Children's Place, Inc. (The)

Good morning and welcome to the Children's Place third 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 third 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 the 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 in the company's SEC's 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 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. We delivered another outstanding quarter with sales, growth margin, operating margin, and EPS all at record levels. To help put the magnitude of our turnaround into perspective, our Q3 adjusted operating income of $117 million exceeded our full year 2019 adjusted operating income of $111 million. The significant structural changes we made to our business in 2020, combined with the accelerated digital investments we made pre-pandemic and our strategic pricing reset, all continue to be key drivers of our accelerated operating margin expansion. Our digital business has always been our highest operating margin contributor due to its high UPT, low single digit return rates, and lower overhead costs versus our stores 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 an industry leading 45% of our Q3 sales versus 35% in 2019. And we are targeting an 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. Year to date, we've seen an 18% increase in our new customer file And with customer acquisition balanced between our channels, combined with our industry-leading 30% transfer rate, we're benefiting from the improved channel mix, which has also resulted in significantly higher average spend per customer. As of the latest NPD report, we increased our market share by 17% for Q3 versus 2020, while at the same time delivering a 900 basis points increase in gross margin versus Q3 2020, fueled by a significant double-digit AUR increase in both channels. And we achieved the strong market share performance despite having significantly fewer stores versus Q3 2020. We continue to see a shift towards mobile and our mobile app results continue to exceed our expectations. Over 71% of our digital transactions now come through a mobile device. and our active mobile users are up 26% on top of the significant file increases we saw during the pandemic in the first half of 2020. Our School is Back giveaway that we launched in August was very successful with respect to increasing our mobile app downloads and will further propel our mobile share for this upcoming holiday season and beyond. We launched Afterpay, a buy now, pay later option for our customers in conjunction with the launch of back-to-school selling, and we remain impressed with Afterpay's performance to date, with AOV running 72% higher than the average of our non-buy-now-pay-later tender options. As we highlighted in our investor deck, we partnered with Afterpay and the Kardashians on our Christmas Family Pajama campaign, which resulted in almost 2 billion impressions for our brand. we continue to focus on leveraging Afterpay's ability to reach new millennial and Gen Z customers through our partnership. With respect to our fleet optimization strategy, due to our ability to secure very favorable lease terms, we are now planning to close approximately 275 stores by the end of full year 2021 versus our original target of 300 stores. While we've realized significant occupancy savings to date, we remain well positioned with respect to lease flexibility with over 80% of our remaining stores having a lease action within the next 18 months. Before I get into brand specifics, I want to thank Greg Poole and our entire sourcing team for their tireless efforts during these past 18 months. They've gone above and beyond in every respect and we are so grateful for the impressive results they delivered during these very difficult times. With respect to Gymboree, we're very pleased to see the continued strong customer response to our third quarter product launches and to see the overwhelmingly positive response to our first deliveries of holiday dress-up product. Clearly, many families are planning to begin to resume their normal activities, and we expect to continue to see increased momentum in this important brand. Our design team continues to do an incredible job of artfully resurrecting the Gymboree brand, and we could not be more proud of the results they are delivering. As you may have seen, on November 9th, we launched our newest brand, Sugar and Jade, targeted to the $8 billion U.S. tween market. We're thrilled to be able to offer the tween customer a dedicated digital-only brand. Based on the strength of our big girls business, sugar and jade is a natural extension of our core competency and we currently have over 4 million names on our file to whom we are actively marketing sugar and jade while managing all the challenges of the pandemic our design team has done a spectacular job bringing sugar and jade to life and we're excited to see the potential for our newest brand with respect to wholesale We remain laser focused on strengthening our partnership with Amazon, and they continue to experience very strong sell-throughs on our product. We recently launched a new storefront on Amazon. We are significantly accelerating our investments in brand marketing, and we're projecting accelerated growth with Amazon for the balance of 2021 and beyond. As you may have also seen, we issued our 2020 Environment, Social and Governance Report earlier this week. I would encourage everyone to take a look at it as we are very proud of the significant progress we have made on our ESG initiatives and goals this past year. With respect to current TCP business, while we're only a few weeks in, Q4 is off to a very strong start. Looking forward, we are carefully monitoring the daily changes and developments with respect to COVID. Our seasoned team will continue to manage any new developments as they arise, as we have since the onset of the pandemic. While we are not providing guidance at this time, Rob will provide more color on Q4 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 the accelerated operating margin expansion we are seeing today. We continue to operate at a high level. We remain firmly on offense, and we believe 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. After I review our Q3 results, I will provide some additional remarks with respect to Q4. In the fiscal third quarter, we delivered a record Q3 adjusted EPS of $5.43. Our Q3 net sales set a record, increasing by $133 million, or 31%, to $558 million versus last year's $426 million. With the return to in-person learning, August contributed 40% of the total sales for the quarter. We're also pleased to see strong momentum in both September and October. Our US net sales increased by 113 million or 31% to 475 million versus last year's 362 million. While our Canadian net sales increased by 5 million or 10% to 53 million versus last year's 48 million. Comparable retail sales were a positive 36% versus Q3 2020. As an additional point of reference, comparable retail sales were a positive 19% versus Q3 2019. Consolidated digital sales increased 36% in Q3 versus 2020, representing 45% of our total sales. Digital sales increased 40% in the US and increased 2% in Canada. Store net sales were $278 million for the quarter, which represents approximately 89% of our Q3 2019 store net sales, despite having 252 or 26% fewer stores in Q3 2021 versus Q3 2019, as well as a high single-digit reduction in operating hours as dictated by the mall landlords. U.S. store traffic remained under pressure, down 17% versus Q3 2019. Canada's storage traffic was down 32% versus Q3 2019. Adjusted gross margin. Adjusted gross margin increased 868 basis points to 43.9% of net sales, a record Q3 gross margin, compared to 35.2% of net sales last year. The gross margin increase was the result of significantly higher consolidated merchandise margins resulting from double-digit AUR increases in both our digital and store channels due to the impact of our strategic pricing reset and strong customer product acceptance. Leverage of fixed expenses resulting from the increase in net sales as well as strong expense leverage resulting from our focus on e-commerce fulfillment optimization, which virtually eliminated the amount of supplemental shift from store required to support our digital business in Q3. And the $4 million reduction in occupancy expenses due to favorable lease negotiations and reductions in occupancy expense for stores closed in the past 12 months. As an additional point of reference, occupancy expenses were $10 million lower in Q3 versus 2019. These gross margin benefits were partially offset by higher inbound freight transportation costs driven by higher container rates resulting from equipment shortages and capacity constraints at the ports, and to a much lesser degree, additional air freight costs. Adjusted SG&A. Adjusted SG&A was approximately $115 million versus $104 million last year and leveraged 375 basis points to 20.6% of net sales compared to 24.3% of net sales last year. The 375 basis point leverage was a result of leverage on the higher net sales partially offset by higher incentive compensation accruals and higher marketing spend. Adjusted operating income. Adjusted operating income for the quarter increased $85 million to $117 million, or 20.9% of sales, a record result, versus an adjusted operating income of $31 million last year, and leveraged 1,349 basis points compared to 7.4% of net sales last year. Interest expense. Our interest expense for the quarter was $4 million versus $3.3 million last year. The increase in interest expense reflects a higher average debt balance this quarter and the higher interest rate associated with our term loan. Tax rate. Our adjusted tax rate was 28% 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 $67 million. We ended the quarter with $174 million outstanding on our revolving credit facility. As we announced this morning, we refinanced both our revolving credit facility and term loan, reducing our term loan to $50 million as part of the transaction, enhancing our liquidity position, and strengthening our balance sheet. Lastly, inventories ended the quarter up 3% versus last year. Moving on to cash flow and liquidity. We generated $71 million in cash from operations in Q3 versus $32 million last year. Capital expenditures in Q3 were $9 million. We repurchased $32 million of stock in the quarter. As announced in our press release this morning, our board authorized a new $250 million share repurchase program. Now we'll provide an update on our store activity in the quarter. We closed five locations in the quarter bringing the year-to-date closures to 47. Due to favorable lease negotiations, we are now planning to close 275 stores by the end of fiscal year 2021 versus our previously announced target of 300 stores. Our current plan calls for an additional 50 store closures in Q4. With over 80% of our store fleet coming up for lease action through the end of fiscal 2022, we continue to maintain meaningful financial flexibility in our lease portfolio. We ended the quarter with 703 stores and total square footage of 3.3 million, a decrease of 12.3% compared to Q3 last year, and a decrease of 22.6% since the onset of the pandemic. While we're not providing EPS guidance, we want to provide you with some thoughts regarding Q4 in the current environment. We are facing the following headwinds in our business for Q4. First, the impact of 225 permanent store closures since Q4 2019, which contributed roughly $58 million in net sales in Q4 2019. Second, 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 the impact of government mandates on our workforce. Gross margin continues to benefit from the structural changes we've made to our business. And we expect Q4 margin to exceed historical levels, but at a lower gross margin rate than Q3 due to a condensed promotional calendar in Q4 versus Q3, as well as continued pressure from higher inbound freight transportation costs, higher container rates resulting from equipment shortages and capacity straits at the ports, and to a lesser degree, air freight costs. We will also continue to make incremental investments in wages in our distribution center to support our e-commerce growth for this holiday season. SG&A is planned to be in the range of $118 million, primarily the result of higher incentive compensation accruals and higher levels of digital marketing spend. 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. At this point, we will open the call to your questions.