Carter's Inc

NYSE:CRI

Earnings Call Transcript 2022-Q3

[Operator]

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

After today's prepared remarks, we will take questions as time allows. Carter issued its third quarter fiscal 2022 earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted on the Investor Relations section of the company's website at ir.carters.com.

Before we begin, let me remind you that statements made on this conference call and in the company's 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 released 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 measures. A reconciliation of these non-GAAP financial measures to the GAAP financial measures is provided in the company's earnings release and presentation materials. Also, today's call is being recorded.

And now I'd like to turn the call over to Mr. Casey.

[Michael Casey, executive]

Thanks very much. Good morning, everyone. Thanks 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.

For the final weeks of what's been a more challenging year than we had forecasted, we expected to build on the strong recovery and record earnings that we achieved last year. 2022 got off to a strong start. We saw high single-digit comparable sales growth through the early months of this year. But in the second quarter, we began to see the effects of historic inflation weighing on consumers and demand for our brands.

Like many retailers, Carter's expected a good multiyear recovery from the pandemic. We knew that year-over-year comparisons would be impacted by the nearly $3 trillion of government stimulus last year, and we considered that in our growth plans. What we did not expect were the adverse effects of the absence of that stimulus this year, combined with a surge in gas prices, food prices and interest rates.

Carter's primary target consumers are women and men in their late 20s and early 30s. This is typically the time in their lives when many marriages occur and family formation often begins shortly thereafter. These women and men are earlier in their careers, just starting out together and working hard to make ends meet. Our target consumers' household income is about $75,000 a year. This segment of the population has been particularly hard hit by inflation.

The Federal Reserve has been raising interest rates aggressively to lower inflation. In the third quarter, Federal Reserve Chairman, Powell, said that the higher interest rates would bring, in his words, "some pain to households and businesses". We've seen some of that pain reflected in our sales this year.

A recent Wall Street Journal survey of economists indicates a high probability of a recession in the next 12 months. In past recessions, Carter's weathered those downturns reasonably well.

Children's apparel is a less discretionary product category. Children rapidly outgrow their outfits in the early years of life, which drives frequent shopping visits by their parents and grandparents. Thankfully, year-to-date, we continue to see the relative strength in our baby product offerings. In the United States, baby apparel contributed about 56% of our year-to-date apparel sales. Our baby apparel sales year-to-date are down about 2.5%. Our total apparel sales are down about 5%.

The latest birth data through March is encouraging. It was the fourth consecutive quarterly increase in births in the United States. It's a noteworthy reversal of what has been a nearly 14-year decline in annual births since the peak in births in 2007.

During the pandemic, many weddings were rescheduled to protect families and friends from COVID. With a nearly 40-year high end weddings forecasted this year, the recent and positive trend in births may continue in the years ahead.

Our third quarter sales were over $800 million, our largest quarterly sales so far this year, but about 5% lower than we expected. Third quarter earnings were in line with the guidance we shared with you in July. We saw mid-teen operating margins in each of our Retail, Wholesale and International segments. By apparel market standards, Carter's is a margin-rich business.

Our U.S. Retail segment was the largest contributor to our third quarter sales and in line with the forecast we shared with you in July. Our monthly comparable retail sales began trending down about 10% in May, and we saw that trend continue in July and August. September sales slowed with mid-teen negative comps weighed down in part by the hurricanes that impacted Florida and heat waves on the West Coast. These are 2 of our largest markets. Comparable retail sales for the third quarter were down 11% and currently trending down about 13% fourth quarter to date.

We saw the market for children's apparel become more promotional in the third quarter as warmer weather lingered longer in many parts of the United States. We achieved our retail price objectives in the third quarter and were less promotional than last year. We had a better mix and level of inventories and less clearance inventory.

And as a result, our retail price realization improved about 8% in the quarter, which covered comparable product cost increases. To date, we've seen no meaningful resistance to our retail pricing, which was up less than $1 per unit compared to last year.

Our pricing team tested lower price points in the quarter to see if they would drive better outcomes, and they didn't. Our average price point is inclusive of many multipack configurations for body suits, pajamas and playwear are less than $11, which we believe is a compelling value proposition. That said, we saw consumers pulling back on units purchased relative to last year, which may reflect lower real wages this year due to inflation.

eCommerce continues to be our highest margin business. eCommerce penetration in the third quarter was about 35% of our retail sales, a couple of points lower than last year. We're seeing lower demand from international guests shopping on our U.S. websites, which we attribute in part to the stronger dollar and reduction in promotions that attracted them in years past.

Interestingly, we've seen a benefit in our stores from improved tourism. Our border and tourist store locations had the best comparable sales in the third quarter and are running positive comps year-to-date. That improvement may be attributed to the relaxation of COVID restrictions since last year in the pent-up demand to travel again.

With our progress improving price realization, more attractive store opening opportunities are available to us and fewer stores may need to be closed. We're on track to open about 30 stores this year in the United States, including 20 in the fourth quarter.

In recent weeks, we achieved a new milestone in omni-channel sales. We saw up to 40% of our online transactions supported by our stores. Consumers increasingly enjoy the convenience of shopping online and picking up their purchase in our stores. These omnichannel customers are our highest-value customers and spend 3x more each year than our single-channel customers.

In the United States, about 70% of children's apparel continues to be purchased in stores. We have a very profitable store model. 98% of our stores are cash flow positive, and we continue to see a good return on our investment in new stores. We plan to open 100 or more stores over the next 5 years net of store closures.

Since 2019, we have closed over 100 low-margin stores, reducing our U.S. retail sales by over $100 million and improving retail profitability by over $10 million. We expect that our outlet stores will be a smaller percentage of our store portfolio in the years ahead.

With the surge in gas prices this past year, our outlet store sales have been trending lower than our strip center and mall stores located closer to densely populated areas.

Our marketing team is focused on leveraging the strength of our loyalty and private label credit card programs to better serve our customers and improve profitability. Carter's has the highest rated loyalty program in children's apparel. Over 90% of our active customers are enrolled in our Rewarding Moments loyalty program.

Our private label credit card holders surpassed 1 million customers this year. These are more frequent shoppers, and the related transaction fees are lower, so these are margin-accretive sales. Our private label credit card has grown to be one of the most frequent cards used by our customers, about 17% of our retail sales, and it's expected to grow in the years ahead.

The data from our loyalty and credit card programs enables our marketing team to better understand the consumers' needs such as the age and gender of the child, so we can personalize and improve the effectiveness of our marketing and increase the lifetime value of the relationship.

Since 2019, we've improved the profitability of our Retail segment by focusing on fewer, better product choices, rationalizing low-margin SKUs, closing low-margin stores. We're reducing the mix of clearance sales through better inventory management and improving price realization with fewer and better promotions.

Year-to-date through September, our Retail segment profitability is up over 30% compared to 2019. The recent trend in our retail sales suggests a slower start to holiday shopping than we experienced last year.

Recall that a year ago, consumers were encouraged to shop early for the best selection, given supply chain delays and inventory shortages, and they did shop early. A year ago, many consumers were benefiting from the access to vaccines and stimulus payments to help families with young children recover from the pandemic.

Last year at this time, it was a period of optimism as many prepared to reconnect with families and friends to celebrate the holidays in the post-pandemic period. Our fourth quarter comparable sales last year grew over 15%. It was one of our strongest holiday seasons ever.

By comparison, this year, families with young children are weighed down by historic inflation and the uncertainty of when things will improve. Our experience this year suggests consumers may be buying what is needed, when it is needed and not shopping as early as they did last year.

For the year, we expect our U.S. Retail segment sales may be down about 11%, with comparable sales down 10%. That said, the holiday shopping period has historically been good for Carter's. Christmas pajamas and special occasion dressing are typically some of our best sellers in the final months of the year.

With cooler weather arriving in more parts of the country, together with a better mix and level of inventories and assuming continued success with price realization, it's possible that the current trend in sales may improve in the final weeks of the year.

In our U.S. Wholesale segment, we have sales growth with 5 of our top 7 wholesale customers in the third quarter, but the growth was below our expectations. Our exclusive brands continue to be the strongest component of our Wholesale segment, with sales growth up 5% in the third quarter and up 10% year-to-date.

Many of our wholesale customers brought inventory in several weeks earlier this year to mitigate the risk of supply chain delays. We believe those decisions were made well before demand slowed earlier this year.

With the slowdown in the economy, some of our wholesale customers are running higher than desired inventory levels. In the third quarter, we saw our wholesale customers curtail inventory commitments, including replenishment orders, to achieve their inventory objectives.

Our wholesale sales in the quarter were also affected by delays in shipping, caused by port delays on the East Coast. We had expected to ship our fall product offerings about 80% on time in the quarter. Our actual shipping was about 70% on time, with the balance running a few weeks late on average.

We experienced higher cancellations due to those late shipments, which is understandable, given fewer weeks remaining to sell through those fall product offerings.

For the year, we expect wholesale sales may be down about 7%, which reflects lower replenishment trends and the risk of shipping delays and order cancellations in the fourth quarter. We're assuming growth with our exclusive brands and lower sales in our core Carter's and Skip Hop brands.

Our new sustainable Little Planet brand for babies and toddlers is growing ahead of plan with our wholesale customers. Little Planet is one of our more innovative launches in recent years utilizing organic cotton and recycled materials to provide a beautiful, affordable premium and sustainable product offering for families with young children.

Little Planet is sold through Target, Kohl's, Amazon, Babylist and Buy Buy Baby as well as through our Retail and International segments. In total, we expect sales from our new Little Planet brand to more than double this year, and we expect to see the distribution of Little Planet expand to more doors in 2023.

We're hopeful Amazon's recent Prime Day is a bellwether for holiday shopping this year. Our Simple Joys brand had one of its best performances during Amazon's signature marketing event, with sales in the 2-day period more than 3x our average weekly sales. From our perspective, Amazon's recent Prime Day was highly successful.

As you may know, Carter's is the largest supplier of young children's apparel to the largest retailers in North America.

No other company has built the scope, depth or success of wholesale distribution that Carter's has achieved for decades, which has enabled us to reach more consumers than any other apparel company serving the needs of families with young children and has enabled us to weather more challenging economic periods. Increasingly, our wholesale sales are concentrated with fewer, better, more financially viable retailers, which may serve us well in the years ahead.

Our International segment contributed 15% of our consolidated third quarter sales. Our operations in Canada and Mexico drove over 75% of our international sales with Canada, the largest contributor. We believe inflation, combined with the late arrival of cooler weather, weighed on Canada's third quarter performance. Gas prices in Canada have increased to over $7 a gallon this year.

Sales in Canada trended similar to our Retail segment in the United States, down 11% in the quarter. All other components of our International business were in line with our expectations. For the year, we are forecasting international sales down about 4%, largely due to sales trends in Canada, and we're forecasting good high single-digit growth in Mexico, given their progress opening co-branded stores.

Our International business is a multichannel model with retail, wholesale and licensing operations. In our wholesale operations, we have about 40 partners operating smaller retail chains and eCommerce platforms in nearly 100 countries. Collectively, these smaller retailers contribute over 15% of our international sales and it is a margin-accretive business.

My comments on the balance of the year reflect the high end of our guidance. Given the unusual and higher level of uncertainty on consumer demand during the upcoming holidays and our progress getting product through the ports into our wholesale customers, we've widened the guidance range more than we typically would given only 2 months to go.

This is the first holiday shopping season in over 40 years that consumers are weighed down by record inflation. Our objective in sharing guidance with you today is to reflect the current market conditions and what we believe is now possible.

Our success for many years has been driven by focusing on essential core products, bodysuits, wash clothes, blankets, bibs, blanket sleepers, pajamas and playwear. These are consumer staples families with young children purchase in multiple quantities on a frequent basis in those early years of their child's life. Our range of wholesale distribution is from Walmart to Macy's.

We believe our brands appeal to the masses. Our Carter's brand has the largest share of young children's apparel, more than 70% share than our nearest competitor. Our brands are sold in nearly 20,000 store locations in North America and on the most successful websites for young children's apparel. Together with our wholesale customers, the online retail sales of our brands this year are expected to be about $1.2 billion.

As history has shown, with time, inflation will subside. We believe the post-pandemic recovery we all began to experience last year will resume. The recovery has been disrupted and delayed by inflation. Like many disruptions to our business in years past, the financial crisis in 2007, The Great Recession that followed, the cotton crisis in 2011 and the pandemic, Carter's weathered those storms and emerged stronger from them.

In 2020, the most disruptive year of the pandemic, Carter's retained a higher percentage of profitability than most in our peer group. A year later, in 2021, we recovered and achieved a record level of profitability. Prior to the pandemic, Carter's has achieved 31 consecutive years of sales growth.

Last year, we reported over $500 million in adjusted operating income, inclusive of extraordinary provisions for air freight, incentive compensation, special compensation and retirement benefits to all employees and higher charitable contributions. Our challenge now is to work our way back to that higher level of profitability, which we are committed to do in the years ahead.

To mitigate the impact on earnings from the near-term market conditions, we plan to reduce inventory purchases in 2023, work our pack & hold inventories down profitably and stay lean on discretionary spending in all components of our business where possible.

We plan to continue investing in our eCommerce capabilities, customer acquisition our stores, which are the #1 source of new customer acquisition, brand marketing and our distribution capabilities to enable a good recovery from the current market challenges.

We expect product costs and transportation costs will remain elevated in the first half of next year, then improve in the second half. In the balance of this year, we plan to firm up our forecast for 2023, and we'll share them with you early next year.

I want to thank all of our employees throughout the world who have supported Carter's through the volatile market conditions and challenges over the past 2 years. With their continued support, I believe Carter's best years are ahead of us.

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

[Richard Westenberger, executive]

Thank you, Mike. Good morning, everyone. Beginning on Pages 2 and 3 of our materials, we've included our GAAP P&Ls for the third quarter and the year-to-date periods. As summarized on Page 4, we had no adjustments to our GAAP results in the third quarter and only minor adjustments in the third quarter last year. For the year-to-date period this year, we had charges related to the early repayment of debt. And last year, we had unusual charges related to COVID, restructuring costs and our store closing initiative. This information is included for your reference, and I'll speak to our results on an adjusted basis this morning.

On Page 5, we've summarized our sales and profit performance in the third quarter. Our net sales declined 8% to $819 million. These results were below what we had expected by about 5%, but reflective of the overall market right now.

Our U.S. and Canadian Retail businesses represented the majority of our sales decline versus last year, a result of lower consumer demand throughout the quarter. Our profitability was within the range we had guided to previously. We had operating income of $92 million in the third quarter, a double-digit operating margin and adjusted EPS of $1.67.

Our year-to-date performance is summarized on Page 6. Given the disruption that record inflation has caused to consumer demand and to our cost structure, our sales and profitability are down versus 2021. Recall that 2021 was a year of record profitability for Carter's.

Given the uncertainty in the market at the moment, especially related to the level and consistency of demand, our focus is on profitability, which has always been a differentiating characteristic of our company.

To provide a little more color on our performance in the quarter, I'll turn to our adjusted P&L on Page 7.

On the $819 million in net sales in the quarter, our gross profit was just over $370 million, representing a gross margin rate of 45.3%. The decline in gross profit versus last year was overwhelmingly driven by lower sales, which represented $33 million of the overall $38 million decline in gross profit.

Gross margin was down 60 basis points, close to last year's record gross margin rate. We had significant favorability in the quarter from not repeating about $15 million of air freight, which was incurred last year to expedite delayed product. Unfortunately, this benefit was offset by a largely identical increase in transportation costs from higher ocean container rates.

As the worldwide economy has begun to slow, we're seeing indications that costs are moderating, and we might see some relief on these elevated transportation costs beginning next year.

The balance of the change in our gross margin rate was largely mix related, with a higher proportion of U.S. Wholesale sales, which carry a lower gross margin than sales in our U.S. and Canadian Retail businesses.

Importantly, we continued our progress in improving price realization across the business in the quarter, largely offsetting higher product costs. Our spending in the quarter was well controlled, down 2% compared to last year. We had [ lower ] spending in a number of variable spending categories corresponding to the lower level of sales in the quarter and provisions for performance-based compensation, which were lower than a year ago.

Freight and distribution costs were up year-over-year. Given the backlog at the East Coast ports, higher market transportation and logistic costs and just our overall higher level of inventory, we've been spending more on logistics and distribution-related expenses.

The congestion at the ports, both West Coast and East Coast, continues to lessen. As these improvements continue and as we work down our inventory level, I would expect that our distribution and freight costs will improve from their current level.

All of this nets down to operating income in the quarter of $92 million, representing an operating margin of 11.2%. Below the line, we continue to benefit from lower interest costs. A year ago, we had $500 million of pandemic-related financing outstanding. We retired that debt earlier this year.

Our effective tax rate was just under 20% in the quarter compared to 21.6% last year. We're expecting a lower percentage of our profitability to be generated in the U.S. compared to our very strong performance last year. This has the effect of driving down our effective tax rate. We're expecting a full year effective tax rate for 2022 of about 22%, down about 50 basis points from last year. This decrease is, again, largely driven by a lower projected mix of earnings to be generated in the U.S. this year.

We've also completed a meaningful amount of share repurchases this year, which has lowered our average outstanding share count. So on the bottom line, adjusted earnings per share were $1.67 compared to $1.93 a year ago.

Our adjusted P&L for the first 9 months of the year is included on Page 8 for your reference. Our year-to-date adjusted operating margin was 11.7% compared to 15% in 2021. This decline was principally driven by fixed cost deleverage on lower sales and higher freight expense.

On Page 9, we summarize some highlights of our balance sheet and cash flow. Overall, our balance sheet is in fine shape. In this environment, having a strong balance sheet such as ours is a key advantage. We have substantial liquidity, roughly $730 million with cash on hand, and the majority of our $850 million revolving credit facility available to us. In the last year, we deleveraged our balance sheet meaningfully, and we believe we have significant flexibility, including additional borrowing capacity, should we desire it to manage our operations and to grow our company over the coming years.

Our Q3 ending inventory was nearly $900 million, up about 24%. Inventories were about $20 million or 2% higher than we had forecasted, largely a result of lower wholesale sales in the quarter, and I'll speak more about inventory in a moment.

Our year-to-date cash flow is lower than last year, largely a result of lower earnings and the increase in inventory. Given the seasonality of our business, we expect to generate significant operating cash flow in the fourth quarter. At the high end of our guidance range, this would imply full-year operating cash flow in the range of $40 million to $50 million.

Cash flow is a priority for us. As demand and inventory levels normalize, we would expect that the business will return to its historical pattern of significant cash flow generation, which is another long-time and differentiating characteristic of Carter's. We continued to return capital to shareholders in the third quarter, and this is summarized at the bottom of Page 9.

In addition to paying $90 million in dividends, we've completed over $240 million in share repurchases through the third quarter, representing about 7% of our shares, which were outstanding as of the beginning of the year.

Regarding inventory, we have some additional information on Page 10. Our inventory at the end of the third quarter was $899 million, up 24% versus this time last year and, as I said, slightly above where we had planned to be. Excluding pack & hold inventory, our inventory increase over last year was about 13%, driven by earlier receipts and higher product costs.

Given the disruptions in the supply chain throughout 2021 and the strength of our business last year, we took action to bring in product earlier than historically, which has contributed to the increase in our inventory. The amount of in-transit inventory remains high, about 28% of our inventory. This is above historical levels, although improved versus last year as a proportion of our total inventory.

Given the dramatic slowdown in demand, which began earlier this year, we've also taken action to better align inventory with the demand we're seeing in the market. In total, we've made decisions affecting roughly $175 million of inventory commitments for 2022 and 2023. These include reducing or canceling planned production and packing and holding certain products to sell profitably in future seasons. Our priority is to maximize the return on our investment in inventory. Given the nature of our product, which we view as fairly timeless and less reliant on fashion, we're not planning to liquidate inventory at deep discounts.

Our pack & hold inventory balance at the end of the third quarter was about $100 million and was comprised largely of fall/winter 2022 product, which we expect to sell in 2023. Recall that in 2020, we packed and held over $100 million of inventory, which we subsequently sold through profitably in 2021. It's our objective to achieve the same favorable result with the 2022 product, which we've now earmarked for sale next year.

Finally, product costs are higher, which is additive to our inventory balance, product costs for the first half of next year are expected to be up in the high single-digit range, consistent with what we're seeing in the second half of this year, with costs likely moderating in the second half of 2023.

Right now, we're projecting year-end net inventories to be approximately $775 million to $800 million or an increase of 20% to 25% over last year. Excluding pack & hold, our projected year-end increase in inventory is expected to be between 10% and 15%.

Beginning on Page 12, we have some additional details on third quarter performance. Overall, our operating margin declined from 13.9% to 11.2%, principally due to lower sales and expense deleverage. These effects were most pronounced in our U.S. Retail and International segments, given the high fixed cost structure of our direct-to-consumer businesses.

Turning to Page 13 and some additional color on each of our businesses and their performance in the third quarter. In our U.S. Retail segment, sales decreased to 12%, and this was in line with our plans. We believe our core consumer has pulled back their shopping activity overall, including for our products, as a result of the higher inflation, which they're experiencing in virtually every aspect of their lives right now.

Total comparable sales declined 11%, with lower sales in both our stores and eCommerce channels. Our retail comps were pressured by lower store and website traffic as well as lower units per transaction. A bright spot in the quarter was our continued progress in improving realized pricing, with average unit retails up high single digits versus last year, in line with our plan.

Retail's operating margin was 14.1% compared to 18.7% last year. This decline was principally due to spending deleverage from lower sales. Higher product and freight costs offset the benefits of improved price realization and lower provisions for performance-based compensation.

In our U.S. Wholesale business, sales were down 2% versus a year ago. Collectively, sales of our exclusive Carter's brands grew 5% in the third quarter and, as Mike said, were up 10% year-to-date through the third quarter. The presence of our brands with these retailers has been very important, with their businesses offering thousands of store locations and their websites garnering millions of visitors.

Replenishment demand slowed during the quarter as customers realigned their inventory levels to better match the lower demand trend occurring across the industry right now. In some cases, wholesale customers are executing broad-based reductions of inventory levels regardless of product category or current performance.

Supply chain delays also affected our Q3 wholesale performance, contributing to higher order cancellations and some planned demand shifting out of Q3 into the fourth quarter. U.S. Wholesale operating margin improved 20 basis points to 13.9%. Better pricing, lower spending on air freight and lower compensation expenses were mostly offset by higher product costs, higher ocean freight rates and distribution expenses.

We incurred about $7 million in one-time distribution expense in the third quarter relating to transitioning product, primarily Skip Hop, from a high-cost third-party distribution facility in California to a lower-cost facility in our Georgia distribution network.

International sales declined 7% in the third quarter. On a constant currency basis, sales declined 5%, representing about a $3 million headwind from the stronger U.S. dollar. Two of the more significant components of our International business: Canada and Mexico. Sales in Canada were down for the reasons that we've discussed. Our business in Mexico delivered double-digit sales growth in the third quarter, driven by the strong performance in the direct-to-consumer part of the business.

International segment operating margin was 14% in the quarter compared to 17.4% a year ago. The decline reflects better price realization and lower performance-based compensation, which were more than offset by a lower mix of high-margin eCommerce sales in Canada and higher ocean freight rates.

Turning now to some of our marketing initiatives, beginning on Page 14. Mike shared a lot of good information on our Little Planet brand in his remarks. We believe that in less than 2 years, Little Planet, which is our newest brand, has become one of the largest and most successful organic and sustainable children's clothing brands in the market.

Demand for Little Planet products has been strong this year, even in the face of consumers becoming increasingly price conscious. Little Planet products are priced higher than the equivalent Carter's products, but Little Planet is positioned to represent an accessible premium brand. We've expanded Little Planet's distribution to over 750 doors, largely driven by a growing presence across our own stores, Target and Kohl's.

We've recently broadened the Little Planet assortment to include outerwear made from recycled materials, launching just in time for colder fall weather. This year, we will again offer a Little Planet family holiday pajamas in organic cotton after a strong performance in last year's holiday season.

Pages 15 and 16 showcase our branding initiatives at Target and Walmart, 2 of our important Carter's exclusive brand wholesale customers. During Q3, we rolled out improved branding for both, Just One You at Target and Child of Mine at Walmart.

This branding is in place both in stores and online and increases the prominence of the Carter's brand, which is the #1 brand in young children's apparel in North America. These branding initiatives are good examples of how we use the creativity of our organization and our ability to invest behind our brands with our most significant wholesale customers.

On Page 17, Carter's exclusive brand for Amazon, Simple Joys, enjoyed prominent placement in Amazon's Early Access Prime event earlier in October. This 2-day event was one of our most successful events to date. We're very pleased with the successful early launch of the holiday selling season for Simple Joys. As Mike commented, our Simple Joys sales during this important Amazon promotion were a multiple of our typical weekly volume.

Turning to Page 18. As we told you on our last call, we've launched a partnership with Hilary Duff, an actress and millennial mom of 3 children, who enjoys an incredible following. Our association with Hilary has generated a good deal of excitement so far. As part of this brand marketing campaign, which is focused on acquiring new customers, we launched the first of 2 baby collections, developed in partnership with Hilary. This product is available on our website and in store.

And on this slide, we show some great in-store brand marketing to showcase this collaboration. Our second baby collection, developed in collaboration with Hilary Duff, will launch in spring 2023.

Moving to Page 19. Retail stores are an important component of our plans to build a larger, more profitable direct-to-consumer business over time. Mike shared a number of the reasons why we're bullish on our stores, including the role stores play in customer acquisition and their contribution to creating compelling omnichannel experiences for our customers. Given the strong financial return of our new stores and the availability of attractive real estate, we're evaluating additional store opening opportunities above those currently planned.

Turning to Page 20. Earlier this month, we launched our holiday marketing. As you can see on this page, we continue to highlight the beauty of our assortment and the breadth of our holiday offerings from Baby's First Christmas to Matching PJ's for the whole family.

We've digitally enabled our holiday gift guide for 2022. This printed guide card will reach consumers' homes next week. It contains a QR code, allowing instant online access to our full holiday assortment as opposed to [ past ] holiday mailers. This year's holiday gift guide is a good example of how we are engaging with our customers in a more modern and digital way.

Moving to Page 21. Our leadership position across social media remains strong. We're seeing continued growth across our community building efforts, especially on TikTok. The next generation of parents are highly engaged with social media, and these channels will help us foster connection and trust as this group moves into parenthood.

Turning to Page 22 with some additional highlights on our business in Mexico. Pictured here is a new co-branded store, which opened recently in North Central Mexico. We're planning to open 12 new stores this year, including 6 in the fourth quarter. We're opening these stores primarily in high-traffic malls in the largest cities across Mexico. Consumers have responded very well to the broader assortment offered in these stores relative to the smaller boutique format stores we've historically operated in this market. Over the next 5 years, we plan to triple our retail square footage in Mexico.

Turning now to our outlook for the balance of the year on Page 24. As Mike said, the industry's outlook for the fourth quarter and the holiday shopping season is not as strong as we experienced last year. Consumer demand may very well remain under pressure as inflation is unlikely to moderate meaningfully by the end of the year.

We're focused on what we can control in this environment. We're maintaining our disciplines around pricing and promotion. We're working to manage our inventory position, and our objective is to stay lean. We're scrutinizing every aspect of discretionary spending across the business while also planning ahead, so we're best positioned for when the market eventually recovers.

While supply chain performance has clearly improved especially over a year ago, challenges remain. Product continues to arrive later than scheduled, increasing the possibility of wholesale customer order cancellations. And higher freight and distribution costs continue to weigh on our P&L. In spite of these challenges, there are a number of positives as we move through the balance of the year.

Our product assortments and holiday marketing plans are compelling. Our inventory position has meaningfully improved over last year, both in quantity and composition. We're well positioned to support consumer demand over the holidays. We remain focused on profitability, which is supported by our progress in price realization and good control of spending across the organization.

Our Q4 earnings per share are also expected to benefit from lower interest expense and the cumulative benefit of our year-to-date share repurchase activity.

In terms of our specific objectives for the fourth quarter on Page 25, given our third quarter performance and current market conditions, we've lowered our outlook for the fourth quarter relative to our previous guidance. We now expect fourth quarter net sales in the range of $845 million to $885 million, which assumes U.S. Retail comps down in the range of 10% to 15% and lower U.S. Wholesale sales, reflecting the risk of lower demand and supply chain delays.

And we're assuming lower International sales, largely driven by lower projected demand in Canada and from our international wholesale customers.

In terms of profitability, we expect Q4 adjusted operating income in the range of $85 million to $115 million and adjusted EPS in the range of $1.40 to $2. If we're successful with our fourth quarter plan, full year 2022 net sales would be in the range of roughly $3.1 billion to $3.2 billion, adjusted operating income in the range of $355 million to $385 million and adjusted EPS in the range of $6.05 to $6.65.

Our teams are focused on delivering the strongest fourth quarter possible. Our company has a history of weathering difficult market conditions, and we expect we will continue to do so in this current challenging environment.

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

[Operator]

[Operator Instructions] And our first question comes from the line of Warren Cheng from Evercore ISI.

[Warren Cheng, analyst]

I was wondering if you can give your thoughts on why the young family or young moms seems to be more discretionary with this category than in the past. So in your prepared remarks, you had some interesting insights on pressures weighing on the core consumer, which we all understand. But can you help us understand just why the consumer behavior seems to be different versus the last recession?

[Michael Casey, executive]

Well, the last recession didn't have a 40-year high in inflation. And when you think of our target consumer, primary target consumer, these are relatively young women and men, late 20s, early 30s, just starting out in their careers. Average household income around $75,000. And when you take it back -- when you look at -- talk about our direct-to-consumer business, probably would be about -- down 10% this year.

You have to ask yourself, is that consumer, our target consumer, is that affected by some portion of 10% in their spending habits this year? We believe they have been. That's what we're seeing in the performance. So it is a less discretionary product category. But I think across the board, our target consumer has been most affected by this record inflation, and they're pulling back.

[Warren Cheng, analyst]

That's very helpful. And my follow-up is on the gross margins. So your gross margins, they were a bright spot in the quarter. You're still maintaining a level, almost 3 points higher than pre-pandemic. And it's great to see that you continue to have success with the retail price realizations.

If we continue to see the softer level of demand or exacerbates, how do you think philosophically about using price to stimulate demand versus maintaining these great gains you've achieved since 2019?

[Richard Westenberger, executive]

Well, our intention, Warren, is not to go backwards on gross margin. We've had some hard-fought wins here in terms of improving our realized pricing, which we always felt was an opportunity in the business. It felt like the business had become overly promotional. The consumer had stopped listening and responding as much to deep discounts. We've tried a bit of that. Given demand is lower. We've tried a little bit of that higher promotional messaging recently, and it just really did not spark things. But we've built some better capabilities, which I think we're going to service long term.

We have a group that's focused on pricing for the first time in our company's history, some great individuals we've added to the company. We've also added some just new technology and tools to help those individuals be a bit more scientific about our pricing. So I think there's still room to go in terms of what we can maximize there.

We also have a terrific supply chain that's continued to focus on our relationships with our suppliers. And I don't think we've completely maximized our opportunity to drive down product costs over time. So the combination of those, I think, returns well and the continued growth in our Retail business, which is the gross margin-rich part of our business.

[Operator]

And our next question comes from the line of Tom Nikic from Wedbush Securities.

[Tom Nikic, analyst]

I believe you said U.S. Wholesale for the year should be down 7%, which kind of implies that Q4 is down in the high 20s. That seems pretty dramatic. And that would result in like -- Q4 wholesale being like way below like fourth quarter of 2019. I mean, I guess, is there like -- and I know all year, you've been kind of talking about like the exclusive brands at the -- kind of the mass merchants doing well.

The decline that you're seeing in Q4, is that basically just like across the board? Are there like some wholesale partners who just like kind of completely turned off the faucet? Like, I guess, if you could help us like kind of understand why Q4 is down so much, that would be helpful.

[Michael Casey, executive]

Yes. Tom, we expected it would be lower. I'd say that relative to the July forecast, it will be about -- in round percentage, it's about 15% lower than what we had expected in July for the fourth quarter. And it's largely because the wholesale customers -- keep in mind, like Carter's, everybody was bringing product in earlier this year to get ahead of supply chain delays. So here's one customer, we probably brought our product in probably 4 to 6 weeks earlier. Some of our wholesale customers brought product in as much as 12 weeks earlier, just to get a head of supply chain delays.

Those decisions were made, I'd say, long before we saw the slowdown in consumer demand, which, at least for us started to be apparent to us sometime in May. So we knew the wholesale fourth quarter sales would be lower because they were elevated last year. If you recall, last year, we moved about -- it was probably because of supply chain delays, about $70 million of wholesale demand moved from the third quarter into the fourth quarter last year. So we knew as we planned this year that a good portion of that $70 million would not repeat in the fourth quarter this year.

So I think a better way to think about it, our wholesale, we have changed our wholesale forecast for the fourth quarter by about 15% relative to what we shared with you in July, heavily weighted to department stores, but it's not only department stores. We've even seen with some of our exclusive brand customers say, "Hey, listen, we got enough. We brought a lot of product in early. We got enough to make our way through the balance of the year. So hold off sending us more."

Even -- something we have rarely seen is automatic replenishment orders turned down. The beauty in our business with automatic replenishment, it's automatic. So as the register rings, triggers in water and more product is on the way from us to our customer to keep the fixture filled.

But I think many retailers across the board, department stores, exclusive brand customers, I'd say, across the board, they're saying, "You know what, this can slow down in consumer demand. It's greater than we had anticipated when we made our inventory decisions this year. So we're going to dial it back." We're going to just -- there's -- they've got probably enough to make their way through the balance of the year.

We'll still have good shipments in the fourth quarter, but certainly will not be at the level that we anticipated earlier this year, nor will it be the sales that they anticipated earlier this year.

[Tom Nikic, analyst]

Got it. And then a quick follow-up. So obviously, you had a really good year last year with stimulus. Do you think possibly what's happened is that last year with all the stimulus that happened, like parents bought maybe multiple years worth of clothes for their kids, so like maybe somebody with a newborn bought enough clothes last year to get the kid through 2 years old or something like that, and then that's possibly weighing on the 2022 performance?

[Michael Casey, executive]

I think that's possible. I don't know about multiple years, but I think that's possible. Again, I still say, when you think about our consumer, our consumer, how they've been affected by inflation -- I remember when I was in my late 20s, early 30s, our target consumer, we had 3 kids within 30 months, it was a paycheck-to-paycheck experience.

Think about where you were in your late 20s, early 30s, paycheck to paycheck. Now if you have record inflation, you're pulling back. I've seen some of the news reports now as people are getting focused on home heating prices, fuel prices, particularly up in the Northeast, they are more than doubled. So it's -- I think the economy is in tougher shape than anybody envisioned, even in July, as we head into the balance of the year.

So did they buy ahead? I think that's part of it. I think more of what we're seeing is they're just pulling back. They're buying more of what's needed and less of what's wanted in buying it when they need it. And again, there's still 2 good months to go, 2 important months to go. But a year ago, everybody was encouraged to buy early.

All of the holiday marketing started early. People wanted to get ahead of it because it was a period of optimism, had the vaccines, they were starting to travel again, reconnecting with families and friends they hadn't seen over the Christmas 2020 holiday. The world is in a different place today than it was a year ago.

So year-over-year comparisons over the past couple of years, I think, have been challenging, right? We keep on going back to 2019. Relative to 2019, our business, at least, particularly our Retail business, is much more profitable than it was in 2019. But I think it's going to -- we knew the recovery would be a bit uneven. I think it's been bumpier than most companies assume this year.

[Operator]

And our next question comes from the line of Jay Sole from UBS.

[Jay Sole, analyst]

My question is just on margins. The adjusted EBIT margin for 4Q implies a pretty big step-down relative to '19 versus the year-to-date trend. So just wondering what's the split in the guidance for 4Q between gross margin and SG&A? And within the gross margin, how should we think about the pressure between U.S. Retail and U.S. Wholesale?

[Richard Westenberger, executive]

Jay, I'm probably a bit more focused on the comparison to last year's fourth quarter. I think 2019, in terms of just timing, is becoming a little distant to look at discrete quarters that far back. But we are focusing on having a good operating margin in the fourth quarter, roughly equivalent -- for the high end of our guidance, roughly equivalent to our fourth quarter margin last year.

Within that, we're planning for expansion in gross margin. And that comes from a few different sources. One, we're spending a little less on transportation. While that's been injurious to the P&L all year, that becomes a little less so in the fourth quarter. It was this time last year when some of the rates really started to spike up. And so that comparison becomes a little less favorable -- a little less injurious, I should say.

And product margin is expected to be good. So that continued progress in price realization, we started to widen out a little bit of the gap from a product margin point of view. The gap between pricing and product cost, that's beneficial.

And then on SG&A, we're expecting a bit of deleverage, which is kind of offsetting. So you kind of have a good guide in gross margin, and a little bit of deleverage from SG&A, which is largely just driven by the lower sales. We've got tremendous favorability that we are driving from not having the outsized provisions that Mike was referring to in terms of performance compensation, charitable giving and such. That's offset, though, just by deleverage on the lower sales. But that's down to a very comparable operating margin for our forecast versus Q4 of last year.

[Jay Sole, analyst]

Got it. Okay. And if I could ask one more? Just on the comp guidance for 4Q, given there's a little trend there between Q3 and Q4, can you tell us maybe how things look quarter to date? And sort of what has to happen in terms of like a catalyst for the for the trend to change? I mean in other words, like could we see this trend [ extension ] 2022, given inflation is so high and obviously, families are still going to be under pressure? Any thoughts about that would be helpful.

[Brian Lynch, executive]

Jay, while our comp guidance is down about 10% to 15%, last quarter, we were down 11%. Like Mike stated, for the month of October, we're down about 13%. And it's an interesting month. The first couple of weeks, we had a good start when weather turned cooler and some of the areas, particularly in the Southeast, but week 3 and 4 have been softer for us.

And when I look across the data we're getting from our retail partners, it's pretty much the same trend. So we're down about 13% with a few days to go, so let's call that October.

I think one of the things we're looking at is, I think as people are buying closer to need, we're hoping what's happening is maybe the holiday shopping period is becoming a little bit more like it was a few years ago versus last year. And last year, folks were worried that there wasn't going to be enough inventory, so they were shopping earlier. And the hope is that, that shopping period is going to be more pronounced this year in November, maybe later in November. So that's you say what has to happen.

I think our experience quarter-to-date is in the midpoint of our guidance for that to get better. We look for a really strong period late November, Black Friday. We started our marketing in a bigger way just this weekend and next week with daily deals and those sorts of things. But the inventory position that people have that we have is better than last year.

Last year, we didn't have as many of the Christmas PJs and our retailer partners were running out of good. So people have the product to do the business. It will come down to what the consumer demand is and what they're willing to spend on children's apparel this holiday season.

[Operator]

And our next question comes from the line of Ike Boruchow from Wells Fargo.

[Irwin Boruchow, analyst]

Going back to Tom's question, just on wholesale, can you talk a little bit, Mike, I guess, you said 15 points lower versus what you thought 3 months ago? How much of that is just order book versus maybe cancellation that you're seeing ahead of holiday?

And then just again, just given the decline that, that implies for Q4, is there any visibility into the spring wholesale order book? How is kind of net pricing look within that book? Any need for markdown dollars that you're expecting now in the first half for spring? Just any more color there would be really great.

[Michael Casey, executive]

Sure. And on the first, the split between lower demand, lower replenishment trends, you had to split it between demand and cancellations because of late deliveries, I'd say, it's probably 50-50. That's our best analysis.

And whereas a year ago, it's a completely different environment. Our wholesale customers were scrambling for goods. It started, number one, of our largest customer, "Send us anything you got." This was a year ago. "Send us anything you got because anything you send us is sounding like it's free." That's what the environment was a year ago.

This year, it's more if you're late, there's kind of a low tolerance for being late. Maybe a week or two late, fine. But if you're more than a week or two late, they're basically saying, "Listen, hang on to it." And this time of the year, especially as we're in the home stretch, the weeks of selling are fewer for fall products.

So if you're late on full product, they're more likely to say, "Hey, don't need it, and hang on to it, and we'll bring it back next year." So demand, late shipment is probably 50-50.

In terms of visibility into next year, I would say, by and large, our wholesale customers are approaching, at least the first half of next year, cautiously. And we had a couple of top-to-top meetings in recent weeks. And that's -- they've shared with us their experiences are similar to ours. So they're going to approach next year cautiously.

And we would expect that there would be lower wholesale demand in the first half of next year. We don't have visibility into the second half, but we'll probably have a better visibility when we update you in February, what we think is possible in the second half of the year. But we are assuming that wholesale demand will be lower in the first half of next year.

You referenced markdowns. A key part, I think it's an important part, this whole pack & hold strategy, which worked beautifully for us in '20 and '21. So when all the stores closed in '20, we packed and held well over $100 million of inventory, beautiful inventory, entire season, so all the summer 2020 was packed and held and brought back and sold at very good margins in summer 2021. And we just held on to spring longer.

It usually has not been our way of doing business. But in light of the kind of historic disruption, we said, let's try something new and different. Our teams did an outstanding job working through that product profitably in '21, which enabled record profitability last year. When business slowed this year, we started to pack & hold.

Today, we probably have a better part of $100 million of inventory that's packed and held, in the end will be brought back next year. And we'll just reduce next year's by a similar dollar amount. Instead of buying new product, we're just going to take the product that's on the shelf now and sell it through profitably. So the whole objective of that is we refer to as a margin preservation strategy. So there's no need to mark down this beautiful product that we put so much thought into and brought it from the other side of the world to throw it down the clearance rack.

We'll bring it back next year, we'll lower next year's buys, and we'll sell through this product in 2023 that we've packed and held just like we did successfully in 2021.

[Operator]

Our final question for today comes from the line of Chris Nardone from Bank of America.

[Christopher Nardone, analyst]

Can you talk about any proactive measures you've taken this year to cut back on some of your variable cost spending? And then how should we think about that potentially coming back as we head into next year?

[Brian Lynch, executive]

Chris, I would say all of the usual suspects have been on the table and have been managed well by our teams, given the lower demand, lower unit volumes. So our DCs have worked very hard to lower the labor in the DCs relative to the unit volume that's going through. Our store labor has been ratcheted back to match the level of sales we're doing at the moment. .

I'd say, beyond that, though, it's really the fixed cost of this business, which are high, particularly in the direct-to-consumer part of the business. But that's been a challenge, just given the lower level of sales. So our objective is to stay as lean as possible and not add to that fixed cost structure. Where we need to, we will. And we're balancing what we believe is going to be a very strong recovery over time.

We don't want to be so draconian in cutting back on spending that we harm the business for the long run. That's what we're managing to. We're managing to have this business be here for another 150-plus years. But we're staying extremely lean on the things that we can control in this environment. We're being very disciplined on inventory.

I think the team has done a great job responding to the lowered outlook for demand and realigning our commitments for inventory. We're being very judicious on adding additional staff to the business just -- both in those variable [ cost ] centers and in our offices. The best thing we can do is just not get ahead of ourselves.

But everything is on the table for review. We're looking at technology projects, marketing, everything that are big-cost centers are subject to review, and that's going to serve us well, and we'll be in a good position once the marketplace starts to recover again.

[Christopher Nardone, analyst]

Okay. Great. And if I can squeeze in one quick follow-up, are you seeing any notable trends of trade-down activity in your category? Or are you even seeing consumers just trading into smaller baskets within your own retail channel? Clearly, there's a pullback in spend. But just if you could provide a little bit more color, that would be really helpful.

[Sean McHugh, executive]

Yes, a couple of things. I think that there is -- there has been some strength in the private label businesses, we've seen that. Our business still is very good at the exclusive brands as well, but there's a little bit of that going on. And I think the other thing is folks are shopping. They're coming to us, but between what they're paying for food and gasoline and whatever and the overall inflation, they're buying less units.

And that's probably the main thing, is the average [ cheque ] is a certain amount, but the unit volume, the number of units per transaction is certainly down. So she's buying 5 T-shirts, now she's buying 4. That's kind of what we're seeing. So that's the differentiation, I'd say, from the past as buying exactly what they need and not what they want versus what Mike said before.

[Operator]

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Mr. Casey for any further remarks.

[Michael Casey, executive]

Thanks very much. Well, thank you all for joining us on the call this morning. We look forward to updating you again on our progress. And best wishes to all of you and your families over the holidays. Goodbye, everyone.

[Operator]

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.