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Edited Transcript of CRI earnings conference call or presentation 27-Feb-18 1:30pm GMT

Q4 2017 Carter's Inc Earnings Call

Atlanta Mar 2, 2018 (Thomson StreetEvents) -- Edited Transcript of Carter's Inc earnings conference call or presentation Tuesday, February 27, 2018 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian J. Lynch

Carter's, Inc. - President

* Michael D. Casey

Carter's, Inc. - Chairman & CEO

* Richard F. Westenberger

Carter's, Inc. - EVP & CFO

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Conference Call Participants

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* Anna A. Andreeva

Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst

* Irwin Bernard Boruchow

Wells Fargo Securities, LLC, Research Division - MD and Senior Specialty Retail Analyst

* James Andrew Chartier

Monness, Crespi, Hardt & Co., Inc., Research Division - Security Analyst

* Kate McShane

Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst

* Laurent Andre Vasilescu

Macquarie Research - Consumer Analyst

* Susan Kay Anderson

B. Riley FBR, Inc., Research Division - Analyst

* Warren Cheng

EVERCORE ISI - Analyst

* William C. Schultz

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Carter's Fourth Quarter 2017 Earnings Conference Call. On the call today are Michael Casey, Chairman and Chief Executive Officer; Richard Westenberger, Executive Vice President and Chief Financial Officer; Brian Lynch, President; and Sean McHugh, Vice President and Treasurer. (Operator Instructions) Carter's issued its fourth quarter 2017 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 www.carters.com.

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

On this call, the company will reference various non-GAAP financial measurements. A reconciliation of those 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.

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [2]

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

Earlier today, we reported exceptionally good growth in our fourth quarter and a record level of sales and earnings for 2017. This was our 29th consecutive year of sales growth and a significant year of progress for our company. In the fourth quarter, we achieved the sales and earnings goals we shared with you on our last call. We saw very strong demand in each of our business segments, with double-digit sales growth in November and December driven by the strength of our fall and holiday product offerings and the contribution from our new growth initiatives.

In 2017, we outperformed the macro trends in the retail apparel industry and the young children's apparel market. We strengthened our retail store model and omni-channel capabilities. We launched a very successful exclusive brand with Amazon, and we added 2 new growth vehicles to our business, with the acquisition of Skip Hop and our largest international licensee based in Mexico.

What we did not expect in the fourth quarter was the significant and positive impact of the new tax law. This new law is expected to lower our previously planned tax provisions by more than $200 million over the next 5 years. We plan to use that savings to reinvest in our business, create new jobs and accelerate our growth.

Like many good companies, we will share a portion of the 2017 tax savings resulting from this historic legislation with our employees. Our Board of Directors has authorized $20 million in special compensation awards to be provided through additional funding of our 401(k) plan and special bonuses to all of our eligible full-time and part-time employees. This is a wonderful recognition of thousands of employees who contributed to the strong results we're reporting this morning.

We're expecting another good year of growth in 2018. We're planning about 5% growth in sales, with low single-digit growth in our wholesale business, mid-single-digit growth in retail and double-digit growth in our international business.

With respect to our wholesale business, we're encouraged by reports earlier this year by some of our largest customers. In our market week meetings in January, we sensed a bit of a positive inflection point as we discussed some of the best holiday performance achieved in the past 3 years. Our customers' focus on technology, inventory management and store rationalization seem to be delivering better results for them. Over time, we expect we'll be working with fewer, better, stronger retailers.

We're forecasting good growth in wholesale this year. We're planning meaningfully higher sales of our Skip Hop brand and our Simple Joys brand sold exclusively to Amazon Prime customers. We expect Amazon will grow to be one of our largest customers over the next 5 years.

With respect to our retail business, we had a very strong fourth quarter driven by higher traffic and conversion rates, and better margins. Our co-branded stores continue to have the best comp performance relative to our other store models. Our co-branded model provides consumers with the best performing components of our Carter's and OshKosh B'gosh product offerings in one convenient location. We entered 2017 with only 20% of our stores being dualbranded, meaning co-branded and side-by-side stores. By 2022, we plan to increase the mix of dual-branded stores to at least 50%.

As we shared with you on our last call, we continue to assess the performance of our store models and the consumer preferences for shopping with us. Our best performing stores are co-branded and located closer to the consumer. By comparison, our weakest comp performance is in our legacy outlet locations and standalone OshKosh stores. Beginning this year, we plan to edit out more of our underperforming stores and plan to close our least profitable stores upon lease expiration. Over the next 5 years, we plan to close 115 underperforming stores and convert about 40 standalone stores to our co-branded format. Stores we plan to keep open had an operating margin of over 20% in 2017 compared to a margin of less than 2% for those we plan to close.

This initiative builds on our strategy launched in 2010 to improve the convenience of shopping for our brands. In 2010, 75% of our stores were in outlet centers. Our plan is to reduce the mix of outlet stores to 20% or less by 2022. Some of our outlet stores are our largest and most profitable stores. Those stores will remain open. But given the success of our e-commerce and co-branded store strategies, we're seeing fewer visits to remotely located outlet centers. We believe this fleet optimization strategy will improve the convenience of shopping for our brands and drive better performance in our retail business.

We believe our stores provide the very best presentation of our brands. About 85% of our customers shop both online and in our stores. Over 70% of our customers shop only in our stores. Our multichannel, multibrand consumer is our most valuable consumer in terms of frequency of visit and annual spending. She spends 3 times as much as the single-channel consumer. The more we've opened co-branded stores closer to the consumer, the better performance we've seen both in-store and online.

Last year, only 17% of young children's apparel was bought online. By 2022, we expect about 30% to be bought online, meaning 70% of children's apparel is still expected to be purchased in stores. Over the next 5 years, we plan to open 160 beautiful co-branded stores closer to our consumers. We're planning net door growth of about 45 stores, less than 10 a year, after closures and conversions to the co-branded format.

Our international business achieved a new milestone in 2017, exceeding $400 million in sales and contributing 12% of our total sales. We're planning double-digit growth in international sales this year driven by our growth initiatives in Canada, Mexico and China and the full year benefit from Skip Hop.

We continue to see very strong demand for our brands from international customers on our U.S. website. A recent study showed that Carter's was among the top 4 most popular websites for international shoppers together with Amazon, Ralph Lauren and Gap. Interestingly, on our U.S. website, we saw the largest international demand coming from Brazil and Argentina with demand up 50% to last year.

With currency exchange rates stabilizing, we're also seeing improved trends in our tourist and southern border stores. This may be a leading indicator of possibly better demand from international wholesale partners. This high-margin component of our business declined this past year due to weakness in their local economies. In 2018, we're planning the wholesale component of our international business to be comparable to last year, with the growth driven by our retail business.

With respect to our supply chain, we exceeded our goal to build internal capabilities that would enable 50% of our products to be sourced directly by 2017. 5 years ago, nearly 100% of our product was sourced through agents. By the end of 2017, we sourced over 60% of our products directly from our suppliers. We believe this initiative has improved the competitiveness of our supply chain and resulted in a stronger product offering, lower product costs and higher service levels.

We're keeping an eye on inflationary pressures driven by rising fuel and cotton prices, higher labor costs and increased demand for manufacturing capacity given the improvement in the global economy. Near term, we're forecasting lower product costs, which should enable gross margin expansion this year.

The new tax law improved our previous earnings forecast for 2018 by $40 million. If we chose to flow through the full impact of the new law to earnings this year, we'd forecast over 20% growth in earnings per share. Over the past 2 months, we've explored alternative uses for that tax savings and plan to reinvest $20 million of the $40 million tax benefit into 2 important components of our business. The first is brand marketing. The second is expedited shipping of our e-commerce orders. Both investments are expected to strengthen the consumer experience with our brands.

Last year, Carter's was ranked by millennials as one of their favorite brands. Our research showed that over 80% of families with young children purchased the Carter's brand last year. It has been the top-of-mind brand for multiple generations of consumers, known for its great quality and extraordinary value. There are nearly 4 million beautiful babies born every year in the United States, 4 million new reasons to come shop with us. We're very fortunate to have this natural traffic driver to our brands.

To further strengthen this unique connection with consumers, we plan to reinvest a portion of the 2018 tax savings and will increase our marketing investment in our core baby business. We plan to increase the mix of emotional brand marketing relative to our promotional marketing.

We also plan to increase the marketing investment in our older age segments. We believe these investments will further strengthen our #1 market share position in the newborn and toddler age segments and enable market share gains in the older age segment. We've made good progress in recent years, aging up our brands and extending the number of years consumers shop with us. Last year, our retail sales in the 0- to 24-month age segment grew by over 5%. By comparison, sales in our 3- to 10-year old age segment, which represented over 40% of our U.S. retail sales grew by over 9%. 2 years ago, we extended the age range of our Carter's brand to size 8 and OshKosh to size 14. Given the success of that product extension and the success we're seeing with our co-branded store strategy, beginning this fall, we will extend the Carter's product offering to size 14, consistent with OshKosh.

Carter's is the best-selling young children's apparel brand in the online channel in the United States, with 3 times the share of our nearest competitor. In 2017, our e-commerce business was our fastest-growing highest-margin business. To further strengthen this component of our business, we plan to reinvest a portion of the tax savings to further strengthen our consumer's online experience with our brands this year. To improve the consumer experience, we've taken steps with our supply chain to improve the speed of delivery of our e-commerce orders. Our research shows that the quicker the delivery, the higher the satisfaction rating and annual spend by consumers. We believe this initiative will further strengthen our position as the absolute leader in online sales of young children's apparel.

As we move through the year, we'll brief you on the effectiveness of these incremental investments in brand marketing and expedited shipping.

In terms of our long-term outlook, we believe our multichannel business model enables sales growth of about 5% a year, on average, over the next 5 years. That's our planning horizon. We plan to grow sales by $1 billion or more by 2022. In round numbers, we're planning about $400 million of growth in our e-commerce sales; $100 million of growth from our stores, net of store closures; $300 million of growth in international sales driven by Canada, Mexico and China; and $200 million of growth in our wholesale business.

With respect to profitability, we're planning our earnings to grow at a faster rate than sales over the next 5 years. Our projections reflect average annual earnings growth of about 10% including the benefit from continued share repurchases.

In summary, we made significant progress last year, strengthening our position as the leader in young children's apparel. We own the largest share of the $20 billion young children's apparel market in the United States, and we believe we have many opportunities to achieve our growth objectives. The outlook for our business is good.

We are well positioned to grow and gain market share. We own 2 of the best-known and best-performing brands in young children's apparel. To the best of our knowledge, no other company in the world has our brand reach or success in young children's apparel.

2018 is expected to be our 30th consecutive year of sales growth. This long track record of growth reflects the extraordinary dedication of our very talented organization. I'm very grateful for the performance our employees made possible for us last year and their commitment to ensure the continued success of our brands and the growth in our business.

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

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Richard F. Westenberger, Carter's, Inc. - EVP & CFO [3]

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Thank you, Mike. Good morning, everyone. I'll begin on Page 2 of today's presentation materials.

Pages 2 and 3 include our GAAP income statements for the fourth quarter and the full year. Most of my comments today will speak to our results on an adjusted basis. This presentation and today's earnings release include a number of important reconciliations of our GAAP results to the adjusted basis of presentation, particularly adjustments that relate to the implementation of the recently passed tax reform legislation and the special employee compensation provisions which we announced today. I encourage you to review these reconciliations as you evaluate our results.

Turning to Page 4, with some highlights of the fourth quarter and fiscal 2017. As Mike noted, we delivered a strong fourth quarter which closed out a very good year for us. Consolidated net sales grew 10% over last year, with growth in all business segments and good contributions from Skip Hop and our business in Mexico, both of which were acquired in 2017. Adjusted earnings per share grew 30% in the fourth quarter driven by strong operating income growth, the benefit of share repurchases and a lower effective tax rate. For the full year, net sales grew 6% and adjusted earnings per share grew 12%, both in line with the initial guidance which we provided at this time last year. We also returned $260 million to shareholders through dividends and share repurchases. We achieved these solid full year results while also investing in new growth vehicles for the future and continuing to invest in technology used across our business.

Turning to Page 5, with a summary of our sales performance in the fourth quarter. Sales in our U.S. Retail segment grew 7%, total U.S. Retail comparable sales grew 4.5%, which built on a 5.5% comp in the fourth quarter of 2016. Sales in U.S. Wholesale grew 11% compared to last year driven by increased demand for our Carter's brands and the addition of Skip Hop revenue. International segment sales grew nearly 21% on a reported basis driven by higher revenues in Canada, contributions from Skip Hop and Mexico and a $4.5 million benefit from favorable movements in foreign currency exchange rates.

Moving to our adjusted P&L for the fourth quarter on Page 6. Building on our strong top line growth of 10%, consolidated gross margin expanded 90 basis points to 44.8%, principally due to favorable product costs, supply-chain efficiencies and lower inventory-related costs. Our adjusted SG&A rate declined 40 basis points to 29.6% reflecting our strong top line growth and expense discipline during the quarter. Net interest and other expense increased 15% reflecting higher borrowings to support seasonal working capital needs and higher interest rates on our variable rate borrowings. On an adjusted basis, our effective tax rate declined significantly compared to last year principally due to the benefit of an accounting change for stock-based compensation and the increased significance of our direct sourcing operations overseas. Our average share count declined 4% compared to last year, reflecting our share repurchase activity. So again, on the bottom line, fourth quarter adjusted EPS was $2.32, up 30% versus $1.79 last year.

Page 7 details the impact of the adoption of the recently passed tax reform legislation on our fourth quarter results as well as the special employee compensation provision we have announced. We recorded a $50 million non-cash benefit related to the revaluation of deferred tax assets and liabilities as a result of tax reform. We also recorded $10 million for a one-time tax on accumulated earnings outside of the United States. We've chosen to invest approximately 50% of this net $40 million benefit from tax reform by rewarding our employees with special cash bonuses and additional company contributions to our employee retirement programs. We are the leader in the young children's apparel market because of our exceptional employees and are very pleased to be able to share these meaningful benefits with them. Our adjusted fourth quarter results exclude the net benefit of tax reform and these special compensation provisions. As I mentioned earlier, this presentation and today's earnings release include a full reconciliation of our GAAP to adjusted results.

Page 8 summarizes our balance sheet at year-end and cash flow for fiscal 2017. Quarter-end inventories were up 12.5% versus last year. When excluding Skip Hop and Mexico, inventories increased 4.5%. We believe our inventories were in good shape heading into the new year. Looking ahead to the end of the first quarter, we expect net inventories will be up in the mid-teens versus last year, driven by new business growth including Skip Hop, Simple Joys with Amazon and Mexico as well as the earlier receipt of certain programs in retail. We expect the year-over-year increase in net inventories will moderate over the balance of the year and our current year-end projection reflects an increase in the low to mid-single digits.

Year-end debt increased by $37 million compared to last year driven by short-term borrowings to support seasonal working capital needs, funding for the 2 acquisitions in 2017 and our continued return of capital to shareholders. Free cash flow for the year was strong at $260 million. In fiscal 2017, we completed a $189 million in share repurchases and paid $71 million in dividends, for a total return of capital of $260 million. Since 2007, we have returned $1.5 billion to shareholders through share repurchase and dividends and have repurchased approximately 35% of the shares we had outstanding 10 years ago at an average price of $62 per share.

In this morning's press release we also announced that our Board of Directors has authorized a new incremental $500 million share repurchase authorization. This authorization similar to past programs has no expiration date. Additionally, reflecting our strong liquidity and planned earnings growth, our board has also authorized a 22% increase to our quarterly dividend to $0.45 per share. This is the fifth consecutive annual increase to our dividend since we initiated it in 2013.

Now turning to Page 10, with an overview of our business segment performance in the fourth quarter. Our consolidated adjusted operating margin increased by 110 basis points, a result of the strong revenue growth, gross margin expansion and SG&A leverage noted earlier. Notable segment highlights in the fourth quarter include 150 basis points of margin improvement in our U.S. Retail business, which represents the third consecutive quarter of margin expansion in this segment, and 80 basis points of leverage in corporate expenses.

The operating margin in U.S. Wholesale remained relatively stable at 21.7%, despite higher provisions for bad debt related to the bankruptcies of Toys"R"Us and Bon-Ton. International segment margin declined versus a year ago due to several factors, which I'll cover more in a moment.

Moving to our individual business segment results, beginning with U.S. Retail on Page 11. U.S. Retail segment sales in the fourth quarter increased 7% versus last year. Our total U.S. Retail comp increased 4.5% in the fourth quarter driven by a strong e-commerce comp of 19%. Store comps declined about 1%. The combined November, December period was particularly strong with a 5.6% total retail comp increase, including positive store comps as well. We're very pleased with our fourth quarter comp performance, especially given the strong prior year comparison.

With regard to comparable sales, I want to highlight a change going forward in how we will report this metric. For several years, we have reported total retail comparable sales along with discrete comparable sale measures for our brick-and-mortar stores and our e-commerce business. Over the past few years we have worked to establish new and compelling omni-channel capabilities in order to better meet consumer's needs. We've learned a lot about how consumers like to shop and how they view their interactions with us across our different channels. Consumer omni-channel shopping activity has increased substantially and many of the traditional boundaries between store and online shopping are becoming blurred. We are increasingly managing and evaluating our retail business across the totality of our relationships with consumers. Effective with our first quarter 2018 reporting, we intend to continue to report a total retail comparable sales metric but we will discontinue reporting separate store and online comps.

In the fourth quarter, we opened 9 net new stores. In fiscal 2017, we added 38 net new stores to bring our year-end U.S. Retail store count to 830. Segment operating income in the fourth quarter improved 17% to $100 million and segment margin improved by 150 basis points to 17.7%. This margin improvement reflects lower product costs and better inventory performance, which were partially offset by store expense deleverage and higher distribution and freight costs.

On Pages 12 and 13, we've included photos of 2 new co-branded stores in the greater Detroit area. Our co-branded format stores, which represent the best of the Carter's and OshKosh brands in a single retail store location, continue to deliver the best comp performance and returns relative to our other store formats.

Moving to Page 14, where we've summarized our U.S. Retail store portfolio plans over the next 5 years. Our focus on portfolio optimization is expected to result in a greater number of store closures compared to recent years. Today, there are meaningful performance differences between stores expected to remain open and those we plan to close. Not only are the continuing stores significantly more profitable, their comp sales in 2017 were on average 640 basis points better than the stores we expect to close. Over the next 5 years, we plan to open approximately 160 new stores and close 115. We also plan to convert about 40 existing single-brand stores to the co-branded format. So we expect that in 5 years we'll be managing a number of stores which is largely consistent with today's store count. As a result of these actions, our U.S. store portfolio is expected to evolve into a more balanced mix of single and dual-brand locations, with a greater mix of brand stores in strip or value centers closer to the consumer versus outlet centers compared to today.

Page 15 features images of a new product introduction - Little Planet. We developed this new brand in response to feedback from millennial moms. This new organic line combined certified organic cotton with Carter's expertise in developing beautiful clothing with exceptional quality and value. Little Planet is just arriving in market now with several of our wholesale customers and it's also available on carters.com.

Turning to Page 16. I want to share some data on the strength of our brands presence and influence on social media. Simply put, we have built the strongest social media presence of all children's specialty retailers. We believe that our brands are unique in the enduring and emotional connections which they establish with consumers, especially with those most closely involved with caring for and raising young children. On sites such as Instagram and Facebook, we have attracted the highest number of followers. Additionally, we have found that our posts and communications on social media attract significant levels of response and engagement from consumers, higher than any other brand in our space. We've illustrated this by including some of our highly successful Instagram posts over December and January. We will continue to develop and expand our social media capabilities going forward. Much of what is envisioned in terms of increased brand marketing will be in the digital arena, where today's millennial moms receive most of their information, especially from their favorite brands. These social media capabilities complement the strong presence we have established in e-commerce over the years. Through our own website, the websites of our wholesale customers and e-commerce operations outside of the United States, we've estimated that online consumer sales of our brands globally in 2018 will represent nearly $900 million.

Turning to Page 17, with an update on Skip Hop. 2017 was a strong year for Skip Hop. Sales across all channels grew over 20% for the full year, with fourth quarter sales growing nearly 30%. Since its acquisition in February last year, Skip Hop contributed approximately $96 million to our consolidated sales and approximately $33 million to our fourth quarter. Skip Hop did not meaningfully contribute to earnings in 2017 principally due to integration activities and increased bad debt and inventory costs. During the fourth quarter, we introduced a small, focused Skip Hop assortment in nearly all of our U.S. stores in time for holiday selling, with good response from consumers. We now have an expanded assortment of Skip Hop in stores for the Spring selling season. The images on the left side of Page 17, from several Atlanta area stores, show a few different fixture configurations featuring a number of Skip Hop products, including the iconic Zoo character backpacks. As we told you on our last call, we added Skip Hop as a separate brand tab on carters.com this past summer. Skip Hop continues to introduce new and innovative products, such as the new diaper bag collection highlighted at the right of Page 17. Consumer response to Skip Hop products on our website has been strong. With the addition of Skip Hop online, we have strengthened carters.com as the destination for new parents and families with young children, providing the best brands in young children's apparel and related products to meet a broad range of needs.

In 2018, we're forecasting another strong year of growth for Skip Hop driven by expanded distribution as well as ongoing product innovation. We also expect a meaningful improvement in the brand's profit contribution.

Moving to Page 18, with results for our U.S. Wholesale business in the fourth quarter. Fourth quarter net sales in U.S. Wholesale increased 11% reflecting the strength of our product offerings, favorable shipment timings and the benefit of the Skip Hop acquisition. Excluding Skip Hop, segment net sales grew 5%. U.S. Wholesale segment operating profit increased 10% to $71 million compared to $65 million last year. Segment margin was 21.7% roughly comparable to the fourth quarter of last year. The margin performance reflects improved core business profitability, which was offset by the addition of the lower margin Skip Hop business. Looking ahead, full year 2018 net sales in U.S. wholesale are expected to increase in the low single-digit range, which is consistent with the growth we delivered in fiscal 2017. We continue to monitor the health of several of our wholesale customers and are actively managing our exposure as best we can as these retailers work to improve their businesses.

Moving to Page 19, and international segment results for the fourth quarter. We had strong growth in international segment net sales, in part due to the contributions from the Skip Hop and Mexico acquisitions and good growth in Canada and China. We saw particular growth in international wholesale sales, which grew 41% in the fourth quarter, again, largely reflecting the benefit of Skip Hop, Mexico and China. As we've mentioned on previous calls, we saw lower demand in 2018 [2017] from several of our international wholesale partners, which we attribute to weak economic conditions in their local markets. We're seeing signs of stabilization in this part of our international business, and are forecasting full year net sales in 2018 to international wholesale customers to be comparable to 2017. In Canada, total retail store sales increased 10% driven by new store openings. Store comps declined 2.6% reflecting lower consumer traffic, which we believe was related to unseasonably warm temperatures and higher promotional activity. Fourth quarter international e-commerce net sales were strong with growth of 17% driven by strong sales in Canada. International segment operating margin was 15.8% in the fourth quarter compared to 20.1% in the fourth quarter of 2016. This decline reflects several factors, including the impact of the acquired businesses on the overall international segment margin, unfavorable changes in sales mix, lower comparable store sales in Canada and the roughly $4 million operating loss in China. We're planning for operating margin expansion in international in 2018.

Page 20 features a new Carter's store recently opened by our wholesale partner in China. In 2017, our partner opened 42 new stores, to bring the year-end total store count to 51 locations. When also including e-commerce sales on Tmall, our total China business in 2017 was approximately $21 million, up 34% over the prior year.

Pages 22 through 25 recap our full year 2017 results. Mike covered many of these highlights in his opening remarks, so I'll simply reiterate, that we delivered strong top and bottom line growth, made important investments to strengthen our business and returned a meaningful amount of capital to shareholders.

The next few pages are included for your reference and review, so we'll move ahead to Page 26. In considering our sales and earnings objectives over the next 5 years, through 2022, we are planning on growing our top line approximately 5% annually, on average, which would add approximately $1 billion in net sales. The U.S. Retail segment, e-commerce in particular, is expected to drive about half of this projected growth. Our International and U.S. Wholesale businesses are also expected to contribute to growth. We're forecasting double-digit earnings per share growth annually over the next 5 years, driven by top line growth, operating margin improvement, an effective tax rate of approximately 23% and continued share repurchase activity.

Moving to Page 27 and our outlook for 2018. As a reminder, the first quarter is one of the smallest of the year in terms of both net sales and profit contribution. We have a couple of unusual things affecting our outlook for the first quarter, including the benefit of an earlier Easter this year, which is somewhat offset in wholesale by fiscal year calendar shifts for many of our customers, which will result in some wholesale demand moving out into the second quarter. For the first quarter of 2018, we're forecasting net sales to grow approximately 2% compared to last year, driven by growth in U.S. Retail and International. Sales in our U.S. Wholesale segment in the first quarter are forecasted to be down year-over-year. While operating income in the first quarter is forecasted down, earnings per share is expected to benefit from a lower effective tax rate versus a year ago. We're currently forecasting adjusted EPS for the first quarter to be roughly comparable to last year's adjusted EPS of $0.97.

We're expecting another good year in 2018. For the full year, we're forecasting 2018 net sales to grow approximately 5% compared to 2017, with our U.S. Retail and International segments driving the majority of expected growth. As Mike covered in 2018, we expect to invest approximately $20 million or 50% of the projected savings from the new lower effective tax rate in brand marketing and strengthening our e-commerce capabilities. Accordingly, 2018 adjusted operating income is planned to be approximately comparable with 2017. 2018 earnings per share are expected to grow approximately 15% compared to adjusted EPS of $5.76 in 2017. This forecast contemplates an effective tax rate in 2018 of approximately 23%. As our business becomes more weighted towards retail, we expect the majority of our sales and earnings growth to come in the second half of the year. We're planning for strong operating cash flow in the range of $375 million to $400 million in 2018. CapEx is expected to increase to approximately $115 million compared to $69 million last year. 2017's level spending was somewhat lower than usual, in part due to the timing of project spend. 2018's investment agenda includes spending on new store openings and remodels in North America, technology initiatives and investments to expand and improve our distribution capabilities.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And for our first question we go to Kate McShane with Citi research.

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Kate McShane, Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst [2]

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I guess I'll start with, just your exposure to different wholesale channels. I think you've discussed before how big mid-tier department stores represent as a percentage of sales. And as we approach the end of your first year of your relationship with Amazon, what have been some of the learnings with their -- this customer and how might things change in 2018?

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Brian J. Lynch, Carter's, Inc. - President [3]

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Well, couple of things. Again just to restate what Richard said, we're -- we feel confident for 2018, we have good growth in our wholesale business. We've got it planned up mid-single digits, more back half loaded probably up -- I'm sorry, low single digits for the year, more back half loaded with mid-single digits in the back half of the year. In terms of mid-tier department stores, our exposures to that has continued to be reduced as some of those folks have either cut back or gone out of business. About 13% of our wholesale business is that midtier department store channel. I would note that most of our accounts are growing. There are some challenges with some of the bankruptcies and we've talked about that. Toys"R"Us for instance has been a very good customer over the years, we're monitoring that situation. For context, they do represent less than 3% of our total sales. So we'll work with them on their go-forward doors and any other closers that occur out there. But we would expect sales that take place in those closed doors are going to be picked up over time by some combination of our retail business and other wholesale partners because I'd say, we don't believe mom's desire to buy our industry-leading brands would decline based on any closures. And we're well positioned online and in over 17,000 doors for the transfer of sales that would take place. So we feel good overall about our wholesale business.

Amazon, you asked about Amazon. We've learnt a great deal from Amazon. It's a really good customer, we work very closely with their team and meet with them often. After the successful launch of Simple Joys last spring, the brand does continue to ramp up. The sales have been primarily in the baby and sleepwear categories, and our inventories are really well positioned for '18 as we've learned what key items mom responds to best on our site. But our early reads on OshKosh and Skip Hop businesses' remained really strong. We're excited about expanding in the playwear on Amazon, we think that that's a good opportunity to age up on the site. And we're going to be adding toddler size ranges for agents for spring for 2018 and other accessories, categories as well. And we think we can continue to grow rapidly with Amazon through our 5-year plan and profitability is expected to increase and be comparable to other top accounts over the next couple of years.

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [4]

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And Kate, just to add to that, as we were analyzing the growth plans for 2018, what I found interesting, we've probably got 15 meaningful wholesale relationships. Some are larger than others, obviously. But of those 15, 8 we're forecasting growth with -- this year. That's probably as good as I can recall in recent years. 2 of the customers will have sales comparable year-over-year and we'll show a decline in 5 of those relationships and 3 of the 5 are mall-based retailers and another is Babies"R"Us, as you might expect with some of the things that they're working through. So I'm encouraged. As I shared with you in our January market week meetings, I sensed a bit of a positive inflection point. Best holiday performance, I would say, in the past 3 years. That's what we were hopeful for is that with all the good initiatives that they've put in place in recent years, their business would start to show some progress. And we're sensing that. Not consistently across all of them, but there's certainly some pockets of strength that give us reasons to believe that we've -- that we'll have a healthier wholesale business going forward.

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Operator [5]

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And for our next question we go to Ike Boruchow with Wells Fargo.

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Irwin Bernard Boruchow, Wells Fargo Securities, LLC, Research Division - MD and Senior Specialty Retail Analyst [6]

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So first question. I guess, Richard, can you discuss the timing shifts that you talked about that are affecting the Q1 wholesale performance in a little bit more detail? And maybe give the dollar amount that you expect to shift between Q1 and Q2, just so we kind of understand what's going on there?

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Richard F. Westenberger, Carter's, Inc. - EVP & CFO [7]

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Sure. That -- the timing shift really has to do with the 53rd-week, which pops up every 4 or 5 years. It happens to be a 53rd-week year for many or at least quite a number of our wholesale customers. That has the effect of pushing out some amount of volume from Q1 into Q2. We are planning wholesale growth in the second quarter. I don't know that I'll quantify with precision, but we are forecasting this -- the wholesale segment to be down high single digits to low double-digits and we get a good portion of that back in the second quarter.

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Irwin Bernard Boruchow, Wells Fargo Securities, LLC, Research Division - MD and Senior Specialty Retail Analyst [8]

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Got it. That's helpful. And then just a follow up, so just one, when we look at the guidance for this year and it seems like you're investing about 50, 60 basis points back into your SG&A due to the tax savings. Given these changes, is there a new margin target the company is thinking about relative to the 14% that I believe you guys have talked about in the past? Just you talked about the sales growth opportunity and EPS growth opportunity over the next 5 years, I'm just curious if there's a margin that we should be thinking about as well?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [9]

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So we're expecting to see a good return on these investments that we're making this year. Before the news of the new tax law, we would have otherwise been planning growth for 2018, probably around 5% top line growth, 5% growth in operating income, operating margin comparable to last year of 13% and change, and about 10% earnings growth. So the tax law made us think differently about were there opportunities to invest, to accelerate our growth longer term. And so that's the path we're taking for 2018. The longer term margin target is more than 13.5%. So it's not currently -- in 2022, it's not showing 14%. I would say it's largely because of the new businesses that we've added this past year, that today are lower margin. Our challenge over the next 5 years is to make them higher margin businesses. But we're fortunate, Carter's is a margin-rich business, it always has been, with opportunities for improvement. Very few brands have the margin structure that Carter's does with some of the new businesses near term will be margin dilutive. But we expect to show meaningful progress in terms of improving the profitability of Skip Hop, Amazon, Mexico and, to some extent, China beginning this year.

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Operator [10]

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And for our next question we go to Susan Anderson with B. Riley FBR.

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Susan Kay Anderson, B. Riley FBR, Inc., Research Division - Analyst [11]

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I was wondering if you could talk about the expanded size offerings at Carter's. I guess, maybe if you could talk about how these will differentiate from the baby and toddler offerings? And then also from the OshKosh offerings for the same age?

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Brian J. Lynch, Carter's, Inc. - President [12]

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Yes, Susan, it's Brian. We really see a nice opportunity to grow our business in the toddler kid's sizes and gain share going forward. We've got the vast majority of new moms and gift givers that buy for babies in our database. We know them well. They love our brands and we like to retain them longer as great customers by addressing their needs for their young children as they grow. And these are those really valuable millennial moms. We acquire them first here at Carter's when their first child was born. We've got the largest share of the 0 to 24 baby business. As Mike shared, about 4 times our closest competitor. And we've got the largest share in toddler. And we've got a strong and growing kids business, which we've define as ages 5 to 10, where we have a top 4 share, despite really not offering the Carter's brands in larger sizes in that segment. So as we evaluated many ways to grow, we find it encouraging as Mike had shared about 60% of our sales in retail is baby, but 40% is in toddlers and kids and the toddler and kid is the fastest growing. So given the success, we're going to add sizes 10 to 14 in Carter's for fall of '18. You asked about differentiation, we really reoriented our design and marketing efforts to have the right age-appropriate creative for each segment. So we've structured around a baby business, a toddler business and what we'd call a kid business. And believe we can strengthen our share in each of those efforts by going forth with that. And we'll share more about it in the Fall.

In terms of OshKosh versus Carter's, we have totally different design teams. They're both incredibly talented, they do a fabulous job everyday but we have different design teams and marketing teams that will be making sure that we tailor the assortments and the marketing to the unique characteristics of each brand and we think there's good opportunities to grow both in our co-branded stores, that now gives us the opportunity to offer mom to enter the store and be able to buy for her baby right up to size 14 and maybe even take some Skip Hop product home for fun with the kids.

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Susan Kay Anderson, B. Riley FBR, Inc., Research Division - Analyst [13]

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Great. That sounds good. And then just 1 follow-up on the Mexico franchise purchase. I know it's also early days but any learnings from the franchise purchase and then how should we think about growth there in 2018?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [14]

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Sure. We bought a good business. They are good people, good management team, we love their stores. We see an opportunity to help them on the sourcing side, the retail store management side. We've got some good initiatives underway to expand the wholesale business. So these are -- this is a business that we've known for many years. It's been a licensee for over 20 years. I would say the go-to-market strategy was a bit disjointed in years past. Our Mexico partners did some of the work, we did some of the work directly with some of the wholesale customers down there. So now we're one company, with a -- with the capacity to make that a much more efficient business. So our early learnings are good. It should be some portion of a $30 million business for as us this year and we expect to double it over the next 5 years.

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Operator [15]

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And we go next to Bill Schultz with Goldman Sachs.

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William C. Schultz, Goldman Sachs Group Inc., Research Division - Research Analyst [16]

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Mike, it's a commendable thing you guys are doing to take this tax windfall and invest behind your people. So just want to put that out there before going into my questions. So just diving into the reinvestment plans a bit more, I just had two quick ones. On the increased marketing spend, how much of those incremental dollars you guys expect to be in digital? And then two, what sort of capital investments do you guys think are needed so that your infrastructure can support faster e-commerce deliveries?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [17]

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It's a good question. So on the brand marketing, it'll be heavily weighted to digital. Richard showed you a terrific slide in terms of how well we're connected to millennial consumers through social media. So we've improved our capabilities in recent years so that we can target consumers more effectively, we can personalize the messages. And the good thing is, before we knew about the tax law, we had a brand marketing campaign underway for the Carter's brand. That, we'll probably be able to share more with you when we update you again in April. So it will be heavily weighted to digital. That's the way that good companies are connecting with consumers today.

And then in terms of CapEx, we've got a game plan. You should expect CapEx going forward should be comparable to a level of spend we've had in years past. Some portion of 2.5% to 3% of sales. We will invest in a new West Coast distribution center beginning this year. And that's more to support Skip Hop and the growth that we're expecting in Amazon. And there were -- there's other opportunities that are less CapEx related to help expedite the shipment of the e-commerce orders. We have some good relationships, some good dialogue going on with our logistics providers that will enable us to expedite the speed of delivery.

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Operator [18]

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We go next to Anna Andreeva with Oppenheimer.

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Anna A. Andreeva, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [19]

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We had two quick questions. Just following up on the 1Q guide, maybe talk about what are you guys seeing quarter-to-date in retail? And remind us what's the earlier Easter benefit that we should expect? And then, secondly on gross margins, so really strong results in retail especially. Maybe talk about the puts-and-takes on the gross margin line as we go through the year. What are you guys seeing, was it AUC and what should we expect as part of the guide for 1Q and the year?

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Richard F. Westenberger, Carter's, Inc. - EVP & CFO [20]

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I'll take the second part of the question, Anna. On gross margin, we've had a continuing trend of lower product costs, which has benefited all of our businesses, wholesale and retail as well. Our projections right now through 2018 show that we continue to have the benefit of lower product costs. There are some signs for inflation on the horizon for early 2019 and that might have an impact later in the year as we start to ship that spring 2019 product. We're also getting benefits from the continued growth of our direct sourcing operations. So we've built substantial size and scale to our operations in Hong Kong. Those folks are doing a great job helping us negotiate with factories on a more direct basis than we have in the past. That's also benefiting gross margin. And then just from a mix point of view, we have the continued growth. Most of our growth is going to come from our U.S. Retail business this year. That is a gross margin rich business, so that should be accretive to the rate as well. So we're planning for gross margin expansion as well across the year and including the first quarter.

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Brian J. Lynch, Carter's, Inc. - President [21]

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In terms of Q1, Anna, we have a positive comp to date. We had a good start in our retail business in January. And I'd say we're down a tick in February, weather, other issues. And then the biggest month to go in March, we're excited about that. Earlier Easter, you are correct. Usually that's a shift of 1 point, 1.5 point in comp. So we would hope to have a really good strong Q1 in our retail business. We'd note that wholesale demand is good, we've had good early selling in spring product in wholesale and replenishment trends have been strong.

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Operator [22]

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And we go next to Laurent Vasilescu with Macquarie.

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Laurent Andre Vasilescu, Macquarie Research - Consumer Analyst [23]

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Can you remind us how much China generated revenues for the fourth quarter and the full year? Any expectations for 2018 revenues? And then any color on where you think the EBIT is for 2018 on China?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [24]

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So the growth at -- we had about $21 million in sales, total sales to China for the year. And I think it's important to keep in mind, we're early days in China. It's heavily weighted to e-commerce. And that's -- my guess is over the next 5 years it'll still be heavily weighted to e-commerce. We have a new -- that's with Alibaba's Tmall website. And then we have a new relationship with Pou Sheng, who opened up a total of about 50 stores by the end of the year. And so it's -- we've lost some fortune about $4 million last year, we hope that we start to show some more progress on improving the profitability of China in the next couple of years.

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Laurent Andre Vasilescu, Macquarie Research - Consumer Analyst [25]

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Okay, very helpful. And following the integration of the Mexican license business. Curious to know if you'd be willing to make any further investments in some license partners to further grow your international revenue business?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [26]

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It's possible. It's possible.

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Laurent Andre Vasilescu, Macquarie Research - Consumer Analyst [27]

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Okay. Very helpful. And then lastly if I could squeeze one more in. With Skip Hop reaching almost $100 million in revenues for FY '17, how should we think about that revenue growth for 2018 as growth rate or dollar terms? And how should we think about the EBIT contribution to the overall business in 2018?

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Brian J. Lynch, Carter's, Inc. - President [28]

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Skip Hop is -- integration is going well I'd say. We have had strong sales. The fourth quarter of last year was the largest quarter the Skip Hop team's ever had. So really excited about that. We've got really good robust sales growth planned this year in all channels with Skip Hop. We launched the site last summer and we doubled the online sales from that. We launched with Macy's, we're working with some other key account relationships and it's been very successful as we add it to our stores. And by Easter time we'll have an expanded assortment in our stores as well as the Canadian stores and our Mexico parter, and we're looking at brand extensions and new accounts as we go forward for '18. So the outlook is very strong for sales growth in all channels. And we think there's a nice opportunity to improve profitability. There were some things that occurred last year, in the first year, that Richard shared some that dampen the profitability a bit. But we feel that could be a good contributor to the company sales and profitability over time. And the sales growth is, I would say, robust this year as planned.

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Operator [29]

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And we go next to Omar Saad with Evercore ISI.

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Warren Cheng, EVERCORE ISI - Analyst [30]

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This is Warren Cheng online for Omar. I just wanted to follow up on Kate's question on the wholesale business, you gave some excellent detail on the performance by -- some different buckets. But I wanted to ask in particular about your business with your top 3 wholesale customers. How has that trended over the last 3 years, and has there been any change recently there?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [31]

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Typically I don't like to give customer specific information. So we won't be answering that question this morning. The performance varies from retailer to retailer from year-to-year based on their different strategies. But the thing we're most encouraged by is that we're forecasting good growth in wholesale this year.

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Warren Cheng, EVERCORE ISI - Analyst [32]

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Okay, got it. And also it looks like the outlook you gave for the wholesale contribution on the 5-year plan of $200 million, that's ticked up slightly. Is that just driven by Simple Joys or are there other drivers there that we should be aware of?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [33]

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We've -- you have two components. You have Skip Hop and you have Amazon.

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Operator [34]

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And we go next to Jim Chartier with Monness, Crespi and Hardt.

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James Andrew Chartier, Monness, Crespi, Hardt & Co., Inc., Research Division - Security Analyst [35]

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First I just wanted to talk about China, how did the stores that were opened, how did they perform? And does Pou Sheng plan to open any more stores in 2018? And then on the organic line, can you give us a little bit more detail about the organic apparel market for kids, how fast is that growing and how big it is today?

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [36]

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So with respect to China, just for context, again, it's a $21 million business, it grew about 30% last year. 75% of the sales are direct to the consumer through Alibaba's Tmall website. The balance is the wholesale business with Pou Sheng. Pou Sheng as you may recall, $2 billion publicly traded retailer, it's got about 8,000 stores under management. And it's early days, we're learning how to do business in China and we're learning the unique consumer preferences for product. It's a big market. It's worth exploring. It's a $12 billion market, it's expected to double over the next 10 years. As we've shared with you on calls past, about 16 million children are born every year in China, it's about 4 times the rate of children born in the United States. Our latest forecast shows some portion of $80 million to $100 million in revenue by 2022. Again, heavily weighted to the e-commerce business. We hope it's got some portion of about a 10% operating margin. It's going to be margins dilutive near term in its early days. And so we hope to show more progress on the profitability over the next couple of years. Pou Sheng, I would say the stores, it's mixed, of the 50 stores, as I understand it they were opened up in about 24 cities, which is -- it would be unlike something we would do in the United States. But again, they have 8,000 stores under management in tier 1, 2, 3 cities in China. So they've -- they're doing what they think is best to roll those stores out. That's their call. As I look at the store performance, some are doing well, some are not. My guess is this year that the focus for Pou Sheng will be more on improving store productivity, it'll be less on growth. By this time next year my guess is we'll have some portion of 60 stores that they're operating. And so we're on our way toward the 200 potential store openings over the 5-year period. But that's highly dependent on whether or not they figure out a model -- store model that is that provides good returns for them. So that's yet to be demonstrated that they can consistently open stores that provide good returns on investment.

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Brian J. Lynch, Carter's, Inc. - President [37]

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Jim, the other question you had on Little Planet, we developed 2 new brands as sources of growth over the past year, Simple Joys with Amazon, which we've talked about and also that Little Planet organics line both made by Carter's. Little Planet is a beautiful line and it really responds to the millennials wanting organic options. We had really strong engagement on all of our social channels at launch and a positive response to a limited offering. It is very early days, we're looking forward to growing that and monitoring the success. We're excited about the creative because not only is it organic but we've been able to achieve some of the vibrant color we have on our other Carter's brands and working with our supply chain. So we're excited about that. It's available as an online shop at carters.com and also at Macy's, Target and Amazon online.

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James Andrew Chartier, Monness, Crespi, Hardt & Co., Inc., Research Division - Security Analyst [38]

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Can you just give us a sense of how big the organic apparel market is in the U.S?

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Brian J. Lynch, Carter's, Inc. - President [39]

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Yes, I'd say too early to comment on our business. It's undetermined in terms of the market size on that. I guess, I would hold off on commenting on that until we get a little further into it.

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Operator [40]

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And ladies and gentlemen, this will conclude our question-and-answer session. Mr. Casey, I will turn the conference back over to you for any closing remarks.

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Michael D. Casey, Carter's, Inc. - Chairman & CEO [41]

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Okay. Well, thank you, all, very much for joining us on the call this morning. We appreciate your interest in the business. And we look forward to updating you again on our progress in April. Bye, everybody.

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Operator [42]

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And again, ladies and gentlemen, this will conclude today's conference. Thank you for your participation. You may now disconnect.