10-Q: Carters Reports Steep Profit Decline Amid Tariff Headwinds and Rising Costs

Carters, Inc. announced a significant drop in second-quarter and year-to-date net income and operating margins, driven by increased costs, a dividend reduction, and the anticipated material impact of new tariffs.

Summary

• Consolidated net sales increased 3.7% to $585.3 million in the second fiscal quarter ended June 28, 2025, compared to $564.4 million in the prior year.
• Consolidated net sales for the first two fiscal quarters decreased 0.9% to $1.215 billion, compared to $1.226 billion in the prior year.
• Gross profit decreased 0.4% to $281.8 million in Q2 2025, with gross margin declining 200 basis points to 48.1%.
• Gross profit for the first two fiscal quarters decreased 4.2% to $572.9 million, with gross margin declining 170 basis points to 47.1%.
• Selling, general, and administrative (SG&A) expenses increased 13.5% to $281.0 million in Q2 2025, representing 48.0% of net sales, up 420 basis points.
• SG&A expenses for the first two fiscal quarters increased 7.5% to $551.3 million, representing 45.4% of net sales, up 360 basis points.
• Operating income plummeted 89.7% to $4.0 million in Q2 2025, with operating margin at 0.7%, down 630 basis points.
• Operating income for the first two fiscal quarters decreased 68.1% to $30.1 million, with operating margin at 2.5%, down 520 basis points.
• Net income decreased 98.4% to $0.4 million in Q2 2025, and diluted net income per common share fell 98.7% to $0.01.
• Net income for the first two fiscal quarters decreased 75.7% to $16.0 million, and diluted net income per common share fell 76.1% to $0.43.
• The cash dividend per common share was reduced by 69% to $0.25 in Q2 2025, from $0.80 in Q2 2024.
• Net cash used in operating activities was $8.3 million for the first two fiscal quarters of 2025, a significant decline from $91.7 million provided in the same period of 2024.
• New tariffs enacted by the Trump Administration are expected to negatively impact pre-tax income by approximately $35 million in the second half of fiscal 2025, with an estimated annualized gross cost of $125 million to $150 million.
• Douglas C. Palladini was appointed Chief Executive Officer and President, effective April 3, 2025.
• No impairment charges were recorded for goodwill or indefinite-lived tradename assets in Q2 2025, despite a triggering event related to new tariffs and a sustained decrease in stock price.

Sentiment

Score: 3

Explanation: The financial performance, particularly profitability and operating cash flow, has significantly deteriorated. While sales saw a modest increase in Q2, this was overshadowed by substantial declines in gross and operating margins, and net income. The dividend cut and the anticipated material impact of new tariffs on future profitability are significant negative indicators. The company's liquidity position is strong, and management is taking steps to mitigate tariff impacts and improve operations, but the immediate financial results are very poor.

Positives

• Consolidated net sales increased 3.7% in the second fiscal quarter, driven by higher unit volumes in U.S. Retail and increased traffic and demand in Mexico and Canada.
• U.S. Retail comparable net sales increased 2.2%, reflecting improved conversion rates and higher units per transaction.
• Canada comparable net sales increased 7.6%, driven by improved traffic and higher conversion rates.
• New store comparable sales continue to outperform the overall fleet comparable sales.
• Maintained a strong financial position with $338.2 million in cash and cash equivalents and $843.1 million available under the secured revolving credit facility as of June 28, 2025.
• No impairment to goodwill or indefinite-lived tradename assets was recorded in the second quarter of fiscal 2025, despite a quantitative impairment test being performed.
• Interest income increased by $1.1 million in Q2 2025 due to increased cash balances and interest on federal tax refunds.
• Other income was favorable in Q2 2025 due to foreign currency exchange rate changes.

Negatives

• Consolidated gross profit decreased 0.4% in Q2 2025 and 4.2% for the first two fiscal quarters, primarily due to lower average product selling prices and increased sales to off-price wholesale customers.
• Consolidated gross margin decreased 200 basis points in Q2 2025 and 170 basis points for the first two fiscal quarters.
• Consolidated operating income decreased 89.7% in Q2 2025 and 68.1% for the first two fiscal quarters.
• Consolidated net income decreased 98.4% in Q2 2025 and 75.7% for the first two fiscal quarters.
• Diluted net income per common share decreased 98.7% to $0.01 in Q2 2025 and 76.1% to $0.43 for the first two fiscal quarters.
• Selling, general, and administrative (SG&A) expenses increased significantly, rising 13.5% in Q2 2025 and 7.5% for the first two fiscal quarters, driven by operating model improvement costs, leadership transition costs, and higher performance-based compensation.
• The dividend per common share was reduced by 69% to $0.25 in Q2 2025, from $0.80 in Q2 2024, to realign with current profitability levels.
• Net cash used in operating activities was $8.3 million for the first two fiscal quarters of 2025, a substantial decrease from $91.7 million provided in the prior year period.
• Anticipated negative impact of approximately $35 million on pre-tax income in the second half of fiscal 2025 due to new tariffs, with an annualized gross cost of $125 million to $150 million.
• U.S. Retail segment operating income decreased 79.2% in Q2 2025 and 81.2% for the first two fiscal quarters.
• U.S. Wholesale segment operating income decreased 25.3% in Q2 2025 and 17.2% for the first two fiscal quarters.
• International segment operating income decreased 35.1% in Q2 2025 and 56.2% for the first two fiscal quarters.
• Unfavorable impact of foreign currency exchange rates on consolidated net sales ($3.1 million in Q2, $9.5 million YTD).
• Increased distribution expense and third-party logistics costs contributed to higher SG&A.
• Higher product input costs impacted the International segment's gross margin.

Risks

• New or increased tariffs, quotas, embargoes, or other trade barriers, particularly from the Trump Administration, could adversely affect the supply chain, cost structure, margins, and competitiveness.
• Retaliatory actions taken by impacted countries could further disrupt global trade and create additional inflationary pressures in raw materials and logistics.
• Inability to fully offset the impact of tariffs through mitigation actions (pricing, product configurations, inventory management, country of origin mix, sharing costs with vendor partners) could materially harm market share, revenue, gross margins, and results of operations.
• Uncertainty regarding policies of the Trump Administration with respect to the future of trade partnerships and relations may negatively impact the carrying value of reporting units and indefinite-lived tradename assets.
• A significant decline in projected financial results could lead to impairment charges for goodwill and indefinite-lived intangible tradename assets, particularly for the 'Other International' reporting unit.
• Changes in global economic and financial conditions, impacting consumer confidence and discretionary spending habits.
• Risks related to consumer tastes and preferences, as well as fashion trends.
• Failure to protect intellectual property.
• Diminished value of brands due to negative publicity or unsuccessful branding/marketing efforts.
• Delays, product recalls, or loss of revenue due to a failure to meet quality standards.
• Increased competition in the marketplace.
• Financial difficulties for one or more major customers.
• Distinct risks facing the eCommerce business.
• Failure to forecast demand for products and manage inventory effectively.
• Increased margin pressures, including increased cost of materials and labor, and inability to successfully increase prices to offset these costs.
• Continued inflationary pressures with respect to labor and raw materials and global supply chain constraints affecting freight, transit, and other costs.
• Fluctuations in foreign currency exchange rates.
• Disruptions in the supply chain, including increased transportation and freight costs.
• A breach of information technology systems and the loss of personal data or a failure to implement new information technology systems successfully.
• Provisions in the secured revolving credit facility could restrict the ability to pay cash dividends or make future share repurchases.

Future Outlook

Additional operating model improvement costs of approximately $4 million to $5 million are anticipated for the remainder of fiscal 2025. Incremental tariffs related to imports from China, Vietnam, Indonesia, and other countries are expected to negatively impact pre-tax income by approximately $35 million in the second half of fiscal 2025, with an estimated annualized gross cost of $125 million to $150 million. The company is pursuing mitigation actions, including pricing adjustments, product configurations, inventory management, country of origin mix adjustments, and sharing costs with vendor partners, but these actions may not fully offset the impact. Capital expenditures of $65.0 million are planned for fiscal 2025, primarily for U.S. and international retail store openings and remodels, distribution facilities, and strategic information technology initiatives. Future dividend declarations will be evaluated by the Board of Directors based on various factors, including credit facility restrictions, business conditions, and financial performance. A new fleet segmentation strategy is planned for implementation beginning in fiscal 2026 to enhance the in-store shopping experience and drive brand loyalty.

Management Comments

• The dividend reduction was taken to realign the dividend with current profitability, especially against a challenging market environment and the possibility of significantly higher product costs due to new proposed tariffs.
• Actions are being pursued to mitigate the impact of tariffs, including pricing of products, product configurations, inventory management, country of origin mix, and sharing costs with vendor partners.
• Operating model work is foundational to improving capabilities and will better position the company for future growth.
• Focused on disciplined cost management and planning additional productivity initiatives across the business.
• New store comparable sales continue to outperform the overall fleet comparable sales, and the company remains committed to selectively opening new stores in high-traffic, impactful locations.
• Sources of liquidity, including available borrowing capacity under the secured revolving credit facility, are believed to be sufficient to manage recent developments, including tariffs.

Industry Context

The childrenswear market remains competitive, with the company operating a multichannel global business model encompassing retail, e-commerce, and wholesale. The filing highlights a challenging market environment and inflationary pressures, particularly concerning labor and raw materials, which are consistent with broader retail industry trends. The significant impact of new tariffs from the Trump Administration on global supply chains and cost structures is a major external factor affecting importers in the consumer goods sector, necessitating strategic adjustments in sourcing and pricing across the industry.

Comparison to Industry Standards

• The filing does not provide specific comparable companies, projects, or results for direct comparison to industry standards.
• The method of calculating sales metrics varies across the retail industry, and Carters' comparable sales metrics may not be directly comparable to those of other retailers.

Management Changes

Legal Proceedings

• Subject to various claims and pending or threatened lawsuits in the normal course of business.
• No current legal proceedings are believed to have a material adverse impact on financial position, results of operations, or cash flows.

Stakeholder Impact

• Shareholders: Experienced a significant reduction in dividend per share (69% cut) and substantial declines in net income and EPS. No share repurchases occurred in the first two quarters of fiscal 2025, contrasting with $33.8 million in repurchases in the prior year period. Future share price volatility is expected due to tariff impacts.
• Employees: Incurred leadership transition costs and saw increased performance-based compensation expense, despite overall profitability decline. The former CEO's retirement involved accelerated vesting of restricted stock awards.
• Customers: Benefited from selective investments in pricing, leading to lower average selling prices per unit. New store openings and remodels, along with a focus on enhancing the in-store experience and new brand launches (Otter Avenue), aim to improve customer engagement.
• Suppliers: May be asked to share the costs of incremental tariffs. Some suppliers participate in a voluntary supply chain finance program.
• Creditors: The company remains in compliance with financial and other covenants under its secured revolving credit facility and has no outstanding borrowings under the facility, indicating a stable relationship with creditors.

Next Steps

• Incur additional operating model improvement costs of approximately $4 million to $5 million for the remainder of fiscal 2025.
• Pursue actions to mitigate the impact of new tariffs, including pricing adjustments, product configurations, inventory management, country of origin mix adjustments, and sharing costs with vendor partners.
• Invest $65.0 million in capital expenditures in fiscal 2025, focusing on U.S. and international retail store openings and remodels, distribution facilities, and strategic information technology initiatives.
• The Board of Directors will evaluate future dividend declarations based on various factors.
• Focus on enhancing the in-store shopping experience, including implementing a new fleet segmentation strategy beginning in fiscal 2026.
• Continue to monitor macroeconomic conditions, including potential impacts from new tariffs or trade restrictions.

Key Dates

Recommendation

The company's financial performance has deteriorated sharply, with net income down nearly 100% in the quarter and over 75% year-to-date. Gross and operating margins have compressed significantly. The 69% dividend cut signals a clear shift in capital allocation priorities and reflects current profitability challenges. Furthermore, the anticipated $35 million negative impact from new tariffs in the second half of fiscal 2025, with an annualized gross cost of $125 million to $150 million, presents a substantial headwind that the company may not fully mitigate. While the company has strong liquidity, the severe decline in earnings and the significant future cost pressures from tariffs indicate a challenging outlook, making the stock a 'sell' for a seasoned investor.

Keywords

Childrenswear, Apparel, Retail, Wholesale, E-commerce, Carters, OshKosh Bgosh, Skip Hop, Tariffs, Profitability, Operating Income, Net Income, Dividend, Supply Chain, Financial Results, SEC Filing, 10-Q, Consumer Goods, North America