Carter’s, Inc. (CRI) Q3 2023 Earnings Call Transcript

Carter’s, Inc. (NYSE:CRI) Q3 2023 Earnings Conference Call October 27, 2023 8:30 AM ET

Company Participants

Michael Casey – Chairman and Chief Executive Officer

Richard Westenberger – Executive Vice President and Chief Financial Officer

Brian Lynch – President and Chief Operating Officer

Conference Call Participants

Warren Cheng – Evercore ISI

Irwin Boruchow – Wells Fargo Securities, LLC

Jim Chartier – Monness, Crespi, Hardt & Co.

Jay Sole – UBS

Christopher Nardone – Bank of America Merrill Lynch

Paul Lejuez – Citigroup Inc.

Operator

Welcome to Carter’s Third Quarter Fiscal 2023 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President and Chief Operating Officer; and Sean McHugh, Vice President and Treasurer.

After today’s prepared remarks, we will take questions as time allows. Carter’s issued its third quarter fiscal 2023 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, and the company does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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 and earnings release posted in 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

Thanks very much, Chris. 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 achieved our third quarter sales and earnings objectives. For the fourth consecutive quarter, we saw a higher than planned demand in our U.S. Wholesale segment. That higher demand drove our best quarterly growth in earnings since 2021.

In our U.S. Retail segment, its third quarter profit contribution was in line with our forecast on lower-than-planned sales unseasonably warm weather in September weighed on our retail sales in the United States and Canada. It was reported to be the warmest September on record. The late arrival of cooler weather in Canada also drove lower sales in our International segment.

In the third quarter, we saw better price realization and profit margins, which were driven by the strength of our product offerings, lower ocean freight rates and a better level in mix of inventories. We continue to make good progress rightsizing our inventory levels in the quarter. Inventories grew last year when inflation peaked at historic levels and consumer demand slowed. Our inventories at the end of the third quarter were down over 30% and expected to trend lower by year-end. Our progress with inventory reduction has improved our cash flow relative to last year by over $400 million through September.

Given our stronger-than-planned cash flow, we have reduced our seasonal borrowings and related interest expense, and we believe we have ample capacity to fully fund our growth strategies and plan to continue returning excess capital to our shareholders.

Our forecast for the year reflects an improving trend in our second half sales and earnings relative to our first half performance. In the second half this year, we are comping up against a significant slowdown in consumer demand that began when inflation peaked in June of 2022. In response to that unexpected downturn in consumer demand, our Wholesale customers aggressively curtailed and canceled inventory commitments in the second half last year.

Assuming success with our forecast in the balance of this year, our second half sales are planned down 4%. By comparison, our sales for the year are planned down 8%. Our earnings per share are planned up 15% in the second half this year and planned down 11% for the year. In our remarks this morning, we will reference our second half assumptions, which we believe will be helpful to understand the improving trend in our performance. Our third quarter got off to a good start. Our consolidated sales in July were comparable to last year. Nearly 80% of our apparel sales in the third quarter were in our baby and toddler product offerings. Those age ranges have the best quarterly performance this year with sales down only 2%.

We continue to see a good response to our new Little Planet brand. It’s our most elevated premium priced product offering. We’re forecasting sales of our new Little Planet brand to be about $70 million this year, up over 50% to last year. We expect that growth will be driven by the strength of the product offering and expanded distribution of our wholesale customers, including Target, Amazon and Macy’s and through our own retail stores in the United States, Canada and Mexico.

In our U.S. Retail segment, our comparable sales were down 10% in the third quarter. We had forecasted a high single-digit decrease in sales. Our retail sales were trending on our plan through the first nine weeks of the quarter, down about 7% to last year. But when temperatures rose to record levels in September, demand for our cooler weather apparel slowed.

In the third quarter, we saw better performance in our stores than online, our comparable U.S. retail store sales were down about 5% in the third quarter. By comparison, our e-commerce sales were down about 19%, largely due to lower traffic. That decrease is in line with third-party credit card data that tracks the online purchases of apparel.

Given the financial strain on families with young children, we believe more consumers are cautious on spending, buying what’s needed and only when it’s needed. Store visits are more intentional and fulfill the need for immediacy. We have a very high conversion rate in our stores than they are coming to buy, not browse. By comparison, e-commerce purchases are more impulsive, often triggered by our marketing texts and e-mails impulse purchases may be more constrained these days given higher credit card balances. Carter’s outperforms the young children’s apparel market in e-commerce penetration to total retail sales.

In the United States, 28% of kids apparel is purchased online. Carter’s penetration is a few points higher than the market. E-commerce continues to be one of our highest margin businesses. Our return rate is one of the best in online retailing, less than 5%, which contributes to our high margin performance. Given the high mix of children’s apparel Bolton stores, we plan to continue opening stores in the years ahead. Carter’s is a highly desirable tenant in shopping centers. Our brands attract families with young children to those centers. We expect to open nearly 50 stores in the United States this year and will close about a dozen low-margin stores.

Our stores opened in recent years are achieving over 20% EBITDA margins and their comparable sales performance this year has outperformed the balance of our stores. Including this year, we plan to open 250 stores in the United States by 2027. These store openings are expected to contribute over $250 million in sales growth, including the benefit of related e-commerce sales. We expect most of these store openings will be in open air centers to provide convenience for consumers, including curbside pickup.

That said, we’ve seen good success with our mall stores in recent years. We’ve been highly selective on mall store openings. We currently have 90 of our 800 U.S. stores in malls and see an opportunity to double that store count in the years ahead.

Carter’s has grown over the years to be the largest and most profitable specialty retailer focused on young children’s apparel. Our stores are the number one source of new customer acquisition. We believe our stores provide the very best value and experience with our brands and providing very high return on investment. Our stores provide a convenient alternative to shopping and big box retailers and we believe our direct-to-consumer capabilities provide market insights that help us support our wholesale customers. We’ve made significant investments in our direct-to-consumer capabilities in recent years, including the same-day fulfillment of online purchases and RFID technology, which increases our visibility and accuracy of inventories.

We’ve invested in marketing personalization capabilities, a highly rated mobile app and loyalty and credit card programs, which increased the frequency of transactions in the lifetime value of our relationships with consumers. We’re forecasting an improving trend in our U.S. Retail segment in the second half this year. The planned improvement reflects a stronger product offering and a significant improvement in on-time deliveries. Recall that a year ago, we were shipping our fall and holiday product offerings about 70% on time due to U.S. port congestion. This year, our second half shipments to our wholesale customers and our retail stores are closer to 100% on time.

With a better mix, the end level of inventories, we are forecasting our U.S. retail sales down 6% in the second half and down 9% for the year. Our market analysis and third-party credit card data continue to indicate that families with young children have pulled back on spending due to inflation. Carter’s advantages in inflationary markets include our focus on essential core products, a high mix of less discretionary baby apparel purchases, our broad and unparalleled market distribution, including our exclusive brands sold through Target, Walmart and Amazon and our compelling value proposition with average retail price points of about $11, including many high-value multipacks. The average transaction in our store is about $50. That’s less than a tank of gas these days.

Children’s apparel is a relatively small component of a young family’s budget but even less discretionary purchases like children’s apparel have been scaled back because of inflation. Our daily market analysis continues to show that our brands are competitively priced. Consumers expect to pay a reasonable premium for national brands and Carter’s is the best-selling national brand in young children’s apparel. In our experience, as long as our brands are priced within $1 or $2 of our private label brands, we are competitive. It’s a time-tested pricing strategy, which we plan to continue in the years ahead. Carter’s has built unparalleled relationships, including exclusive brands for the largest retailers of young children’s apparel in North America.

As the best-selling national brand in young children’s apparel, our brands complement their private label brands and drive traffic to their stores and websites. A high percentage of our wholesale product offerings are focused on baby apparel, and our baby apparel continues to be the best-performing component of our product offerings. A high percentage of our baby apparel is on automatic replenishment. So when the register rings across thousands of store locations, replenishment orders are automatically created and shipments are made to keep the fixtures filled and our essential core products in stock. Our exclusive brands sold to Target, Walmart and Amazon are forecasted to grow to 51% of our total wholesale sales this year, a couple of points higher than last year.

Increasingly, our wholesale sales are concentrated among fewer, larger and growing retailers. Our U.S. Wholesale sales in the third quarter reflect earlier-than-planned shipments of our fall and holiday product offerings we have adjusted our previous fourth quarter wholesale sales plan accordingly. We are forecasting an improving trend in our U.S. Wholesale segment this year with sales down less than 2% in the second half and down 7% for the year. We’re comping up against the wholesale destocking period in the second half last year. Given our wholesale customers progress managing their inventories, their sell-throughs, price realization and margins earned on our brands this year are generally better than last year.

As a result, we have wholesale orders that support growth in our spring and summer 2024 product offering, a portion of which will begin shipping to the major retailers later this year. We expect better visibility to wholesale demand for our fall and holiday 2024 product offerings when we complete that sell-in process early next year.

For the year, our international sales are forecasted to be 15% of our total sales. We are also forecasting an improving trend in international sales with sales planned up 3% in the second half and down about 3% for the year. Our sales in Canada, Mexico and Brazil are expected to contribute about 85% of our international sales this year.

The balance of our international sales are through wholesale relationships with about 40 retailers representing our brands in over 90 countries in through over 100 online platforms outside of North America. Some of our international wholesale customers have been adversely affected by inflation, the stronger dollar and global conflicts. We’re assuming growth in Mexico and Brazil this year, which is expected to partially offset lower sales in Canada and other markets. Our supply chain continues to be a source of strength in our performance this year. On-time shipping performance has been excellent. Our supply chain team has negotiated meaningfully lower ocean freight rates, which are contributing to our second half earnings growth.

Product costs are also expected to be lower in the second half of this year and next year. We expect those lower costs will enable us to strengthen our product offerings, sharpen price points and improve profitability next year. In summary, we achieved our third quarter sales and earnings objectives. My comments on the outlook for the year reflect the high end of our guidance this morning with the late arrival of cooler weather, the fourth quarter has gotten off to a slow start, we’ve seen a strong correlation between warmer weather and the demand for our fall and holiday product offerings, where weather is cooler, sales trends are better. With colder weather on the way, we expect our sales and earnings trends will improve as we move through the final weeks of the year.

With nine weeks to go, we have adjusted our guidance to reflect what we believe is possible this year. We believe inflation, generational high interest rates and the suspension of pandemic-related stimulus payments to childcare centers have weighed on families with young children this year. Thankfully, birth trends in the United States have stabilized. Birth this year are expected to be comparable to last year. And with a near 40-year high in weddings last year, continued strength in the labor markets and moderation in inflation, we believe market conditions will improve. Carter’s is the best-selling brand in young children’s apparel. We believe our unparalleled market distribution capabilities and brand reputation for quality and value will enable Carter’s to continue leading the market and be well positioned to gain market share in the years ahead.

I want to thank all of our employees for achieving stronger-than-planned performance in the third quarter and their commitment to help us achieve our growth objectives in the final weeks of this year.

At this time, Richard will walk us through the presentation on our website.

Richard Westenberger

Thank you, Mike. Good morning, everyone. On Pages 2 and 3 of our presentation materials, we provided our GAAP income statements for the third quarter and year-to-date periods. Page 4, summarizes adjustments to our GAAP results for the third quarter and year-to-date periods for costs we incurred this year related to organizational restructuring.

In the second quarter of last year, our strong liquidity enabled us to strengthen our balance sheet by early retiring pandemic-related debt. The loss associated with this early debt extinguishment is included as an adjustment to last year’s Q3 year-to-date GAAP results. This information is included for your reference and this morning, I will speak to our results on an adjusted basis, which excludes these items.

Moving to Page 5. As Mike said, we achieved the sales and earnings objectives which we shared with you back on our July call. Net sales in the quarter were $792 million, slightly above the high end of our guidance range. These consolidated sales results reflect higher than planned demand in our U.S. Wholesale business. Retail sales in the U.S. and Canada were lower than we had forecasted, we believe a result of warm weather that contributed to unfavorable traffic trends particularly in September. Profitability, both operating income and earnings per share exceeded our forecast. The drivers of our better-than-planned profitability were strong expense management and continued progress in reducing inventories, which has led to better cash flow, lower borrowings and lower interest expense.

Page 6 summarizes a few highlights of our third quarter performance relative to last year. Third quarter sales declined 3%. We had growth in our U.S. Wholesale business, which was offset by lower sales in our U.S. Retail and International businesses. Adjusted operating income grew 5%. Adjusted operating margin improved 100 basis points to 12.2% and driven by over 200 basis points of expansion in gross margin rate with average unit pricing up in the low single digits and average unit product costs down modestly. Adjusted EPS grew 10% in the third quarter above operating income growth due to the benefits of lower interest expense and our share repurchases. We were encouraged by our third quarter results.

Recall that 2021 represented record profit performance for our company. Our profitability began to be affected by the historic spike in inflation and its impact on consumer demand throughout the marketplace in the early part of 2022. So we were pleased to see growth and profitability this past quarter.

Page 7 includes the same P&L metrics for the first three quarters of 2023 versus last year. Year-to-date net sales were down 9% and adjusted operating income and adjusted EPS were down 29% and 26%, respectively. Our year-to-date performance reflects the significant impact of various macro factors on consumer demand, particularly in the first half of the year, including inflation and higher interest rates.

Turning to our third quarter P&L on Page 8. I’ve covered the drivers of net sales in the quarter. And on this nearly $800 million in net sales, we achieved a gross margin rate of 47.5%, an increase of 220 basis points over last year. Lower ocean freight rates were the largest contributor to this year-over-year gross margin expansion. We also had lower inventory charges in this year’s third quarter. A year ago, we incurred significant inventory charges as demand slowed in our business, including in wholesale, as our customers aggressively reduced their inventory commitments in response to the slowdown in consumer demand in their businesses.

In Q3, we also continued to modestly improve realized pricing. Spending was well managed again this quarter below what we had forecasted and comparable to last year, variable costs related to sales volume were down as were marketing expenses largely due to the timing of spend.

Distribution and freight expenses declined, reflecting in part costs in the prior year to transition out of a high-cost distribution center in California we moved that distribution activity to our lower-cost distribution network here in Georgia. Offsetting these spending declines were higher provisions for performance-based compensation and higher professional fees in the quarter.

Adjusted operating income grew 5% to $96 million with solid expansion in our adjusted operating margin, as I mentioned. Below the line, net interest expense was lower than last year and better than we had forecasted. Our strong cash generation and liquidity enabled lower seasonal borrowings on our revolver compared to last year’s third quarter.

Our effective tax rate in the third quarter was 22.5%, up 280 basis points over last year, reflecting a greater proportion of our earnings in the U.S. this year. Our weighted average share count declined by approximately 2 million shares or 5% versus last year, driven by our share repurchases. So on the bottom line, adjusted diluted earnings per share were $1.84, up 10% compared to $1.67 last year.

On Page 9, we’ve included our year-to-date adjusted P&L for your reference. As noted earlier, our third quarter performance represented an improvement in trend in our business. Our first half performance reflected the significant impact of the various macro factors we’ve mentioned.

On Page 10, we’ve summarized some highlights of our balance sheet and cash flow. Our balance sheet is in excellent shape. Total liquidity was $945 million with cash on hand of approximately $170 million at quarter end and virtually all of the $850 million credit facility available to us. Q3 ending inventory was $621 million, down 31% year-over-year, which was better than we had forecasted. The improvement versus last year reflects lower days of supply and increased productivity.

In the third quarter, we made good progress selling through inventory, which we packed and held last year as consumers and wholesale customers pulled back on demand. Pack and hold inventory balances were $44 million at the end of Q3 compared to over $100 million at the end of last year’s third quarter.

We expect we’ll work through substantially all of our remaining prior season pack and hold inventory by the end of this year. Total net inventories are also expected to be lower at the end of the year. Debt declined $170 million compared to the third quarter of last year, made possible by our significantly improved operating cash flow. We’ve continued to manage our cash and debt position subsequent to quarter end. In October, we paid down the $70 million in seasonal revolver borrowings outstanding at the end of Q3 leaving $500 million in senior notes, which don’t mature until 2027 as our only outstanding debt. Year-to-date, operating cash flow was $206 million a significant improvement compared to a use of cash of over $200 million last year.

This improvement reflects lower inventories and other favorable changes in working capital. Given our year-to-date progress and outlook for the fourth quarter, we’ve raised our full-year operating cash flow outlook from over $300 million to over $350 million. Year-to-date CapEx increased by $15 million to $42 million largely due to investments in new stores here in the U.S., in Canada and in Mexico. Lastly, on this page, year-to-date, we’ve returned significant capital to shareholders this year. Over the last number of years, we’ve distributed virtually all of the free cash flow which the business has generated annually to our shareholders.

Turning to Page 12 for a summary of the performance of our business segments in the third quarter. Q3 consolidated net sales declined $27 million versus last year. As we’ve covered growth in our U.S. wholesale business was offset by lower sales in U.S. retail and to a lesser extent, lower international sales. Overall profitability improved both in operating income and operating margin driven by our U.S. wholesale business. Corporate expenses increased by $9 million over last year reflecting higher consulting and professional fees focused on our sales and earnings initiatives.

On Page 13, we’ve summarized the performance drivers for each of our business segments in the third quarter. U.S. Retail sales declined 8% as macroeconomic factors, including inflation and meaningfully higher interest rates continued to adversely affect consumer traffic and demand. Comparable sales declined to 10%. We had previously forecasted a decline in the high single digits.

As we said, we believe that warm weather in September likely affected consumer demand for fall product. Nearly all of U.S. Retail’s shortfall to its Q3 sales forecast occurred in the month of September. As has been the case all year, our stores were a stronger performing component of our U.S. retail business with a more significant comp decline in e-commerce.

While traffic in our U.S. Retail business was lower versus last year, we achieved improved pricing and grew average transaction values. U.S. Retail’s operating margin was 13%, down from just over 14% last year. This margin performance reflects expense deleverage on lower sales, higher product costs, partially offset by improved realized pricing and lower transportation costs. Segment operating profit was $49 million compared to $58 million last year and was consistent with our forecast, largely due to good management of spending in response to lower topline sales. In U.S. Wholesale, sales grew 4% driven by higher-than-planned demand for our seasonal products, nearly all of our brands contributed to growth in the quarter.

In addition to higher demand for seasonal product, we’re seeing an improved trend in demand for products carried by many of our wholesale customers under automatic replenishment programs. Several of our customers had suspended their replenishment programs last year as they worked to reduce inventory commitments in light of the impact of inflation on consumer demand.

Order cancellations were lower than a year ago and part of a result of better on-time shipping performance. U.S. Wholesale operating margin was elevated in the third quarter at 22%, up significantly from 13.9% a year-ago. Wholesale profitability this year benefited from comparisons to some unusual costs incurred a year ago, including $7 million in costs to transition distribution activity from the West Coast and higher inventory charges last year.

For the full-year, in 2023, we’re planning U.S. Wholesale adjusted operating margin will be in the high teens, which is more consistent with the run rate for profitability in this part of our business. International net sales declined 4%, principally due to lower demand in our Canadian retail business, particularly for cold weather apparel, given the unseasonably warm temperatures in September. With the arrival of colder temperatures as we’ve moved through October, we’ve seen a meaningful improvement in traffic and comp sales in our Canadian business.

Sales in the wholesale component of our international business were lower, largely a function of bookings planned for third quarter, which are now expected to ship in the fourth quarter. Sales in Mexico grew in Q3, driven by the retail component of the business. Mexico is a growth market for us. We’ve been making investments there in building out a great multichannel business model, including stores, e-commerce and wholesale.

International’s operating margin was 11.7% compared to 14% last year. The decline was largely driven by expense deleverage and higher product costs, which were offset in part by improved price realization and lower transportation costs. On Page 14, we’ve included our Q3 year-to-date adjusted segment results for your reference.

Turning to Page 15. The summer, we introduced a new brand campaign for Carter’s with the tagline, “Love Every Moment” which reminds parents to savor each of the moments that come with raising small children. This campaign has been very well received by consumers with terrific early engagement. We recently launched a new series of emotional brand messages for the upcoming holiday season, all reinforcing the “Love Every Moment” theme.

These messages can be seen in all of our direct-to-consumer marketing channels and in our retail stores. Additionally, we make our great photography and creative available to our wholesale customers for their use in presenting the Carter’s brand in their own marketing programs. For millennial and Gen Z parents clothing, which is organic and sustainable has become increasingly important as they build out their children’s wardrobes.

As shown on Page 16, our newest brand, Little Planet is focused on sustainable materials and fabrics. While customers love these attributes, they’ve embraced Little Planet, first and foremost, because it’s a beautiful product with a clean and elevated aesthetics. Little Planet is delivering good growth for us this year through its significantly expanded presence in our own stores and in the wholesale channel with a number of our leading customers.

Moving to Page 17, continuing our heritage of product innovation, we recently introduced a new brand in our baby assortment called Purely Soft. Purely Soft products are made from an all-season eco-friendly fabric that has a distinctive silky soft feel. The Purely Soft Baby and Sleep collection is currently available in 200 Carter’s stores and on our website. We’re planning to expand the distribution of Purely Soft to all of our Carter’s stores next spring with an expanded assortment of solids and prints. Additionally, this brand is available in all of our major wholesale customers, which carry our flagship Carter’s brand.

Turning to Page 18. In addition to opening new stores, we’ve been working to improve the productivity and customer experience in our existing stores and 150 of our former side-by-side co-branded stores, we’ve created new distinct baby and toddler and kid experiences. This new presentation has increased the focus and impact of these product categories, which address different age segments. Our results so far have been very positive. We’re testing additional product and brand presentations, which we hope will inform further improvements to new and existing stores.

Moving to Page 19. With the next generation of parents now increasingly beginning their shopping research and information gathering on social media platforms, our branded content on TikTok and Instagram continues to resonate. We recently surpassed 200,000 followers and 1 million likes on TikTok and doubled our monthly Instagram engagement rate by providing content relevant to families with young children, ranging from educational clips, highlighting our product expertise to in-store shopping videos. The next few pages feature some of our product and marketing plans for our exclusive brands at Target, Walmart and Amazon.

Beginning on Page 20, Carter’s exclusive brand for Target Just One You recently launched its new holiday fashion assortment. Just One You marketing is featured across Target’s websites, social and search channels, and influencer network collectively supporting growing demand from target customers.

Turning to Page 21 in Child of Mine Carter’s exclusive brand for Walmart. With the introduction of our new fashion styles and our enhanced in-store presentation, Child of Mine has significantly increased its brand awareness among new parents who are shopping at Walmart. Some recent Child of Mine brand enhancements include new baby and toddler holiday dress collections, perfect for special moments when families gathered together for the holidays. These collections along with our best-selling layout styles are featured across Walmart’s digital and store marketing channels.

Moving to Page 22. Our exclusive brand at Amazon Simple Joys has now kicked off the holiday shopping season on Amazon. Many brands have some level of presence on Amazon. Our Simple Choice assortment on Amazon is extensive and provides everything a parent needs for their little ones. Additionally, the vast majority of our Simple Joys products on Amazon have tens of thousands of consumer reviews with an average customer rating of 4.7 stars. Our Simple Joys brand store pages on Amazon have recently been refreshed providing Amazon’s customers with an improved shopping experience and access to our new holiday campaigns.

Turning now to our outlook for the balance of the year, beginning on Page 24. Today, we’re tightening the high end of the range of performance we believe is possible with two very important months left to go in the year. There are a number of factors which we believe will contribute to continued improved results in Q4, particularly in profitability. Importantly, we’re assuming consumer demand trends are better than we experienced in the third quarter, and we’re encouraged by the response to date to our fall and holiday event-related assortments, including family dressing and Christmas PJs. Our supply chain performance has improved meaningfully compared to last year, enabling much better on-time delivery performance for our wholesale customers.

We also have a better level and mix of inventories, particularly in our retail businesses. We expect fourth quarter earnings to benefit from the contributions from the new high-margin stores, which we’ve opened along with the closure of low-margin stores. We’re forecasting good expansion in gross margin driven by improved pricing and lower ocean freight rates. We’ve continued to plan our inventory commitments conservatively, which we believe will drive better sell-throughs and price realization. And lastly, we’re planning for a lower average share count given our progress with share repurchases.

Moving to Page 25, and our specific thoughts on what we think is possible for the fourth quarter. Our outlook for fourth quarter sales has been adjusted in part due to the higher-than-planned wholesale demand for seasonal product, which we realized in the third quarter. We’re planning net sales in the range of $862 million to $877 million. As I said, we’re planning for good gross margin expansion in Q4 with SG&A dollars planned down. Below the line, we’re forecasting a higher effective tax rate and lower shares outstanding. Adjusted operating income is planned in the range of $133 million to $143 million. And lastly, we’re forecasting adjusted EPS in the range of $2.50 to $2.72.

Now turning to Page 26. As shown on this slide, if we’re successful with our fourth quarter plans, the resulting second half would represent meaningfully improved performance relative to the first half of the year. We’re expecting better second half sales trends in all of our business segments. And on second half profitability, we’re planning meaningful improvement relative to our results in the first half of the year and the second half of last year. Second half adjusted operating income is expected to grow over last year in the range of 9% to 14% with an adjusted operating margin of roughly 14%. Given all this, our expectations for where our full-year results will end are summarized on Page 27.

We are planning net sales in the range of $2.950 billion to $2.965 billion, a modest revision to the high end of our previous guidance for sales given the slowdown in demand we experienced in September and October. Adjusted operating income is expected in the range of $325 million to $335 million, again, down somewhat at the high end of the range from our prior forecast. Earnings per share are planned in the range of $5.95 to $6.15, which is consistent with our prior outlook.

As noted earlier, operating cash flow is now expected to be over $350 million, an improvement over our previous view. Through October, we’re generally running in line with our forecast, Wholesale a bit ahead and U.S. Retail a little behind. But important to note that the more significant volume weeks of the fourth quarter remain ahead of us. November and December combined represents about 70% of the sales and profitability we’re planning for the fourth quarter. The arrival of more consistent colder weather and closer proximity to the holidays have historically been catalysts in our business in the fourth quarter. All of our teams are focused on finishing 2023 in a very strong fashion.

And with these remarks, we’re ready to take your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question will come from Warren Cheng of Evercore ISI. Your line is open.

Warren Cheng

Hey good morning. I just wanted to ask, I want to understand the comp expectation that’s baked into the fourth quarter guidance. So it sounds like the exit rate from the second quarter was down in the high teens range. Did you see an improvement in the U.S. costs in October from that September level? And also, can you remind us, typically, if there’s a late start to the season, is there a catch-up that occurs when the weather cools. So is it more of a pushout of the sales? Or are those September and October sales is just sort of lost for the season?

Michael Casey

Warren, I’d say we’ve seen a strong correlation between the trend in our retail sales and the warmer weather or weather is cooler, the trends are better. So for the fourth quarter, we’re assuming a high single to low double-digit negative comp in retail sales in the fourth quarter. The trend in October did slow relative to September. So we have seen – to put it in context, we’re probably running some portion about $8 million off our retail plan in the fourth quarter to nearly $900 million quarter, and we see some upside in the wholesale side of our business. So again, we saw sluggishness that began in the second week of September. And even with that sluggishness, we outperformed the expectations that we shared with you in July.

We were running probably a solid negative 7% comp through most of the third quarter and then started to lose ground in the final weeks of September. And then that continued into October. So not unusual, firstly, 80 degrees in New York this weekend. That doesn’t exactly lend itself to shopping for fall and holiday product. Next week in New York, it’s going to dip into the 30s at night in the highs and the 50s. So where we’ve seen that kind of weather change, we’ve seen a meaningful improvement in the retail performance. We’ve already started to see it in Canada. Colder weather, snow has come to Canada, and we’ve seen a meaningful change in the trend and their performance, we expect to see it as we head into the final weeks of this year.

Warren Cheng

Got it. Yes. I think October was warmer than May this year. And then, Mike, another is just a higher level question for you. If I step back, your gross margins are running more than 400 basis points higher than pre-pandemic levels, but your comps have been negative for almost two years now. And I think we all understand the pressure on your consumer, especially from – have been inflationary in nature. Has there been any thought on revisiting your approach to pricing in this environment and for us using that as a tool to help stabilize the comps.

Michael Casey

Well, we have revisited the pricing. Pricing is competitive. We have good people at Carter’s looking at our pricing relative to our competitors every day. We have raised our prices because costs went up, freight rates went up, but our competitors have raised their prices as well. Our biggest competitor are the private label brand competitors. And we’re priced within $1 or $2 of the private label brands. And what we’ve seen over time, as long as we’re priced within $1 or $2, we are competitive. We have tested, we have very smart people testing different pricing configurations, different prices, we’ve tested lower prices. It did not drive a change in unit velocity that would suggest that we should do that on a more sustained basis.

So I think what we’ve seen in terms of the negative comps is more a reflection of the consumer spending through a roller coaster of experiences in recent years. Keep in mind, as Richard shared with you, we had record profitability in 2021. We came roaring back from the worst of the disruption from the pandemic in 2020, actually saw 2022 get off to a strong start, had high single-digit positive comps in our retail business in the early months of 2022 as we move through 2022. And all of a sudden, gas prices doubled and food prices went up and the consumer couldn’t find baby formula and then when inflation peaks, good retailers. Some of our largest wholesale customers announced a significant decrease in the trend in consumer traffic and purchases.

So I don’t think we’re unique in this. If we felt as though lowering prices would drive stronger comps, we would do it. We feel as though we are competitive. This is a very profitable company. We have been focused during this time period on margin preservation and cash flow. Some that we compete with aren’t profitable at all. It’s a function of the strength of their product offering and how they buy the inventory. Most of the price realization we’ve realized in recent years was largely through good inventory management not always with the strength of the product offering, right? But it’s largely through inventory management.

Our clearance units in the third quarter were down some portion of 20%. So if you don’t have clearance product, you have a better mix of product and you’re getting paid for a better mix of products. So that’s largely what we’ve seen in the – as a driver in our price realization. We’ll continue to monitor it. Again, we have people looking at it every day and we’ll continue to look at through the balance of the year. We were more promotional than planned in the tail end of the third quarter, we’ll probably be more promotional than planned in the fourth quarter, just given the slow start, but we are less promotional than last year, largely given the strength of the product offering a better level and mix of inventories. But in times like this, you focus on the things you can control and which you can control, are the level of inventories, the strength of the product we’re offering and continue to focus on cash flow.

Warren Cheng

Thanks, Mike. Thanks, team. Good luck.

Michael Casey

Thanks, Warren.

Operator

Thank you. [Operator Instructions] Next question will come from the line of Ike Boruchow of Wells Fargo. Your line is open.

Irwin Boruchow

Hi. Good morning, guys. A couple of questions from me. Two of them actually, I think, piggyback off of what Warren had just asked you. But Mike, just on the comps, I understand the guidance for 4Q, what’s embedded. Can you just explicitly let us know quarter-to-date where you’re running on the comps? Second question is on the product cost, I think you said you expected those to be favorable into the back half of this year and early next year. But I think, Mike, you said something along the lines of sharpening price points or gives you an opportunity to sharpen your price points. Can you just elaborate on what you mean? Are you talking about putting some price investment into the business, not flowing all that AUC into the margin. Just kind of curious what exactly you meant and have one more, but I’ll hop on.

Michael Casey

Sure. So heading into next year, we have visibility to wholesale demand for our spring and summer 2024 product offerings given the good work our supply chain team has done working with our merchants and designers, the product costs are expected to be lower going into the first half of next year. And so because the product costs are lower, the pricing will be for those early deliveries for spring and summer 2024 the pricing will be comparable to lower. So we are expecting margin expansion. So again, we see some opportunities on some key item price points to test lower pricing. We see less need for increasing prices given the progress that we’ve made on ocean freight rates and product costs going into next year. And again, our comps in the third quarter were down 10% and right now in October, running down about 16%.

Irwin Boruchow

Great. And last question maybe for Richard. I think you talked about SG&A down in 4Q. You guys have really been tight on expenses. Is there any initial thoughts on SG&A into next year? Should we continue to expect you guys to really keep that SG&A tight? And just kind of curious if there’s any initial views you can kind of give us on the expense line? Thank you, guys.

Richard Westenberger

Yes, Ike. I would say we continue, to Mike’s point, be managing for profitability, margin preservation and cash flow. Those are the things that we have with the most control over in this kind of environment. We’ve done a lot of very good work looking at our cost structure of the organization. I’m really pleased with how they responded to the challenge. Everybody understands the environment that we’re in. And the best thing we can do is just keep ourselves as lean as possible. As you saw in the press release this morning, we did take some charges related to organizational restructuring. That has lowered our staffing costs. There’s other things that we’ve been looking at and making good progress on indirect procurement. We’ve been focused on marketing effectiveness.

So our focus will remain on SG&A, keeping it as low as possible. I think it’s too early to be specific on next year’s plans, but you can be assured that it’s an ongoing discipline and an area of focus for us, and we’ve made good progress in managing it this year.

Irwin Boruchow

Great. Thank you, guys.

Richard Westenberger

Sure.

Operator

Thank you. [Operator Instructions] Our next question will come from the line of Jim Chartier of Monness, Crespi, Hardt. Your line is open.

Jim Chartier

Good morning. Thanks for taking my question. Just wanted to talk about product costs. Given kind of the big reduction in cotton over the last 12-plus months. I would have expected maybe some of that to flow through into lower product costs in the back half of this year. So I was hoping if you could talk about what some of the offsets to the lower cotton costs were for the back half of this year. And then maybe what some of those factors look like for spring of next year and fall of 2024? Thanks.

Richard Westenberger

So Jim, I would say we are starting to see the benefit of lower cotton and other input costs in our product costs. I think that leads into the P&L kind of over time, you receive that product. It goes into inventory and then you realize some of that margin upside when you sell the product. Recall that we’re still working through that pack and hold inventory that was procured at a time when product costs were elevated. Where we are seeing a tremendous benefit on is in these inbound transportation costs. That’s been a big source that gets inventoried into the cost of the inventory as well. So we’re expecting good favorability from that here in the fourth quarter. That is a benefit that will continue through the first half of next year as well.

Once we get to midyear next year, we’re more or less kind of anniversarying those lower rates that have benefited the second half of this year. But we are planning for lower product costs in the first half of the year. I think the biggest determinant of that even beyond cotton is just worldwide capacity. The global marketplace has meaningfully slowed down. And we have terrific teams here in Atlanta and in Hong Kong to work with our factories. We’ve had a series of meetings, top-to-top meetings with our largest vendors recently. And they’re hungry. They love doing business with Carter’s, we’ve been a source of great growth over the years, a good partner for them as well, and they are hungry for business.

And so I think that available worldwide capacity is the bigger determinant. Cotton certainly is a benefit to us, but we’re seeing good capacity across Asia, and we think that will drive even first half of next year. We don’t have complete visibility to the second half of the year, yes. Hopefully, we’ll have more of that to share with you on the next call.

Jim Chartier

Great. Thank you.

Richard Westenberger

Sure.

Operator

Thank you. [Operator Instructions] And our next question will come from Jay Sole of UBS. Your line is open.

Jay Sole

Great. Thank you so much. Maybe, Mike, I just want to follow up on the Wholesale business. I think you touched on this, but can you elaborate a little bit more on how the sell-through is at your big wholesale customers? I mean, how do you see the product, how do you see the sales moving in like Amazon Prime Day, for example, in October, like how did you see that event for the company? If you can tell us a little bit more detail on that, that would be super helpful.

Brian Lynch

Yes, Jay, the sell-throughs have been good in Wholesale. I’d say fall is better than last year. Now higher AURs, as Mike talked about, a good margins for the retailers. And I recall, they did buy seasonal lower. But sell-throughs have been good. Their inventory is in good shape. We commented on the supply chain is doing a heck of a job this year. We’re near 100% on time. So we’ve got a meaningfully fewer cancelled plans. So they’re faring well, I would say, particularly the top three are doing really well. We did have some orders move into Q3 from Q4, but we seem to have good momentum in the business. So I would say the outlook is positive. Our relationship with Amazon is good. Prime Day, we exceeded their expectations, but we look at it for on an annualized basis, and we feel good about our overall Amazon business.

Michael Casey

Just the key thing we’re looking at, Jay, as Brian said, the seasonal business was booked down in the second half of this year. Our wholesale customers had to make those decisions in the second half last year. That’s the lead time and that’s when inflation hit and consumer demand pulled back. So they made those decisions on the second half seasonal bookings in the second half last year. And that’s booked down about 10%. But by comparison, the high-margin replenishment business for them and for us is playing up about 10% in the second half this year. That’s the everyday essentials, that’s the milk, bread and eggs equivalent at the grocery store. So those are the big fixture fills of bodysuits, wash clothes, towels, bibs, blankets, all the essentials that parents buy multiples of in those early days, months, years, years of life, that business, that replenishment business at wholesale is trending to be up 10% in the second half.

Jay Sole

Got it. Okay. Super helpful. Mike, thank you so much.

Michael Casey

Welcome.

Operator

Thank you. [Operator Instructions] Our next question will come from the line of Christopher Nardone of Bank of America Global Research. Your line is open.

Christopher Nardone

Great. Thank you, guys. Good morning.

Michael Casey

Good morning.

Christopher Nardone

First question I have is, can you just walk us through the level of gross margin expansion that’s embedded in your fourth quarter guidance? If you can try to help quantify some of the big drivers there. And then as a follow-up, as we zoom out and think about it to next year, can you talk about your confidence in stabilizing the retail business? And maybe talk us through some of the initiatives you have underway to help turn around that business? Thank you very much.

Richard Westenberger

Sure, Chris. On fourth quarter gross margin, we do have significant expansion year-over-year plan. I think that’s been a consistent element of our second half forecast. As you saw, posted an over 200 basis point increase in the third quarter. We’ve got something above that plan for fourth quarter at both ends of our guidance range, it’s above 300 basis points of gross margin expansion. I’d say as it was in the third quarter, the single biggest driver of that is lower transportation costs. These lower ocean freight rates will continue to benefit the fourth quarter. That’s the most substantial. I’d say that’s at least 200 basis points of the improvement we have planned. Beyond that, we do have some further modest pricing realization improved. Product costs are lower as well as we talked about.

We have a mix benefit that accrues to the fourth quarter just because the U.S. Retail business will be a bigger proportion of our sales mix in the fourth quarter than it was in third quarter. We’re expecting, as Mike said, an improving sales trends. So that contributes. And then finally, and a much less significant factor is just our inventory position is much cleaner than it was a year-ago. As we continue to work through our pack and hold inventory. I’m anticipating we’ll have less kind of inventory charges and related costs. So those would be the principal drivers of Retail.

Brian Lynch

Yes. I would just say in terms of Retail, we’ll give you a better outlook in February. But when we think about the business overall, I think we’ve made significant improvements in product. Richard talked about the fact that we’ve got cost reductions coming through the P&L. And our approach in that was really threefold, investing and making the product better, make select price increase – price reductions, I should say, in kind of our key volume items and then improving profitability. So we feel good about the product. Our customer experience. We have teams working really hard to improve our customer experience, where we’re reimagining our store experience. We shared some of the improvements in our side-by-side business there. We focus on kids different from baby toddler and then significant investments in our online experience to our website.

We’ve just replatformed that site with a good headless architecture and got great creative on there. Marketing capabilities, we continue to strengthen. We’ve invested in technology and the team to strengthen our marketing capabilities as we go into next year. We’re going to have continue to focus on store growth. We’re going to have 50 new beautiful stores in the United States, which are the number one generation of new customer acquisition for our company. And overall, I think we’ve got a strong team. We’ve got a lot of good initiatives. We’re doing the right things, I think in terms of in a difficult environment, managing the business effectively, a high-margin business with a strong outlook for the future. And some of it will turn on macro, too. We are assuming that things will improve as we go forward with inflation moderating and coming off of some of the challenges we’ve had this year.

Christopher Nardone

Great. Thank you.

Operator

Thank you. [Operator Instructions] Our next question will come from Paul Lejuez of Citi. Your line is open.

Paul Lejuez

Hey. Thanks, guys. I’m curious if the weather is impacting traffic and the business overall? Or is it just the seasonal piece of the business where it becomes more of a conversion issue or is it impacting traffic overall? And are you seeing that same pressure on sell-throughs within the wholesale channel amongst your big partners?

Michael Casey

Yes. It’s largely a traffic issue, both online and in the stores, and where weather is cooler, traffic is better. So it’s not – conversion rates have actually been good. Conversion rate. Those who come our buy-in. Those who – and they like the product offering, the conversion has been good. The average transaction values have been higher, but it’s largely been a traffic issue. And where weather is cooler, more seasonal traffic has been better. And I would say we have visibility into our performance in every major retail customer that we do business with. And I would say trends, you’ve seen a noteworthy impact of weather with our wholesale customers as well for our products.

Brian Lynch

Paul, I would say the customers that the big three we call Target, Walmart and Amazon. They’ve got a little bit more of a natural traffic flow for groceries and essentials and what have you. So those that component of the wholesale business, I would say, is less impacted by some of the traffic challenges, they’re impacted. But if you’re selling groceries as well, you’re going to have more regular linear traffic trends.

Paul Lejuez

Got it. And sorry if I miss what was the 50 new stores that you mentioned just on the last response, what was that for? Was that for next year or over the next couple of years?

Michael Casey

This year. This year. That’s the run-rate right now. We’ll probably open up a better part of 50 this year, assuming we continue to see good experience. We’re working on the 2024 openings right now. We assume that we’ll probably open up a better part of 50 next year as well.

Paul Lejuez

How about net openings, though? Are you thinking about some closings as well? Just as you’ve kind of seen the last two years of performance, are there stores that you need to reevaluate after the weak performance in DTC for the past couple of years?

Michael Casey

We do probably close about a dozen low-margin stores this year when leases expire, rarely do we close a store early because the lion’s share of our stores, nearly all of our stores are cash flow positive. So rarely, we closed them early. But when a lease comes up for renewal, you have to decide whether or not you’re going to re-up for another 10 years. And we’ve done in recent years. We just assumed let that lease expire and move to a better location where there’s better traffic patterns, better cotenancy, better condition of the center. We’re seeing good results with the new store openings. But going forward, the next year, we’ll probably close 10 or more stores as well. We did the heavy lifting on store closures when the pandemic hit probably closed about 140 stores since the pandemic probably gave up some portion of $140 million in sales.

But by doing that, we’ve actually made retail more profitable because we pushed more store – more sales into existing stores. So that what we call that transfer benefit was meaningful. It was probably about 25% of the sales from store closed, stores went over to existing stores at higher margins. So we continue, I think there’s – so something recently. I think some portion of 350 stores come up for lease renewal, lease consideration that every year gives us an opportunity to close stores that we don’t think are going to contribute meaningfully to the growth in sales and profitability in the years ahead.

Paul Lejuez

Okay. Thanks. But Mike, the comps have been down pretty significantly for two years in a row despite benefiting from that transfer. So how do we connect the dots there?

Michael Casey

Well, you need a better mix of stores, you need to drive more traffic to those stores through better, more effective marketing capabilities. We have new marketing personalization capabilities. We’ve made significant investments in e-commerce. But the more we open up stores closer to the consumers and close some of these outlet stores that are located further away. I can tell you is we’re seeing good returns on new store openings. It’s the number one source of new customer acquisition and about 70% of kids apparel is bought in stores. So we continue to believe stores are important.

Paul Lejuez

Thanks, guys. Good luck.

Michael Casey

Thank you.

Operator

Thank you. This will end the Q&A portion of the conference. I would now like to turn the conference back to Mike Casey for closing remarks.

Michael Casey

Thanks, Chris. Thank you all very much for joining us this morning. We wish you and your families a happy, healthy holiday season. We’ll update you on our progress in February. Goodbye, everyone.

Operator

This concludes today’s conference call. Thank you all for participating. You may now disconnect, and have a pleasant day.