our strong Wholesale business is a unique strength of Carter’s business model. Our wholesale partners provide 19,000 points of distribution across North America. Throughout the pandemic, we’ve leaned into marketing support for our Wholesale customers, especially Kohl’s, Macy’s, Target, Walmart and Amazon, which have been such important destinations for consumers seeking our brands during the pandemic.

Our Wholesale customers recognize the importance to consumers of having Carter’s and OshKosh as the market leading brands on their sales floors and websites. This marketing highlights are fall and holiday product and utilizes our iconic photography and branding, which consumers have come to know so well. As the world continues to recover from the pandemic, many of our Wholesale customers have strengthened their market positions with consumers and assets remain very important destinations for our products.

Page 19, we show some of the rich holiday marketing plan by Kohl’s and Macy’s, which will prominently feature the Carter’s brand. Turning to Page 20, and International segment results. Reported segment sales grew 15% in the third quarter. On a constant currency basis, segment sales grew 10%. International wholesale in Canada drove the strong growth.

Sales in Canada grew 5%, reflecting growth in both e-commerce and stores since launching omni-channel capabilities earlier this year, Canada’s omni-channel demand has ramps nicely, with stores supporting over 25% of online orders. Sales to international wholesale customers grew 70% over last year, principally driven by demand from our partner in Brazil and Amazon outside the United States. Profitability in the International segment increased meaningfully over the last year with adjusted operating margin increasing to 17.4%. This performance reflects strong sales growth and improved gross margin.

On Page 21, we continue to make good progress building our business in Mexico, despite significant COVID related disruption in this market over the past 20 months. We’ve opened three new co-branded stores in Mexico this year, including this one in Monterrey, which is quickly jumped to be one of our highest performing locations.

Turning to an update on our supply chain on Page 23. As we’ve been discussing, there are number of supply chain related challenges we’re managing through right now. These issues are not unique to Carter’s. Fortunately, we’ve taken strong steps to address these issues. First, as it relates to delay product, we’ve managed the situation over the past number of months. In close, collaboration with our wholesale customers and our suppliers, where necessary we canceled production in order to avoid order cancellation and the creation of excess inventory and related liabilities.

Our mindset has been to maximize the return on investment on our inventory rather than default to heavy clearance activity or over-reliance on the off-price channel. We’ve developed new strategies to pack and hold inventory for future seasons and to make greater use of our own retail channel to sell through excess inventory.

In certain cases, we’ve spent to expedite product from Asia to the United States, while we certainly don’t relish spending so much on air freight. We’re fortunate to have the financial strength to be able to do, many other companies do not have this same ability. Factory and transportation delays and higher transportation costs have been well-documented issues in the marketplace. Our teams have responded well by reducing our reliance on the heavily congested West Coast ports. And we’ve renegotiated our ocean freight agreements in order to improve speed and service and lock-in rates below where spot market prices have trended.

Third continent oil costs are up. These higher input costs will affect our 2022 product costs. Fortunately, our global sourcing teams have locked in product costs for the first half of next year, which are only up modestly and within our ability to cover with higher pricing. As a point of reference, we’ve estimated that raw cotton represents about 16% of the cost of a finished good.

So movements in that particular input are usually very manageable. We’ve always considered our supply chain capabilities to be a competitive and strategic asset for Carter’s. This perspective has been validated over last year, as our teams have responded so admirably to the various challenges that the pandemic has presented.

Now for our outlook for the balance of the year, beginning on Page 25. For the fourth quarter, our outlook for sales in total has improved relative to our previous forecast. This is driven in part by the movement into Q4 of wholesale shipments previously planned to occur in the third quarter and higher forecasted international demand.

As we indicated on our last call, there are several factors affecting comparability from last year’s fourth quarter, and these factors are listed here. We’re expecting to post sales of over $1 billion in the fourth quarter with adjusted operating income of $127 million and adjusted EPS of approximately $2 per share.

For the full year then on Page 26, we were encouraged by our profit performance in Q3, a combination of improved gross margins, despite incurring extraordinary transportation costs and overall effective management of other spending across the business. Our updated forecast essentially flows through the profit upside, realized in the third quarter to the full year. So on somewhat lower full year projected net sales, we’ve increased our profitability forecast. If we’re successful in achieving our forecast, 2021 would represent record profitability for the business and growth far greater than we thought possible this year.

The charts on Page 26, show our performance for 2019 and 2020, in addition to our current outlook for 2021’s full year results. We’re now targeting full year net sales of approximately $3.450 billion, adjusted operating income of $490 million, up from our previous forecast of $475 million, and adjusted EPS of $7.57, up from our previous guidance of $7.28. We’re focused on delivering a very strong fourth quarter, to conclude, what’s been a very good year for Carter’s.

And with that update on the third quarter and our outlook for the balance of the year, we’re ready to take your questions.

[Operator]

Thank you. [Operator Instructions] We’ll take our first question from Paul Lejuez with Citi.

[Paul Lejuez, Citi]

Hey, thanks guys. You guys quantified the wholesale impact to sales. Curious, maybe I missed it. Did you quantify the impact to the retail channel, if there was any significant impact? And do you expect any impact in that channel in the fourth quarter? And then second, just curious, the drivers of that 6% retail comp that you mentioned. Could you just talk about those comp metrics. Thanks.

[Michael Casey, Chairman and Chief Executive Officer]

They did a terrific job working through it and the retail team, they had a focus on making the most out of the product that they had and managing the promotions. I think the comp was driven by strong over the counter performance and better price realization. So children’s apparel is the only thing we do with our large wholesale customers, children’s apparel is a component of what they do. And so I think our focus over the years, executing at a high level is reflected in the retail performance in the third quarter. And the outlook for the year, we’re expecting a good comps from the retail segment in the fourth quarter as well.

[Paul Lejuez, Citi]

Mike, I don’t know if it was my mind, but you might’ve cut out. You cut out, at least to me, I didn’t hear, you answered the retail impact. What did you quantify that at all?

[Michael Casey, Chairman and Chief Executive Officer]

The retail team was certainly impacted by the late delays. I think they navigated well against the challenges, because they achieved their plans in the third quarter.

[Paul Lejuez, Citi]

Got it, thanks. And just one follow up, you talking about price increases for next year. How are you planning units for next year? What sort of elasticity of demand do you expect out of you’re taking prices up by, I think, you said mid single digits.

[Michael Casey, Chairman and Chief Executive Officer]

Well, we’ll let you know more in February. We’re still working through the plans for 2022. We are expecting to raise prices at least in the first half by mid single digit. We’re in the process of working through the cost for the second half of 2022. So I’ll share more with you, but we are planning good growth in both sales and profitability for 2022.

[Paul Lejuez, Citi]

Got it. Thanks, Mike.

[Michael Casey, Chairman and Chief Executive Officer]

You’re welcome. Thank you.

[Operator]

We’ll take our next question from Susan Anderson with B. Riley.

[Susan Anderson, B. Riley]

Great, good morning. I guess, just really quick on the wholesale impact from supply chain, was it just that they couldn’t get the product to their stores, as quickly as the retail side? And then I think you mentioned $70 million in sales was missed is all this being shifted into third quarter, you talked about maybe some risk of cancellation, which is in your guidance. So just curious what portion of that potentially could get canceled and how much is basic versus seasonal product.

[Michael Casey, Chairman and Chief Executive Officer]

Yes, I’ll answer that. In wholesale, the demand for the product continued to be really good. We’ve had few cancels to date as Richard share with you. And that Q3 decline was directly attributed to late arriving production. We were not able to get about $70 million of the product to the wholesale account. And you just some rough math, if we had shipped that $70 million, we would have been up about 20% the last year and above 2019 levels.

So I think Richard shared about 50% of that product already shipped in October, small portion of that may end up canceling, but most of it we expect to go. So we should have a good Q4, plan in Q4 mid to high single digits. We’ve got some cancellations planned in the business and it’s a fluid situation with the ports. We’ll see where it turns out, but we’re optimistic that overall we’re going to have a good Q4.

[Richard Westenberger]

Well, the late product was heavily weighted to fall, the fall season. We expect that both our retail stores, our retail business and the wholesale customers will have a good selection of Christmas related product. But fall is the late deliveries – in the third quarter we’re heavily weighted to fall product.

[Operator]

We’ll take our next question from Jim Chartier with Monness, Crespi, Hardt.

[Jim Chartier, Monness, Crespi, Hardt]

Good morning. So just following up, so, Brian, I think you said wholesale would have been up 20% in third quarter. And it looks like, it would have been upwards 2019, but then your fourth quarter guidance, even with kind of the benefit of that shift implies like a 10% decline versus fourth quarter of 2019. Just curious, what the difference is between those two quarter?

[Brian Lynch, President]

I think we’re making assumptions on, obviously, what’s going to move into the fourth quarter and what’s going to ship versus cancel. And then as I said, we’ve got a real fluid situation with the poor tier folks. And so we’ve got a really good order book for Q4, but in our guidance reflects the fact that we may have some additional cancels or products that we ended up packing holding for next year.

[Richard Westenberger]

For the full year, we were not planning on getting all the way back to 2019’s level for wholesale. And some of that is by design in terms of not driving as much off price channel activity that we had back then. So it’s a little dated the comparison to 2019. We are going to have good growth year-over-year over 2020. So this will be a multi-year recovery as Mike described it in the past. It gives us more opportunity to build back over time.

[Jim Chartier, Monness, Crespi, Hardt]

Great. And then I think typically you start shipping some spring orders late in fourth quarter. Do you expect some of that to shift into first quarter? And then you mentioned the double digit inventory growth at year end expected in part due to strong first half 2022 demand. Just curious what the wholesale order book looks like for spring.

[Michael Casey, Chairman and Chief Executive Officer]

Yes. The spring order book is good. And I think, we’re planning to be uploaded mid single digits in wholesale. We’ll see how things turn out in terms of shipment flow, but I think we’ll have a good spring, we’re planning for a good spring. Some of it will move over into spring some of the fall winter, we’ll slide over some of it we’ll pack and hold. But in terms of the discreet, spring summer order book which kind of defines the first half in wholesale. We’ll show more in the next call, but I would say that we’re planning on good growth and low to mid singles in that business.

[Richard Westenberger]

We move the spring orders up a couple of weeks, see if we can’t get ahead of some of these supply chain delays.

[Jim Chartier, Monness, Crespi, Hardt]

Great. And they just on the new leases that you’re signing, what’s kind of the length of those, and what’s the flexibility to exit those. And then what percentage of leases are up for renewal in 2022.

[Michael Casey, Chairman and Chief Executive Officer]

10 year leases with five-year kick outs and probably, we renegotiated about 25% of the leases this year, I guess, is we’ll renegotiate some portion about 25% of leases next year.

[Jim Chartier, Monness, Crespi, Hardt]

Great. Thanks and best of luck.

[Michael Casey, Chairman and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from Ike Boruchow with Wells Fargo.

[Ike Boruchow, Wells Fargo]

Hey, good morning, everyone. I guess, maybe Richard just on the higher inventory provisions in wholesale this quarter. I understand the revenue and the timing shifts, but I guess, can you just kind of give some context on that? I mean, we continue to hear about lower markdowns and better pricing and what have you in gross margin in the space. But I’m just kind of curious, what drove higher provisions are maybe you’re up against an awkward conflict, just trying to understand that. Just trying to understand the wholesale margin this quarter, it just seemed a little low versus what we would have expected.

[Michael Casey, Chairman and Chief Executive Officer]

Sure. Well, I would say that there’s really two dynamics within the inventory costs that largely hit the wholesale segment. It’s about $11 million or $12 million year-over-year swing. Two elements. One, a year ago, we were releasing inventory reserves. So we don’t have that benefit this year. And we did take some incremental new reserves just anticipating some order cancellations late in the quarter. I wouldn’t say, it’s all that material, but we’d have to take our best evaluation of how we see things at the time that we end the quarter. And we’ll have better visibility as we move through the quarter, but we did take some incremental provisions just for things that we think probably will end up being canceled by our customers.

[Richard Westenberger]

The biggest dividend, the wholesale margins in the third quarter were air freight. Air freight was heavily weighted to support our largest wholesale customers from memory was around $15 million. Then you have this impact of not competing against inventory releases in the last year. The benefit of that last year didn’t repeat this year, and then you also have a higher compensation provisions reflected in the wholesale margins.

[Ike Boruchow, Wells Fargo]

Got it. And then taking a step back Mike for you. It’s a good problem to have, you gave us your new multi-year margin target earlier this year and you’re way above that already, so five years early, so congrats. But I guess the question is, how much of the gains you’re seeing this year are more transitory. Should we be expecting that you believe there’s a build off of 2021 into next year. Or is there a rebased it’s going to be necessary? I know you’re not going to give guidance explicitly, but just to help us kind of understand how to frame out the next 12 months would be helpful?

[Michael Casey, Chairman and Chief Executive Officer]

We view 2021 is a new base to grow off of. So with the models we’re putting together show good growth in sales and profitability off the 2021 base. So a lot of these changes were accelerated. We always envisioned there was an opportunity to run leaner on inventory. And some of those initiatives were well underway before the pandemic hit. Our retail team was buying about 90% of their forecast for memory for fall 2019. And so some of these disciplines were in place, but running leaner on inventory, editing out low margin clearance, sales, improving price realization. That’s been one of the more significant changes that we’ve made in their business and that our merchandising design team edited out lower margin skews focused on longer life cycle product that doesn’t wind up on the clearance rack after 13 weeks. So a number of those structural changes we’ve made in the business, which I would say are substantive and give us a benefit in the years ahead.

[Ike Boruchow, Wells Fargo]

Got it. Thank you.

[Michael Casey, Chairman and Chief Executive Officer]

You’re welcome.

[Operator]

Our next question comes from Jay Sole with UBS.

[Jay Sole, UBS]

Great. Thanks so much. Maybe just wondering if you dig into gross margin a little bit, how much was the air freight expense in the quarter and how much are you seeing it impact the fourth quarter? If we can start there, that’d be great.

[Richard Westenberger]

It was about $16 million in total in the third quarter. Most of that, the vast majority 15, call it affected the U.S. Wholesale segment. For fourth quarter, we’re planning about $15 million.

[Michael Casey, Chairman and Chief Executive Officer]

Nearly $40 million for the year.

[Jay Sole, UBS]

Understood. And then maybe if we can talk about buybacks, you mentioned you repurchased about 2.5% of the outstanding shares in Q3. What can we expect for Q4, maybe just high level for buybacks?

[Richard Westenberger]

Jay, I think I’d rather report our progress and then signal exactly our intent. I think, we bought back a meaningful amount in third quarter, and I think that should be a positive signal of how we’d like to use excess capital going forward. We believe in the growth story of the company, and we think this will be a good way to use some of our – what is typically, once we get past all the noise and anniversarying the crazy numbers from the pandemic, this is a business that generates significant cash. We have a history of returning that cash to shareholders. We’d like to continue to be in that mode.

[Jay Sole, UBS]

Okay. And then maybe one more, like, if I can ask you about RFID, it sounds like pretty interesting initiative for your retail business. But is there an element of the Walmart and Target relationship that the RFID will help in? What kind of financial benefit do you think that RFID will bring to the business?

[Michael Casey, Chairman and Chief Executive Officer]

That’s the beauty of having built these relationships with Target than Walmart over the past 20 years. We’re a better company because of those relationships and we’ve learned from them. They’ve implemented RFID over the years. And for a specialty retailer, I think it’s rare to have RFID. But it’s been a recommendation from our retail team for the last few years. And we decided to make the investment and it’s rolling out now. I’ve been in the stores recently, our store associates are thrilled with the technology that they have. In the stores, it makes the work much more efficient, enables them to provide a higher service level to our customers. What we’re most excited about is, we’ve got some portion of $7 – 700 beautiful stores from Maine to Hawaii, and now we’ll have a higher level of visibility to what inventory they have in their stores.

So if we’ve got a family with young kids in Seattle and they order online, we can see which one of our beautiful stores in the Seattle area have what they need and we could package it up in the store and ship it to them. They’ll get it quicker than getting it from browse open in Georgia. And those transactions are margin accretive. So their margin accretive to an already margin rich e-commerce business. So there’s – we’re excited about it. It’s some portion of about a $10 million investment and it’ll have a – we expect a multiple that investment in terms of return over the next five years.

[Jay Sole, UBS]

Got it. Super helpful. Thank you so much.

[Michael Casey, Chairman and Chief Executive Officer]

You’re welcome.

[Operator]

Our next question comes from Warren Cheng with Evercore ISI.

[Warren Cheng, Evercore ISI]

Hey, good morning guys. It’s glad to hear – good morning. Glad to hear that early holiday demand has been good start. But I just wanted to better understand, if demand sides, okay, but the congestion continues to worsen how margins would play out. How long could that impact be? How much of your assortment is seasonal versus core? And you commented in your prepared remarks that you could use pack and hold and own retail a couple of new levers to manage those clearance levels. I just wonder if you could elaborate on that as well?

[Michael Casey, Chairman and Chief Executive Officer]

Yes. The big challenge with pack and hold was last year. So we had well over $100 million of pack and hold inventory. When stores closed at the beginning of the pandemic, that was never a big part of our business. We sold through what we ordered, but with that disruption last year, we learned a new skill and I think we navigated through it beautifully.

And in terms of demand, I would say is robust. I wouldn’t say, it’s a good. I’d say, it is robust. Consumers are out, they’re shopping, they’re spending. If we had more inventory, the sales would have been higher. And but as we go forward, the risk is really on any fourth quarter cancellations, if fall continues to come in late. You can’t move a lot of fall to the right.

You can move spring to the right. You can move summer to the right. But at some point you have to say, if the fall goods aren’t here, we’ll work with our wholesale customers to determine how much they need, given the selling window remaining. How much should be packed and held in brought up in next year and how much should be canceled. So those are the scenarios that we’re working through and we’ve worked that risk of cancellations into our fourth quarter forecast.

[Warren Cheng, Evercore ISI]

Thanks. And for my follow-up, I wanted to ask about your comment that Cambodia and Vietnam are expected to improve next year. Can you just remind us how much of your production is back online today? And later you’re hearing from your production partners in terms of when the rest might – may come – might come back online.

[Michael Casey, Chairman and Chief Executive Officer]

Well, both Cambodia and Vietnam are back online. I’d say Cambodia is making more progress than Vietnam. Based on their vaccination rates, we’re speaking with our suppliers daily. We have a visibility to what their attendance rates are, what their production levels are. Vietnam, it’s only about 20% of the units are sourced from Vietnam and now the slight this past week, it’s some portion of 20% of that 20% is ramping up more slowly, just because of COVID related restrictions in Vietnam and access to the vaccine.

So Vietnam will be a slower build given the fact that some 20% of Vietnam is ramping up more slowly, but the factories are back open and trying to get people back in and complying with the COVID related restrictions. But both are up back up and running.

[Warren Cheng, Evercore ISI]

Thanks guys. Good luck.

[Michael Casey, Chairman and Chief Executive Officer]

Thank you.

[Operator]

We’ll take our last question from Tom Nikic with Wedbush Securities.

[Tom Nikic, Wedbush Securities]

Hey, good morning, everyone. Thanks for squeezing me in here. I wanted to follow up on the gross margins. I think it sounds like a lot of the games that you’ve expect to keep – I kind of want to talk about the seasonality of it. I think this – in 2021, 1H gross margins were really exceptional. And I think 2H is going to be a little bit more modest, more like in the mid-40s. Do you kind of think, like, you get back to like a more normal seasonality in future years, where it’s a little more like evenly spread between first half, second half. Or do you think, like, if you look out to 2022, you’ll hold some of those exceptionally strong gross margins in the first half of the year.

[Richard Westenberger]

I would say, there’s certainly a seasonality in the business. And the comparisons for last 18 months have been really challenging, because you have things moving around. You have ordered timing differences between the quarters, wholesale orders can move significantly between quarter end dates and create issues. I guess, the way I’d answer your question is we expect to build on the progress that we’ve made this year. These are as we’ve turned to structural, fundamental changes we’ve made the business.

We think we’re running a stronger business. So you look for the silver lining in difficult situations. And I think the pandemic has had some of that for us. We are running the business with less inventory. I think we have a more rational promotional strategy, which still presents significant and compelling value to consumers. So our intention would be not to go backwards on gross margin. I think some of these disciplines, the entire organization I think is energized around how we’re running the business. And there’s no intent to go backwards. I think certainly comparing anyone period to a prior period is a little challenging, because you can have some things moving around that the name of the game for us is improving from where we are today.

[Tom Nikic, Wedbush Securities]

Understood. Thanks. And if he get outcast and start making music together again, that’d be great.

[Michael Casey, Chairman and Chief Executive Officer]

Thank you, Tom.

[Operator]

That concludes today’s question-and-answer session. Mr. Casey, at this time, I will turn the conference back to you for any additional or closing remarks.

[Michael Casey, Chairman and Chief Executive Officer]

Okay. Thanks very much. Thanks for joining us this morning. We appreciate your interest in the company. Look forward to updating again on our progress in February. Until then, best wishes to all of you and to your families over the holidays. Goodbye, everybody.

[Operator]

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