Carter’s Inc. Takes Care of Business and Beats on Earnings

OshKosh B'gosh and Carter's stores in Charlotte, NC. Source: Carter's

Carter's (CRI 0.48%) showed some slight growing pains in the third quarter, but the kids-focused retailer remained right where management wants it to be for the year. While the bricks-and-mortar side of the business took baby steps in the sales category, Carter's online business continues to grow by leaps and bounds. Likewise, adjusted earnings scrambled up 13.6% for the quarter and are on-track to increase roughly 14% to 16% for the year. As it gears up for the holiday season, Carter's should continue to reach a new, expanding audience for its top-notch kids apparel.

Tending to the financials
On the top-line, Carter's came up slightly short of analysts' predictions of $811 million in sales. But it skipped past the consensus forecast of $1.24 in earnings per share.

$USD in millions, except EPS

There was no mention of challenging weather this go-round, but currency issues did affect sales slightly. On a constant currency basis, sales would have increased 5.5% versus the same period last year. For perspective, the company's sales fell right in the middle of the 4% to 6% range forecasted by management in the second quarter.

On the income side, earnings per share proved better than expected. The 13.6% gain was well above the 7% to 10% growth forecasted by management. Keep in mind there were a few adjustments made (as shown above) for nonrecurring items that cropped up in the third periods of both 2013 and 2014. These were excluded for a more appropriate apples-to-apples comparison.

It's good to see the company is tracking toward its goals each quarter. Sales growth moderated from the double-digit pace achieved in the first half of the year, but it remains balanced across the business.

U.S. sales grew by 5% year over year driven by both the Carter's brand (up 4%) and OshKosh (up 9%). Meanwhile, the international segments were up a healthy 8% year over year.

Perhaps, most importantly, the company's investments in its e-commerce channel are paying off: Online sales continue to experience a growth spurt with 28% and 32.1% year-over-year sales gains in Carter's and OshKosh, respectively. Carter's might have been late to the online game, but it's making up ground and pacing toward its goal of 30% gains in e-commerce this year. Management attests that e-commerce remains Carter's "fastest growing, highest margin business."

Overall, profitability metrics like gross margins and operating margins remained stable. The company achieved lower marketing overhead since it decided not to repeat a television commercial that was run in the same period last year. This- along with lower bad debt expense and an exit from retail in Japan-reduced selling, general, and administrative expenses as a percent of sales by 1%.

Meanwhile, operating cash flow dropped from $63.5 million to $24.9 million in the third-quarter of 2013 and 2014, respectively. This was due to "unfavorable movements in net working capital" which includes higher inventory costs and changes in the timing of payments. Management believes this trend will be reversed since the bulk of its cash flow is generated in the fourth quarter of each year.

Gauging holiday expectations
If there were any causes for concern from the company's report, it's not about execution but about a tenuous holiday season that is just around the corner. Nearly every retailer is asking the same question, "Will it be a boon or a bust?"

So far, there are signs of sluggishness in Carter's retail (but not wholesale) outlets through October. Keep in mind that the holidays have yet to commence, but here's what CEO Michael Casey had to say about the trend so far:

If I had to say, I think consumers are waiting a little longer to shop for their fall apparel. I'll speak to only our retail business. Our wholesale business has been good...I'd say, consistent comps in July, August, September, and on average around 3.5%, thereabouts, and we've seen a decline in comps in October. ... Usually when you see the cold weather arrive, you start to see a significant increase in business. We simply just haven't seen that yet. And so we're hopeful that as we approach the holidays, as we move into November, we'll start to see better trends.

Final Foolish takeaway
All things considered, Carter's business looks very healthy, and it's largely avoided the hiccups that have hampered growth at other retailers this year. For the fourth quarter, management is still guiding toward 10% to 12% sales growth versus 2013 and earnings per share could increase by 20% to 25%.

If all goes well -- and parents purchase some new holiday outfits for little Jack and Jill -- Carter's will have another solid year to show for itself. At this rate, full-year earnings would track toward 15% growth, which is an impressive showing during an otherwise topsy-turvy year for American retailers.