Children's Place, Inc. (The)

Good morning and welcome to the Children's Place first quarter 2021 earnings conference call. On the call today are Jane Elfers, President and Chief Executive Officer, and Rob Helm, Chief Financial Officer. The Children's Place issued its first quarter 2021 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, we will take 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 Factors 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 for 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. Following the March 11th presidential address, which confirmed immediate stimulus payments, announced an accelerated vaccination timeline, and promised the country an earlier than anticipated return to normal, we experienced a significant and sustained sales lift. We delivered outstanding first quarter results with growth margin, operating margin, and EPS all at record levels. Our Q1 21 net sales of 435 million exceeded our Q1 19 net sales of 412 million despite having 261 or 27% fewer stores versus Q1 2019, and historically low demand for Easter dress-up product, and a 15% reduction in mall operating hours versus 2019. All key metrics across both our digital and stores channels exceeded expectations. Our exceptional sales growth was driven by several factors including double-digit increases in AUR versus Q1 2020 resulting from strong product acceptance, higher price realization, reduced promotional activity, and unprecedented stimulus, as well as an acceleration in back-to-school sales, our ability to retain new digital customers we acquired during the pandemic, and a significant reactivation of store customers that we had temporarily lost due to the government mandated closure of all of our stores. Our record Q1 2021 gross margin was driven by significantly higher merchandise margins in both our digital and stores channels, significant occupancy savings from favorable lease negotiations and fewer stores as compared to Q1 2020, and meaningful e-commerce fulfillment optimization. Focusing on digital. Consolidated digital sales increased 37% in Q1 versus 2020, representing 42% of total sales. Digital sales increased 35% in the US and 82% in Canada, driven by a double digit increase in traffic partly as a result of our ability to retain new customers acquired during the pandemic. Our digital business has always been our highest operating margin contributor due to its high UPT, low return rates, and lower overhead costs versus our stores channel. And with the pandemic-driven acceleration to a steady state annual digital revenue of approximately 50%, We are now gaining additional leverage on fixed overhead costs and driving higher digital operating margins. In addition, we continue to plan for reductions in our per order e-commerce fulfillment costs in 2021 due to a number of packaging and network optimization efforts combined with the ability of our third party fulfillment partner to service higher levels of demand in 2021. which should virtually eliminate the amount of supplemental ship from store required. With respect to our stores, it's important to note that our Q1 21 store net sales of 231 million represent 85% of our Q1 19 store net sales, despite having 261 or 27% fewer stores in Q1 21. versus Q1 2019. U.S. store sales exceeded expectations, driven by strong product acceptance, double-digit AUR increases, and higher ADS. Similar to what we saw in Q4, traffic levels remained under pressure, down 36% versus 2019 levels. Our outside store performance, bolstered by our strong transfer rate further reinforces our strategic fleet optimization strategy. Merchandise margins were up significantly in our stores channel, driven by higher AURs due to strong product acceptance and reduced promotions. Importantly, we were also pleased to see existing customers return to our stores in significant numbers from the limited shopping options available to them last spring. due to the government mandated closure of the vast majority of brick and mortar retailers. Canada store sales were down 43% with traffic down 69% due to the continued impact of government mandated COVID-19 temporary closures impacting approximately 50% of our Canadian fleet during the quarter. With respect to our fleet optimization initiative, we closed 25 stores during Q1, and we plan to close 98 more stores in full year 21, bringing our total two-year store closures to our previously announced target of 300 stores. As we covered extensively in our Q4 remarks, birth rates have been downtrending for years and are not expected to rebound until at least the end of this decade. As I am sure you all saw earlier this month, the 2020 birth rate data was released and, as we anticipated, births for 2020 were down dramatically to the lowest level since 1979 at just 3.61 million births. The data also reveals an 8% decline in births in the month of December, the biggest drop for the month of December since 1964. Those December babies were conceived before the pandemic started to accelerate, and experts predict that birth rates will fall even further in 2021. It's important to note that less than 5% of our revenue comes from newborns aged zero to two, so we have multiple opportunities and ample time to offset these sustained birth rate drops. As we indicated on our Q4 call, We recognized a long time ago that U.S. birth rates were not going to be a tailwind, so our strategic focus has been on taking market share for the better part of the last decade. Our purchase of Gymboree gives us a sizable market share opportunity in our under-penetrated toddler space that more than makes up for the anticipated sales drop from sustained birth rate declines over the next decade. The big kid destination strategy that we put in place almost a decade ago continues to secure a leadership position in the big kid space. We believed, correctly, that the big kid space was overcrowded with too many retailers vying for a declining sales base without a positive catalyst with respect to birth rates. The big kids competitive playing field has narrowed significantly in the last few years, which aligns with our well-documented strategy of trading short-term margin pain for long-term margin gain. It's important to note that among the kids retailers who declared bankruptcy and liquidated thousands of stores in the last few years, Justice and Crazy 8 did not carry any newborn size zero to two product, and Gymboree was almost completely out of their unprofitable newborn business at the time of their second bankruptcy. My point is, none of the large children's retailers had newborn market share to seed because their mall-based businesses like ours were targeted to the four-year-old and up age range, making TCP a natural market share beneficiary of these large liquidations. With respect to current business, Q2 is off to a strong start. We are not providing EPS guidance due to the uncertainty and volatility surrounding the pandemic, particularly as it pertains to the return to 100% in-person learning. As you may know, July is our biggest month in Q2, and within July, the majority of sales are concentrated into the last two weeks of the month with the start of back to school shopping. We believe that if the vast majority of elementary schools return to 100% in-person learning this fall, we will be an outsized beneficiary. In addition, we believe the expanded child tax credit benefits outlined in the American Rescue Plan, which include a monthly payment to approximately 39 million families covering 88% of all the children in the United States should provide an additional tailwind for our business just in time for our key back to school selling season. These payments are scheduled to begin on July 15th and provide for monthly checks of $300 for each child under age six and $250 for each child between six and 17 years old. Looking ahead, Q4 also presents an opportunity for TCP to regain our historical leadership positions in the dress-up category, assuming the vaccine rollout is successful and social distancing mandates continue to be removed leading up to the holidays. We leveraged a very difficult period in 2020 to accelerate our strategic transformation and we believe we are now well positioned to deliver accelerated operating margin expansion in 2021 and beyond. The acceleration of our digital business, our highest operating margin channel, made possible by our pre-pandemic digital transformation investments, combined with the significant sales transfer rate we are achieving from our strategic decision to close 300 or a third of our stores in less than 20 months is resulting in an industry leading approximately 50% steady state annual digital penetration. Our longstanding fleet optimization strategy enables us to close the 300 stores without financial penalty and reset our occupancy costs. These occupancy cost reductions should continue to be a significant operating margin tailwind throughout 2021 and beyond. In addition, by aligning our overhead cost structure in 2020 to our digital first strategy, we have gained efficiencies and removed significant expense from our P&L. These efficiencies will continue to benefit us in 2021 and beyond. We anticipate further operational efficiencies and sales opportunities when social distancing and other restrictions such as limits on hours of operation are further removed and we are able to return to normal operations in both our stores and distribution centers. We continue to navigate the extraordinary complexity of the pandemic. while remaining firmly on offense. Our longstanding strategic plan has served us well. We are a stronger company today than we were prior to the pandemic, and we look forward to continuing to deliver accelerated operating margin expansion for our shareholders in 2021 and beyond. Now I'll turn it over to Rob.

Thank you, Jane, and good morning, everyone. I will review the Q1 results and then I will provide some thoughts on Q2 and the balance of 2021. In the fiscal first quarter, we delivered a record adjusted EPS of $3.25. Net sales increased by 180 million or 71% to 435 million versus last year's 255 million. Our US net sales increased by 160 million or 71% to $384 million versus last year's $224 million, while our Canadian net sales increased by $13 million or 76% to $30 million versus last year's $17 million. Comparable retail sales were a positive 83% versus Q1 2020. As an additional point of reference, comparable retail sales were a positive 21.5% versus Q1 2019. Our net sales were positively impacted by several factors during the quarter. First, the significant majority of our US stores were open for the entire quarter this year versus the temporary closures we experienced for approximately 50% of the quarter last year as a result of mandated government shutdowns. Second, strong customer response to our casual product assortment. And third, the unprecedented level of stimulus payments resulting from the government pandemic relief legislation announced in mid-March. These factors, along with favorable weather and an easing of COVID-related restrictions, resulted in consolidated net sales increases in both March and April of over 100% versus the prior year. These positive factors resulted in better than expected performance across all of our key retail metrics. Our Q1 net sales were negatively impacted by the impact of our 199 permanent store closures in the past 12 months, inclusive of 25 stores we closed during this quarter and the 178 stores we closed during fiscal 2020. The impact of the government mandated temporary closures in Canada, with approximately 50% of our fleet closed for more than half of the quarter, and the impact of an approximately 15% reduction in mall operating hours as mandated by our mall landlords. Adjusted gross margin. Adjusted gross margin increased 2,571 basis points to 43.4% of net sales, a record Q1 gross margin. The gross margin increase was the result of, one, the leverage of fixed expenses resulting from the increase in net sales, as a result of anniversarying the temporary closure of our entire fleet in Q1 2020. Two, significantly higher merchandise margins in both our digital and stores channel, resulting from a double digit AUR increase due to strong customer product acceptance, leading to higher price realization and reduced promotions. And three, a reduction of 21 million in occupancy expenses during the quarter, due to rent abatements of $8 million with the balance of the decrease coming from favorable lease negotiations and reductions in occupancy expenses for stores closed in the past 12 months. We anticipate occupancy savings for the balance of the year. These gross margin benefits were partially offset by higher inbound freight transportation costs driven by ocean carrier equipment shortages and higher container rates. Adjusted SG&A. Adjusted SG&A was approximately $104 million versus $92 million last year and leveraged 1,231 basis points to 23.9% of net sales. The 1,231 basis point leverage was a result of the leverage on the higher net sales and cost savings resulting from the significant store closures in Canada for the majority of the quarter, partially offset by higher incentive compensation accruals. Adjusted operating income. Adjusted operating income for the quarter increased $136 million to $71 million, or 16.2% of sales, a record result, versus an adjusted operating loss of $65 million last year and leveraged 4,168 basis points. Interest expense. Our interest expense for the quarter was $4 million versus $2 million last year. The increase in interest expense reflects a higher debt balance and the higher interest rate associated with our term loan. Tax rate. Our adjusted tax rate was 27%, in part due to the anticipated higher incentive compensation accruals in the current year. Moving on to the balance sheet. Our cash and short-term investments ended the quarter at $65 million. We ended the quarter with $197 million outstanding on our revolving credit facility. During the quarter, we extended our existing accordion feature of $35 million for one year, maintaining 360 million of total availability under our revolving credit facility. We ended the quarter with total inventory of 24% versus last year. It is important to note that our Q1 2020 inventory included a provision of approximately $63 million last year. If you remove the impact of the inventory provision, our inventory increased 5% versus last year. The entirety of this increase in inventory versus last year continues to be comprised of the back-to-school basics we have been carrying since last June. Our seasonal carryover inventories are down approximately 49%. Moving on to cash flow and liquidity, we used approximately $17 million in cash from operations in Q1 due to the repayment of certain suspended 2020 rents, net of abatements, as well as other planned changes in working capital, which brought our vendor payables back in line with historical levels. It is also important to note that we historically experienced negative cash flows in the first half of the year as the result of the seasonality of our business. We remain confident that between our cash on hand, cash from operations, and credit facility, we have the necessary liquidity to support our operations. Capital expenditures in Q1 were approximately $7 million. Now I'll provide an update on our store activity in the quarter, along with planned actions we are taking to continue to accelerate our fleet optimization initiative. During the first quarter, we completed the balance of lease agreements on our 2020 occupancy negotiations with our key go-forward landlords. We recognize the rent abatement of $8 million in Q1, bringing the total abatements on the account of 2020 to $21 million to date. We expect to recognize the remaining portion of our 2020 abatements in Q2, which will be meaningfully lower than Q1. We also realized significant occupancy savings from favorable lease negotiations on our go-forward store portfolio. and from the 199 store closures in the past 12 months, inclusive of the 25 stores we permanently closed in the quarter. We ended the quarter with 724 stores and total square footage of 3.4 million, a decrease of 20% compared to Q1 last year. We are planning to close an additional 98 stores by the end of fiscal 2021, which will bring our total store closures to our previously announced target of 300 stores. While we are not providing EPS guidance due to the continued uncertainty and volatility caused by the pandemic, we wanted to provide you with some thoughts regarding Q2 and full year 2021. Starting with Q2 net sales, as Jane mentioned, we are off to a strong start for the quarter. With respect to the channel level sales, we would like to remind you that we experienced unprecedented levels of e-commerce demand last year as we leveraged our omni-channel capabilities to fulfill orders from our temporarily closed stores. E-commerce represented over 70% of our sales in Q2 last year, but approximately half of those sales were filled from stores' inventory. We anticipate that our e-commerce sales will be lower in Q2 this year versus Q2 last year. We also anticipate store sales will be significantly higher in Q2 as we anniversary the shutdown of our entire store fleet for approximately 50% of the quarter last year. Lastly, we're planning for lower sales in our Canadian stores business. Given the ongoing government mandated lockdowns that have been in place since the beginning of March and are scheduled to be in place until sometime in June, impacting approximately half of our Canadian fleet, We expect that Q2 gross margin will moderate from Q1 levels as a result of several factors, including the deleverage of our fixed expenses on the lower net sales, the larger Q1 abatement, and the higher inbound transportation costs due to continuous supply chain disruption. SG&A is planned to be in the range of $110 million, which is higher than Q1 due to the anticipated reopening of the temporarily closed stores in Canada, as well as the expected easing of the landlord reductions in store operating hours, and higher than Q2 last year due to the anniversary of the COVID-19 closures, as well as higher incentive compensation accruals. Moving on to the balance of 2021. For the second half of the year, we expect store sales to be flat to 2020 levels as increased store productivity should offset the impact of our permanent store closures over the previous 12 months. We are planning to close an additional 98 stores during fiscal 2021 to achieve our accelerated store closure target of 300 stores and expect approximately 75% of our total revenues to be generated outside of traditional malls in fiscal 2022. We anticipate digital sales will represent approximately 50% of total sales, which puts our steady state annual digital revenue penetration significantly ahead of our competition, supported by our digital investments, strong transfer rate, and fleet optimization initiatives. We anticipate increased costs for inbound freight will continue to impact our business. Raw material input costs are also rising. We have been able to successfully mitigate these increased costs to date with our 2021 AUC projected to be down low single digits through our holiday placements. We are planning to return to positive operating cash flows for fiscal year 2021. However, we expect operating cash flow generation to be slightly lower than historical levels for the first half of the year due to the repayment of the suspended 2020 rents, net of abatements, as well as other planned changes in working capital. As a reminder, we're planning to receive a tax refund in the range of $40 million as part of the benefits provided under the CARES Act. I've mentioned on our prior calls that our term loan provides us with the opportunity to use a significant portion of this refund to pay down the term loan without penalty. We are planning for capital expenditures in the range of $50 million for the year 2021. with the large majority allocated to digital and supply chain fulfillment initiatives. Lastly, based on our current liquidity position and assuming a normalized back-to-school selling season, we plan to resume our capital return program in the third quarter of 2021. As a reminder, we currently have $91 million remaining of our $250 million authorization. At this point, we will open the call to your questions.