Children's Place, Inc. (The)

Good morning and welcome to the Children's Place third quarter 2020 earnings conference call. On the call today are Jane Elfers, President and Chief Executive Officer, Mike Scarpa, Chief Financial Officer, and Rob Helm, Senior Vice President, Finance. The Children's Place issued its third quarter 2020 earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted to the investor relations section of the company's website. This call is being recorded. If you object to our recording of this call, please disconnect at this time. All participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. After the speaker's remarks, there will be Questions as time allows. Before we begin, I would like to remind participants that any forward-looking statements made today are subject to the Safe Harbor statements found in this morning's press release, as well as in the company's SEC filings, including the risk factor section of the company's annual report on Form 10-K for its most recent fiscal year. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially. The company undertakes no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof. After the prepared remarks, we will open the call up to your questions. We ask that each of you limit yourself to one question so that everyone will have an opportunity. It is now my pleasure to turn the floor over to Jane Elfers.

Thank you and good morning, everyone. Our back to school sales were significantly impacted by the move to remote and hybrid learning models across the country in response to the COVID-19 pandemic. Post the back to school peak, when our assortments converted to more casual options and the weather turned cooler, our sales improved And for the quarter, we returned to profitability and generated positive cash flow from operations. Starting with our accelerated digital transformation. Increased digital adoption, accelerated by COVID-19 and supported by our digital transformation and omni-channel initiatives, continues to drive online sales to an increasingly greater share of our overall sales. Digital sales accounted for 44% of our Q3 sales, and year-to-date, digital sales represent 55% of our total sales. Importantly, our continued digital growth is coming from both existing and new customers. Since March, we have increased the number of new digital customers versus last year by approximately 100%, converted over 800,000 store-only customers to omnichannel customers, and increased our mobile app downloads by over 60%. The customer's accelerated shift to digital provides The Children's Place with continued market share opportunities as we leverage our recent digital transformation investments and our foundational personalization of initiatives to continue to acquire new customers into our omnichannel ecosystem. Moving on to our accelerated store closure plan. As we close stores, a key measure of the success of our digital transformation and fleet optimization strategies is our ability to retain, transfer, and convert our store-only customers to e-commerce and omnichannel customers. Our e-commerce and omnichannel customers are our best customers. They shop with us more often and spend approximately three times more than our non omnichannel customers. Today, we have some very important metrics to share with you regarding our customer transfer rates. Year to date through the end of September, which allows for one year of post store closure tracking, our transfer rate has increased to 31% versus our full year 2019 transfer rate of 20%. This substantial transfer rate increase further reinforces the decision we made back in March to significantly accelerate store closures by giving us even greater confidence in our ability to continue to shift a substantial portion of our store's revenue to our digital channel. Looking ahead to Q4, we're approaching the fourth quarter with heightened caution and expect both sales and profitability to be under pressure due to the numerous headwinds created by the pandemic, specifically the meaningfully reduced demand for dress-up product, significantly reduced store traffic, the recent nationwide spikes in COVID-19 cases resulting in additional temporary store closures, social distancing requirements, and reduced mall operating hours. With respect to our digital business, To ensure on-time holiday delivery, we have already been advised by our major carriers to move our standard shipping cutoff up by three days from our original date of 12-18 to 12-15 due to the capacity constraints across the domestic transportation network. In addition, the related freight surcharges imposed by our major carriers will put additional pressure on e-commerce margins during the quarter. Lastly, and most importantly, our business model is driven by occasions and events in the lives of our customers. Historically, the multiple holiday events that occurred during Q4 made Q4 the highest sales quarter of the year. Similar to the significant negative impact we experienced from the lack of an Easter or a back to school catalyst, we are experiencing the same negative impact from the lack of holiday dress-up catalysts. We reduced our dress-up receipts at the time of the holiday by last April, but we now expect Q4 to represent historically low demand for dress-up product. This is due to the pandemic-driven cancellation of nearly all school-related social events, including in-person holiday parties, parades, and concerts, combined with a holiday season that provides for limited socializing through strict social distancing requirements limited family gatherings, and mandated cancellations of large in-person social events. While we continue to manage through the many short-term challenges brought on by the pandemic, we remain focused on the opportunities. We estimate that the pandemic has accelerated our longstanding transformation strategy by approximately five years with respect to store closures and digital penetration. The good news is that due to the accelerated investments we made in digital transformation prior to the pandemic and the work we had done on fleet optimization over the past decade, we were prepared. We believe that our focus on scaling our digital transformation investments and accelerating store closures, further bolstered by our increased sales transfer rate, positions the company for accelerated operating margin expansion in a post-COVID environment. And now I'll turn it over to Mike.

Thank you, Jane, and good morning, everyone. I'll start by reviewing our Q3 results. I will then provide an update on our progress on the strategic actions taken to significantly accelerate our store closures. I will then provide insight on how we are approaching the fourth quarter. Starting with our Q3 results, In the fiscal third quarter, we returned to profitability, generated positive operating cash flow, and delivered adjusted EPS of $1.44. Net sales decreased approximately 19% to $426 million versus last year's $525 million. Our sales for the first five weeks of the quarter were significantly impacted by a decrease in back-to-school sales across all channels due to schools adopting remote and hybrid learning models. From the beginning of August through Labor Day, we dropped over 40% in total net sales. Sales were also negatively impacted by the 151 permanent store closures during the past 12 months, as well as the extended temporary store closures in New York and California, which impacted 52 stores for a significant portion of the quarter. Immediately following Labor Day, when we passed the peak back-to-school selling period, our assortments converted to more casual options, the weather turned cooler, and our sales improved. After we passed the peak back-to-school selling period, we experienced productivity at over 90% of last year's levels for our stores that reopened. Post Labor Day, our e-commerce channel rebounded and saw sales increase of approximately 20%. Despite the negative impact from back to school, e-commerce penetration increased to approximately 44% of total net sales. Our U.S. sales decreased approximately 20% versus last year, while Canada's sales only decreased approximately 5%. Canada performed better than the United States due to almost 90% of Canadian schools utilizing 100% in-person learning. Adjusted gross margin. Adjusted gross margin decreased 210 basis points to 35.7% of net sales, a significant improvement versus the margin declines we experienced in the first half of the year. Merchandise margin expanded in the quarter in both the digital and stores channels. The overall gross margin decrease was the result of the increased penetration of our e-commerce business, which operates at a lower gross margin, and the deleverage of fixed cost due to lower sales. Adjusted SG&A. Adjusted SG&A was approximately $104 million versus $117 million last year, and deleveraged 210 basis points to 24.3% of net sales. The 210 basis point decline was a result of the deleverage of fixed expenses resulting from the decline in sales and higher incentive compensation accruals, partially offset by a reduction in store expenses resulting from our permanent store closures, as well as a reduction in operating expenses associated with actions taken in response to the COVID-19 pandemic. Adjusted operating income. Adjusted operating income for the quarter was $33 million versus operating income of $63 million last year, and deleveraged 430 basis points to 7.8% of sales. Tax rate. Our adjusted tax rate was 30% versus 23% last year. Moving on to the balance sheet, our cash and short-term investments ended the quarter at $64 million as compared to $36 million in Q2. We ended the quarter with $179 million outstanding on our revolving credit facility compared to $251 million outstanding on our revolving credit facility in Q2. The decrease in the revolving credit facility and the increase in cash was due in large part to the $80 million term loan financing we completed in the third quarter, as well as our positive operating cash flow. The term loan provides us with additional capital and further strengthens our financial position and provides us with increased financial flexibility. We ended the quarter with total inventory up 9.7 percent versus last year, driven by sales declines and key back-to-school categories, which accounted for the entire increase in inventory. We will continue to carry this inventory to support back-to-school demand whenever schools can safely reopen for in-person learning. This product is basic, saleable, go-forward product that is visible in our stores and on our website. Our seasonal carryover inventories are down approximately 45 percent. Moving on to cash flow and liquidity, we returned to positive cash flow in Q3 and generated approximately $32 million in cash flow from operations as compared to $77 million in cash generated in Q3 last year. Between our cash position and revolving credit facility, we have ample liquidity to support the needs of our business for the foreseeable future. Capital expenditures in Q3 were approximately $9 million. I'll now provide a brief update on our store activity in the quarter, along with planned actions we are taking to accelerate our fleet optimization initiative. We permanently closed 16 locations in the quarter, which brings our total store closures to 118 for the first three quarters of fiscal 2020. As e-commerce demand has accelerated year to date, we have seen a significant migration of our store-only customers converting to omnichannel customers, supported by the meaningful increase in our transfer rate. This data gives us continued confidence in our accelerated store closure plans, where we are targeting 300 store closures between fiscal 2020 and 2021. We remain on track to close 200 store locations in fiscal 2020, which includes the 118 locations closed during the first nine months of the year. The roughly 80 remaining closures are targeted for a January closure post-holiday. We are targeting 100 store closures at the end of fiscal 2021, which will result in a store fleet of approximately 625 locations entering fiscal 2022. By the end of fiscal year 2021, we will have reduced our reliance on our brick and mortar channel resulting in a leaner, more profitable store footprint. This will position us to enter fiscal 2022 with 75% of our total revenues generated outside of traditional malls. Outlook. Due to the continued level of uncertainty in the current business environment, we are not providing EPS guidance for 2020. However, we will provide our current thinking as to the pandemic's potential impact on our business in Q4. Based on the numerous headwinds Jane outlined earlier on the call, combined with the impact of the 151 permanent store closures over the past 12 months, we would expect Q4 net sales to be at or slightly lower than Q3 levels. Due to the pandemic, gross margins will continue to be under pressure in Q4. In addition to the factors that resulted in a 210 basis point decrease in Q3, there are two additional factors that will further deteriorate gross margin. One, we anticipate roughly 150 basis points in additional gross margin dilution in the quarter due to incremental freight surcharges and capacity constraints from our major carriers. And two, we also anticipate that store closures and the related inventory liquidation will reduce gross margins by roughly 50 basis points, similar to what we saw in our Q2 when we closed 98 stores. We expect SG&A dollars to be moderately lower than last year. As a reminder, SG&A was reduced in Q4 last year by the reversal of an incentive compensation accrual. which represents a headwind of approximately $10 million or 200 basis points to the current year expense base. Inventory levels will remain elevated due to the back to school and basics product that we do not plan to liquidate and that we will continue to carry to support back to school demand for whenever schools can safely reopen for in-person learning. We expect to continue to generate positive cash flow from operations in Q4. Lastly, for 2021, we believe that we will be able to take advantage of what has been a favorable AUC environment so far with respect to orders, driven by lower input costs and excess manufacturing capacity. At this point, we will open the call to your questions.