Executive Summary / Key Takeaways

• Strategic Reset for Sustainable Growth: Carter's, under new CEO Douglas Palladini, is undergoing a significant transformation focused on long-term, sustainable, and profitable growth, prioritizing enhanced product design, targeted marketing, and operational efficiency to recapture market share and deepen consumer loyalty.
• Tariff Impact and Aggressive Mitigation: The company faces substantial tariff headwinds, with an estimated annualized gross impact of $200 million to $250 million. Carter's is implementing aggressive mitigation strategies, including price increases, vendor cost-sharing, and production diversification, with a stated intention to fully offset these costs by 2026.
• Operational Streamlining and Store Optimization: An organizational restructuring aims to reduce office-based roles by 15% by year-end 2025, generating $35 million in annual savings. Additionally, 150 low-margin North American stores are slated for closure by 2028 (100 by 2026), expected to be accretive to operating income through sales transfers and expense elimination.
• Mixed Recent Financials, Promising Outlook: Q3 2025 saw consolidated net sales comparable year-over-year, but operating income and net income declined significantly due to higher product costs (tariffs), increased SGA, and one-time charges. However, U.S. Retail comparable sales showed a second consecutive quarter of positive growth, and preliminary 2026 guidance anticipates sales and earnings growth.
• Technological Underpinnings for Agility: Carter's is investing in AI-enabled allocation tools, dynamic demand forecasting, and a transformed concept-to-consumer process, which has already shortened product development by three months, enhancing responsiveness to consumer trends and improving operational efficiency.

The Enduring Legacy and Strategic Pivot of a Childrenswear Giant

Carter's, Inc. (NYSE:CRI), a name synonymous with children's apparel for over 160 years, stands as North America's largest and most enduring company exclusively for babies and young children. Founded in 1865, Carter's has built a formidable presence through its namesake brand, OshKosh B'gosh (acquired in 2005), and Skip Hop (acquired in 2017), alongside exclusive lines for major retailers like Child of Mine (Walmart (WMT)), Just One You (Target (TGT)), and Simple Joys (Amazon (AMZN)). This multi-channel approach, encompassing over 1,000 company-operated stores, 19,500 wholesale locations in North America, and over 1,100 international points of sale, provides unparalleled market reach.

The children's apparel market, however, has presented challenges, growing less than 1% annually since 2019. Factors such as declining birth rates, a pronounced shift in consumer behavior towards mass-channel retailers, and persistent inflation impacting young families have reshaped the competitive landscape. This environment has seen the rise of private labels from major retailers and an influx of smaller, digitally-native brands. Carter's, as the market leader, finds itself in a dynamic arena where it must continuously adapt.

Against this backdrop, Carter's is undergoing a significant strategic transformation under the leadership of new CEO Douglas Palladini, who assumed the role in April 2025. His mandate is clear: to return Carter's to "quality, sustainable, long-term and accretive growth." This involves a pivot from merely maintaining operating margins to strategically investing in product quality, enhancing emotional loyalty drivers, and balancing financial efficiency with surgical investments.

Technological Edge and Operational Agility

A cornerstone of Carter's strategic pivot is its investment in technological differentiation and operational agility. The company is actively transforming its "concept to consumer" process, leveraging external experts to streamline operations from consumer insights through product development to final purchase. This initiative has already yielded tangible benefits, notably shortening the product development calendar by a full three months. This accelerated timeline dramatically increases Carter's ability to read and react to consumer signals, fostering greater agility in bringing newness to its assortments.

Furthermore, Carter's is enhancing its capabilities through advanced analytics and AI. The company is deploying a new AI-enabled allocation tool designed to optimize product assortments in the right stores at the right time. A dynamic demand forecast tool is also being implemented to improve buying decisions and in-season sell-through management. These technological advancements are expected to improve organizational efficiency and productivity, directly contributing to better inventory management and more responsive market engagement. The company's IT investments also prioritize the digitization of product design and development, leveraging AI models, cloud migration, and consolidating systems and platforms, all aimed at foundational simplification and enhanced capabilities. This technological roadmap is crucial for Carter's to maintain its competitive moat, drive higher average selling prices (ASPs), lower costs, and improve margins, thereby strengthening its market positioning and long-term growth strategy.

Competitive Positioning and Strategic Responses

In the competitive children's apparel market, Carter's holds a leading position, leveraging its strong brand heritage and diversified distribution channels. Compared to direct competitors like The Children's Place (PLCE), Gap Inc. (GPS), and Kohl's (KSS), Carter's benefits from its specialized focus on babies and young children, fostering deep brand loyalty among parents. While PLCE may offer faster trend adoption for certain demographics, Carter's emphasizes reliability and quality, which resonates strongly in its core segments. Against GPS, with its broader casual wear portfolio, Carter's niche in infant essentials and efficient distribution channels provide a distinct advantage. KSS, with its extensive physical presence, offers accessibility, but Carter's aims to differentiate through specialized product quality and an enhanced digital experience.

Carter's is strategically remapping its North America wholesale model, anchored by Walmart, Target, and Amazon, to include more of its core brands in more accounts and doors. This move acknowledges the significant investment mass-market retailers are making in private labels, but Carter's aims to grow as their primary national brand. The company is also expanding its "House of Brands" strategy. Little Planet, its sustainable brand, has seen double-digit sales comps and grown its consumer base by 50% this year, with these new fans exhibiting a 1.5x higher lifetime value than the average consumer. The recent launch of Otter Avenue, a toddler-focused brand, further expands Carter's reach into white space in the market, commanding higher prices through premium design. These initiatives are designed to counter the scale of larger competitors and the agility of fast-fashion brands by offering differentiated products and experiences.

Financial Performance: Navigating Headwinds with Strategic Adjustments

Carter's recent financial performance reflects a period of strategic adjustment amidst significant external pressures. For the third fiscal quarter ended September 27, 2025, consolidated net sales were $757.8 million, a slight decrease of 0.1% year-over-year. This was primarily driven by lower demand in U.S. Wholesale, offset by growth in U.S. Retail and International segments. Average selling prices per unit saw a low-single-digit increase, while units sold experienced a low-single-digit decrease.

Consolidated gross profit for Q3 2025 decreased by 4% to $341.6 million, with the gross margin contracting by 180 basis points to 45.1%. This decline was largely attributable to a high-single-digit increase in the average cost per unit sold, significantly impacted by approximately $20 million in incremental tariffs and investments in product make. Selling, General, and Administrative (SGA) expenses rose by 11.7% to $318 million, increasing 450 basis points as a percentage of net sales to 42%. This surge in SGA was due to costs associated with organizational restructuring, operating model improvements, leadership transition, investments in new stores, and higher performance-based compensation and marketing expenses. Consequently, consolidated operating income plummeted by 62.2% to $29.1 million, with the operating margin shrinking by 640 basis points to 3.8%. Net income saw an 80.1% decrease to $11.6 million, partly due to an $8.8 million pre-tax, non-cash pension settlement charge.

Looking at the first three fiscal quarters of 2025, consolidated net sales decreased by 0.6% to $1.97 billion, primarily impacted by lower Simple Joys brand sales and unfavorable foreign currency exchange rates. Gross profit for this period decreased by 4.2% to $914.5 million, with gross margin down 170 basis points to 46.4%. Operating income fell by 65.5% to $59.2 million, resulting in an operating margin of 3%.

Despite these consolidated pressures, the U.S. Retail segment showed resilience, with net sales increasing by 2.6% in Q3 2025, driven by a mid-single-digit increase in average selling prices and growth in the core baby assortment. This marked a second consecutive quarter of positive comparable net sales. The baby category, a key strength, has posted sales growth for five consecutive quarters, and Carter's has gained market share in both baby and toddler categories. The International segment also delivered a 4.9% sales increase in Q3 2025, with Mexico showing robust growth of 30.9%.

Liquidity and Capital Allocation for Future Growth

Carter's maintains a solid financial position, with $184.2 million in cash and cash equivalents as of September 27, 2025, and $843.1 million available under its secured revolving credit facility. While net cash used in operating activities for the first three quarters of 2025 was $136.3 million, primarily due to decreased net income and increased inventory purchases related to tariffs, the company anticipates generating positive operating cash flow for the full fiscal year, with the majority historically occurring in the fourth quarter.

Inventory levels at the end of Q3 2025 increased by 8% year-over-year to $656.1 million, with $34 million of this increase attributed to incremental tariffs and investments in product make. Capital expenditures are projected at $60 million for fiscal 2025, focusing on retail store enhancements, distribution facilities, and strategic IT initiatives.

In a move to realign capital allocation with current profitability and higher product costs, Carter's reduced its quarterly dividend per common share by 69% to $0.25 in Q2 and Q3 2025. The company also has substantial share repurchase capacity, with $599 million remaining under authorization. Furthermore, Carter's is proactively managing its debt profile, having secured commitments for a new five-year asset-based revolving credit facility of at least $750 million in October 2025, and is evaluating refinancing opportunities for its $500 million senior notes maturing in March 2027.

Outlook and Strategic Initiatives for 2026

Despite the ongoing uncertainty surrounding tariffs, Carter's has provided a preliminary outlook for 2026, anticipating growth in both sales and earnings. Sales growth is expected to be higher than a typical year, primarily driven by necessary price increases implemented in response to tariffs. The company's strategy assumes that tariffs are an industry-wide issue, leading competitors to also raise prices, thereby maintaining Carter's competitive positioning.

Gross margin rates are projected to be lower in 2026 due to the net unfavorable impact of tariffs and shifts in wholesale customer mix. However, earnings growth is expected to be significantly bolstered by productivity initiatives, including $45 million in gross savings for 2026. A key component of these savings is an organizational restructuring initiated in Q3 2025, targeting a 15% reduction in office-based roles by year-end 2025, which is expected to generate approximately $35 million in annual savings starting in fiscal 2026. An additional $10 million in cost reductions will come from lower SG&A across various spending categories. These savings are crucial to offset the substantial impact of higher tariffs and other inflationary pressures, while also funding planned investments, including a nearly 20% or $16 million increase in marketing spend in 2026 to drive demand creation.

The company's store portfolio optimization plan involves closing approximately 150 low-margin North American stores, mostly at lease expiration, with about 100 expected by 2026. These stores collectively represent $110 million in annual net sales, and the closures are anticipated to be accretive to operating income through sales transfers to digital platforms and existing stores, coupled with the elimination of fixed store expenses. While new U.S. store openings are paused, investments are being directed towards new store-type testing and in-store experiences to enhance fleet productivity.

Risks and Challenges

Carter's faces several pertinent risks that could impact its investment thesis. The primary concern remains the persistence and magnitude of tariffs. The current effective duty rate is in the high 30% range, significantly higher than the historical 13%. While management intends to fully offset the annualized gross impact of $200 million to $250 million by 2026 through various mitigation strategies, the success of these actions hinges on consumer acceptance of higher prices and the ability to effectively relocate production and share costs with vendors. There is an inherent risk that raising prices could lead to a loss of unit velocity, impacting sales volume.

Furthermore, the broader macroeconomic environment, including persistent inflation and potential deterioration in consumer confidence and employment data, poses a risk to consumer discretionary spending. The organizational restructuring, while aimed at efficiency, carries risks of higher-than-anticipated implementation costs, management distraction, and potential workforce attrition. The company's goodwill and indefinite-lived intangible assets are also subject to impairment risk, particularly in an evolving trade policy environment. Foreign currency fluctuations, especially with the strengthening U.S. dollar, continue to be a headwind for international segment profitability.

Conclusion

Carter's is at a pivotal juncture, undergoing a comprehensive transformation to reassert its market leadership and drive sustainable, profitable growth. Under new leadership, the company is strategically addressing market challenges, particularly the significant tariff headwinds, through aggressive mitigation efforts and operational streamlining. The commitment to enhancing product design, leveraging technological advancements for agility, and optimizing its store portfolio underscores a clear path forward.

While recent financial performance reflects the costs of these strategic adjustments and external pressures, the underlying momentum in key categories like baby apparel and the positive comparable sales trends in U.S. Retail offer promising indicators. The preliminary outlook for 2026, forecasting sales and earnings growth driven by pricing power and substantial productivity savings, suggests a belief in the efficacy of these initiatives. For investors, Carter's presents a compelling narrative of a deeply entrenched brand leveraging its history and market position to adapt to a dynamic environment, with technological innovation and disciplined capital allocation serving as critical enablers for its long-term success. The ability to fully offset tariff impacts and consistently drive traffic to its revitalized offerings will be key determinants of its future profitability and market standing.