Children's Place, Inc. (The)

Good morning and welcome to the Children's Place second quarter 2021 earnings conference call. On the call today are Jane Alford, President and Chief Executive Officer, and Rob Helm, Chief Financial Officer. The Children's Place issued its second 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 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 risk 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 Alfers.

Thank you and good morning everyone. We delivered another outstanding quarter with growth margin, operating margin, and EPS all at record level. The significant structural changes we made to our business in 2020, including an accelerated fleet optimization strategy to close 300 stores or a third of our fleet in less than 20 months. An occupancy cost reset on our remaining stores. Optimization of our e-commerce fulfillment costs. The introduction of Gymboree into our portfolio of brands. and a restructuring of our P&L to support our digital-first business model. Combined with the accelerated digital investments we made pre-pandemic, all continue to propel our results. Importantly, we're now able to add another significant structural change to our list. With the pandemic-driven acceleration of competitor liquidations and store closures, the competitive landscape now enables us to reset our pricing and promotional strategy. As you may remember, we made the strategic decision prior to the pandemic to pressure our margins in the short term in support of what we believed would be a healthier, less crowded competitive landscape in the future. Well, the future's now, and we anticipate that our pricing reset will continue to be a key driver of accelerated operating margin expansion in 2021 and beyond. Moving on to digital and marketing. 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 storage channel. And with the pandemic-driven acceleration of our digital business, we are now gaining additional leverage on fixed overhead costs and driving significantly higher digital margins. As our digital business continues to grow on both the top and bottom lines, we are making additional investments in marketing and technology to continue to support this growth. Our digital sales represented 43% of our Q2 sales versus 29% in 2019. And we are targeting an industry leading approximately 50% steady state annual digital penetration. We are focused on investing in brand awareness through our digital marketing channels, and we are seeing higher cost efficiency on marketing spend versus prior to the pandemic. With respect to customer acquisition, we've leveraged our marketing tactics and focused our additional investments to achieve a 50-50 split between digital and stores acquisition. which is approximately in line with where our digital penetration is planned going forward. With customer acquisition balanced between our channels, combined with our industry-leading 30% transfer rate, we are benefiting from the improved channel mix. This mix change has resulted in significantly higher average spend per customer. We continue to see a shift towards mobile and our mobile app results continue to exceed our expectations. Over 70% of our digital transactions come through a mobile device and our active mobile users are up double digits on top of the significant file increases we saw during the pandemic in the first half of 2020. We launched Afterpay, a buy now, pay later option for our customers. in conjunction with the launch of back-to-school selling. While it's only been a few weeks, we are impressed with Afterpay's performance to date, with AOV running 50% higher than the average of our non-buy-now-pay-later tender options. Afterpay has over 20 million users in the US, and we are focused on leveraging Afterpay's ability to reach new millennial and Gen Z customers through this partnership. With respect to back to school marketing, we launched a $1 million School is Back giveaway in early August in an effort to help families through these difficult times. In addition, we are donating $1 million of back to school product to Baby to Baby, a nonprofit organization that provides children living in poverty with the basic necessities that every child deserves so kids can proudly wear their new clothes for their return to the classroom. With respect to our fleet optimization strategy, we're on track to close our previously announced 300 store target by the end of this year. While we have realized significant occupancy savings to date, we are well positioned with respect to lease flexibility with 85% of our remaining stores having a lease action within the next 18 months. With respect to Gymboree, we are extremely pleased to see the strong customer response to our August back to school offerings. And we anticipate that as families are able to begin to resume more normal activities, we will continue to see increased momentum in this important business. As we have discussed many times, Gymboree is a unique brand and you will not find similar product in scale anywhere else in the kids market. This is a brand-loyal customer, and as you can read on our social media sites, Mom loves what we are doing with this iconic brand. We're focused on our partnership with Amazon, and they are seeing very strong sell-throughs on our back-to-school assortments. We recently launched a new storefront on Amazon, and we are investing in brand marketing with strong results to date. we are now projecting accelerated growth with Amazon for the balance of 2021 and beyond. With respect to current TCP business, the last two weeks of July were strong and Q3 is off to an explosive start. The combination of schools anticipated to return to 100% in-person learning this fall, the enhanced child tax credit payments that started to deliver on July 15th and cover 88% of the kids in the United States, our strong in-stock position on key back-to-school basics, our compelling back-to-school fashion assortment, record breaking results from our tax-free events, our significantly enhanced and expanded digital marketing tactics, our strategic pricing reset and a less crowded competitive playing field all provide strong tailwinds for our key back to school selling period. Looking forward to September and beyond, we are carefully monitoring the daily changes and developments with respect to the Delta variant. Our seasoned team will continue to manage these unanticipated developments as they arise, as we have since the onset of the pandemic. While we are not providing guidance at this time due to the uncertainty, Rob will provide more color on the back half of 2021 in his prepared remarks. In closing, 2020 was the most transformative year in our company's history. We leveraged a very difficult period to significantly accelerate our strategic transformation and structurally reposition the company for accelerated operating margin expansion. We continue to operate at a high level, and we remain firmly on offense. We believe that we are uniquely positioned to continue to deliver accelerated returns 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 Q2 results, and then I will provide some thoughts on our Q3 and the balance of fiscal 2021. In the fiscal second quarter, we delivered a record Q2 adjusted EPS of $1.71. Net sales increased by $45 million or 12% to $414 million versus last year's $369 million. Our U.S. net sales increased by $39 million or 12% to $372 million versus last year's $333 million. while our Canadian net sales increased by 4 million, or 13%, to 37 million versus last year's 33 million. Comparable retail sales were a positive 14.1% in the quarter versus Q2 2020. As an additional point of reference, comparable retail sales were a positive 12.4% versus Q2 2019. Our net sales were positively impacted by strong customer response to our product assortment, Higher customer spending resulting in part from the unprecedented level of stimulus, including the enhanced child tax credit payments to our customers under the government pandemic relief legislation. Higher back-to-school sales driven by the announced return to in-person learning. And lastly, the significant majority of our U.S. stores were open for the entire quarter this year versus the temporary closures we experienced for more than 50% of the quarter last year, as the result of government mandated shutdowns, ending the quarter with more than 99% of our retail stores open to the public for business this year. Our Q2 net sales were negatively impacted by the impact of our 118 permanent store closures in the past 12 months, inclusive of 42 stores we closed this fiscal year to date, and the 76 stores we closed during fiscal 2020. The impact of the government mandated temporary closures in Canada, with approximately 50% of our fleet closed for May and June, and the impact of an approximately 10% reduction in mall operating hours as mandated by our mall landlords. Consolidated digital sales decreased 33% in Q2 versus 2020, representing 43% of our total sales. Digital sales decreased 36% in the US and increased 7% in Canada. As you may remember, our U.S. digital penetration was approximately 70% in Q2 2020 due to the majority of our stores being closed for over half of the quarter. Store net sales were 219 million for the quarter, which represents approximately 80% of our Q2 2019 store net sales, despite having 265 or 28% fewer stores in Q2 2021 versus Q2 2019. 10% fewer operating hours as dictated by the mall landlords, and half of our Canadian stores closed for two-thirds of the quarter. Similar to what we saw in Q1, U.S. stores traffic remained under significant pressure for Q2, down 32% versus 2019 levels. Our store performance, bolstered by our strong transfer rate, further reinforces our strategic fleet optimization strategy. Importantly, we were 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. Our Canada store business was under significant pressure due to the COVID-19 pandemic during Q2. Canada store sales increased 20% versus 2020, with 100% of the fleet closed for the first six weeks of the quarter in 2020. Versus 2019, Canada's sales decreased approximately 39%, with traffic down approximately 59% due to the continued impact of government-mandated COVID-19 temporary closures, impacting approximately 50% of our Canadian fleet for two-thirds of the second quarter. Adjusted gross margin. Adjusted gross margin increased 2,168 basis points to 40.6% of net sales, a record Q2 gross margin, compared to 18.9% of net sales last year. The gross margin increase was the result of, one, significantly higher consolidated merchandise margins, resulting from double-digit AUR increases in both our digital and stores channels due to strong customer product acceptance, leading to higher price realization and reduced promotions. It is also important to note that consolidated merchant margins expanded versus 2019, despite an approximate 1400 basis point penetration increase in our digital channel to 43% of our total consolidated net sales. Second, a reduction of 13 million in occupancy expenses during the quarter, primarily due to favorable lease negotiations and reductions in occupancy expense for stores closed in the past 12 months, as well as rent and payments of $2 million. We anticipate meaningful occupancy savings for the balance of the year and beyond. And lastly, the leverage of fixed expenses resulting from the increase in net sales as a result of anniversary and the temporary closure of our entire fleet in Q2 2020. We also saw good expense leverage benefits in the quarter from the results of our work on e-commerce fulfillment optimization, which virtually limited the amount of supplemental shipping store required to support our digital business in Q2. These gross margin benefits were partially offset by higher inbound freight transportation costs driven by ocean carrier equipment shortages, capacity constraints, and higher container rates. Adjusted SG&A. Adjusted SG&A was approximately $114 million versus $104 million last year and leveraged 48 basis points to 27.6% of net sales compared to 28.1% of net sales last year. The 48 basis point leverage was a result of leverage on the higher net sales and cost savings resulting from the significant store closures in Canada, partially offset by higher incentive compensation accruals as well as higher marketing spend to support the increased e-commerce penetration. Adjusted operating income. Adjusted operating income for the quarter increased $89 million to $40 million, or 9.7% of sales, a record result. versus an adjusted operating loss of $49 million last year and leveraged 2,302 basis points compared to a negative 13.3% of net sales last year. Interest expense. Interest expense for the quarter was $4.7 million versus $2.6 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 higher incentive compensation accruals in the current year. Moving on to the balance sheet. Our cash and short-term investments ended the quarter at $64 million. We ended the quarter with $200 million outstanding on our revolving credit facility. We ended the quarter with total inventory up 21% versus last year. The increase in our inventory levels versus last year continues to be driven by the back-to-school we have been carrying since last June. We anticipate our inventory levels will normalize post our back-to-school selling season ending Q3. Moving on to cash flow and liquidity. We generated approximately $13 million in cash from operations in the quarter, inclusive of the repayment of the majority of the balance of 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. Based on our liquidity position, and our planned cash flows for the back half of fiscal 2021, we have resumed our share buyback program and purchased $11 million during the quarter, leaving us with $80 million outstanding on our current authorization. Capital expenditures in Q2 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 second quarter, we finalized the balance of lease negotiations with our landlords covering our 2020 occupancy. We recognized the rent abatement of $2 million in Q2, bringing our finalized total abatements for fiscal 2020 to 23 million. We also realized significant occupancy expense savings from favorable lease negotiations on our go-forward store portfolio. And from the 118 store closures in the past 12 months, inclusive of the 17 stores we permanently closed in Q2. We ended the quarter with 708 stores and total square footage of 3.4 million, a decrease of 13.7% compared to Q2 last year and 22.2% since the onset of the pandemic. We are planning to close an additional 81 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, we want to provide you with some thoughts regarding Q3 and full year 2021. Starting with Q3, we are off to a very strong start for the quarter. We expect to continue to be an outsized beneficiary of the enhanced child tax credit payments under the American Rescue Plan and expect to continue to see tailwinds for our business resulting from these payments throughout the back half of fiscal 2021. We also have seen benefits from the additional tax-free days in the calendar this year in key markets like Florida, among others, and a new tax-free market in West Virginia. We experienced historically low levels of back-to-school demand in both our digital and stores channels in August 2020 due to remote learning in response to the pandemic. Both digital and store sales will be significantly higher in August 2021 versus 2020, as parents stock up on key back-to-school basics for the first time in two years. With all of these tailwinds, we continue to experience some near-term headwinds in our business. First, and most significantly, the impact of the 265 permanent store closures since 2019, which contributed roughly $52 million in net sales in Q3 2019. The impact of late deliveries and factory delays resulting from the continued disruption in the global supply chain due to the pandemic. And lastly, the uncertainty surrounding the COVID Delta variant and its potential impact on our business. We expect that Q3 gross margin will exceed our Q3 2020 gross margin as we continue to see merchandise margin in both channels driven by significant AUR increases as a result of reduced promotions and higher price realizations. occupancy savings from our favorable lease negotiations and permit store closures, and lower e-commerce fulfillment costs due to a number of optimization efforts, as well as our ability to virtually eliminate the supplemental amount of shift from store needed to support e-commerce demand in the quarter. These items will be somewhat offset by higher inbound freight transportation costs driven by ocean carrier equipment shortages, capacity constraints, and higher container rates. SG&A is planned to be in the range of $115 million, increasing slightly from Q2 levels as a result of our expectation that our entire Canadian fleet will be open for the entire quarter in Q3, and inclusive of higher incentive compensation accruals and higher levels of digital marketing spend to support our e-commerce business. Moving on to the balance of 2021, we are planning to close an additional 81 stores during the balance of fiscal 2021 to bring our total closures to our previously announced 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 penetration significantly ahead of our competition, supported by our digital investments, strong transfer rate, and fleet optimization initiatives. We continue to experience late deliveries and factory delays resulting from the continued disruption in the global supply chain due to the pandemic, as well as increased costs for inbound ocean freight due to equipment and container shortages. We are pulling up product receipts where possible and have been able to keep air freight costs to date to a minimum. We anticipate that we will continue to see disruption in the environment at least until the end of 2021. 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 2021 placements. However, we are planning that starting with spring 2022, we will see AUC increases due to higher raw material costs in inputs such as cotton and polyester, as well as general wage inflation in the countries in which we source our products. We are planning to return the historical operating cash flow levels for fiscal year 2021 with significant positive cash flows planned for the back half. As a reminder, we are planning to receive a tax refund in the range of $40 million as part of the benefits provided under the CARES Act. And our term loan provides us with the opportunity to use up to $25 million of this refund to pay down our term loan without penalty. We are now planning for capital expenditures in the range of $40 million for fiscal year 2021, with the large majority allocated to digital and supply chain fulfillment initiatives. And lastly, as I mentioned earlier on the call, we resumed our capital return program during the second quarter and expect that our operating cash flows will provide us the opportunity to continue to return capital to our shareholders throughout the back half of fiscal 2021. At this point, we will open the call to your questions.