Children's Place, Inc. (The)

Good morning and welcome to the Children's Place second quarter 2022 earnings conference call. On the call today are Jane Elfers, President and Chief Executive Officer, Rob Helm, Chief Financial Officer, and Josh Truppo, Vice President, Financial Planning and Analysis. At this time, all participants are in a listen-only mode. 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. As a reminder, this conference is being recorded. The Children's Place issued its second quarter 2022 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. 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 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. It is now my pleasure to turn the call over to Jane Elfers.

Thank you and good morning, everyone. Our Q2 sales and profitability fell well short of our internal expectations due to a significant miss to our retail sales projections in the period from early June through early July. The combination of an unexpected and meaningful increase in promotional activity from our key competitors and the widely reported inflation-driven consumer slowdown put significant downward pressure on our fashion AURs and margins during the quarter. AUR ended the quarter flat versus our projection of up mid-single digits. Our fashion AUR was down negative mid-single digits a significant miss from our internal projections, while our basics AUR was a positive low teens as planned. In addition, a $6 million unplanned expense late in the quarter further pressured our margins. This expense was required to address unplanned inbound supply chain disruptions. We had to address a significant imbalance in our channel inventories caused by this disruption, the majority of which stemmed from the rapid backup of our East Coast ports as other retailers scrambled to move their shipments from the West Coast. Rob will cover these two issues in more detail during his prepared remarks. Moving on to digital. Digital represented 47% of our retail sales in Q2 versus 45% in 2021 and 30% in 2019. U.S. e-commerce traffic held up well during the quarter at positive 7% versus last year. As planned, Canada e-commerce traffic was down due to the lapping of the temporary store closures last year. We continue to deliver industry-leading digital results supported by the combination of our structural reset since the pandemic, our increased marketing investments, and our focus on optimizing our channel results. Digital is our highest operating margin channel, and based on the strength of our digital business and our increased investments in this channel, digital is projected to represent 50% of our 2022 retail sales. Looking ahead, we are projecting digital to represent approximately 60% of our total retail sales by the end of full year 24 versus 33% of retail sales in 2019, almost doubling our digital penetration in only five years. And when you factor in our growth expectations for Amazon, our projected digital penetration grows beyond 60% of total consolidated revenue by the end of full year 24. With respect to digital marketing, we are focused on investing in top of funnel brand awareness. We are realizing positive early results with a 4% increase across the customer base in acquisition, retention, and reactivation for the second quarter. Acquisition was particularly strong with digital acquisition of positive 13% and store acquisition of positive 1%, despite the lower store base versus last year. 76% of our transactions occurred on a mobile device during Q2. Our mobile app continues to drive strong customer engagement, especially among our loyalty members, who represent 95% of our mobile app transactions. Our mobile app customer spend frequency is 10% higher than non-app customers, and basket sizes of customers transacting on our app is 15% higher than our non-app customers. Our current Back to School campaign is focused on fostering children's education and making important resources accessible. We partnered with actor, author, and philanthropist Kevin Hart for our Back to School campaign. Since our launch on July 26, we have garnered over 33 billion impressions across almost 500 print, broadcast, and digital outlets. This campaign is packed with rich photo and video content that is being syndicated and amplified across both earned and paid digital media. In addition, early results showed robust engagement with over 9.8 million completed video views and strong clicks to site. We continue to see strength in partnering with celebrities and influencers, both micro and macro, to drive brand awareness and consideration across key product categories. With respect to Q3, we have already seen positive search trend increases for our holiday and special moments assortments. Results quarter to date show a 92% increase over last year in site searches across our Halloween and holiday Christmas sleepwear assortments. Our consistently superior merchandise offerings and our ongoing brand campaigns targeted at these special product assortments have established the children's place as a market leader in holiday product offerings, further driving brand loyalty and traffic. We believe that our increased and targeted back to school marketing efforts are already having a positive impact on our third quarter sales. Our quarter to date sales trend is above our trend for the last two weeks of July. Total retail sales are running down 11% versus 2021 and up 11% versus 2019. And our AUR is currently running up positive high single digits, higher than our back half AUR outlook now assumes based on the uncertain environment. Our basics business continues to be very strong. And with respect to our fashion assortments, our customers responding to the combination of our significantly increased back to school marketing efforts and our curated back-to-school fashion assortments. Digital traffic is up over 5% quarter-to-date versus last year, and quarter-to-date digital sales are running down 5% versus last year, higher than we had anticipated considering our record-shattering August last year. As we have shared, August historically represented about 35% of our Q3 retail sales. Last year, August represented just over 40% of our sales, an outsized percentage to the typical third quarter due to the combination of pent-up demand, the return to in-person learning, and the child tax credit stimulus. This year, we're projecting August sales to represent about 38% of the quarter due to the continued growth in our e-commerce business, which generates significantly higher basket sizes. Moving on to Amazon. Our Amazon business was outstanding in the second quarter. Amazon is delivering very strong results from the inventory and marketing investments we have made, and our partnership continues to strengthen. As I mentioned, due to the East Coast port congestion late in the quarter, we had to overspend in our DC to provide Amazon with the necessary inventory to continue to support their outsized trend coming into and out of Prime Day. We had outstanding Prime Day results and our sales have continued to build every week since Prime Day. We believe that the Amazon customer is a higher income customer and advantage as our core TCP customer is feeling significant pressure from the unprecedented inflationary environment. Amazon launched our iconic Gymboree brand on their website in late July. Amazon supported the Gymboree brand launch with several key traffic driving placements across Amazon.com, including the Back to School, Amazon Fashion, Kids Fashion, and New Arrivals landing pages, as well as the Amazon Homepage Gateway. Early results are encouraging, and we look forward to building this exclusive partnership for years to come. Moving on to Gymboree. In addition to launching Gymboree on Amazon and Q2, we are very pleased with the early reads on our Gymboree back-to-school product launches. For the second quarter, we experienced an 18% increase in spend per customer versus last year. We also know that the Gymboree customer is a higher income customer than our core TCP customer, which we believe will be an advantage as we continue to scale this brand. We introduced Gymboree Uniform product for the first time in Q2, which drove significant revenue, site search volume, strong social sentiment, and ad click engagements that continue to grow each week. The Gymboree customer let us know last year that she wanted holiday product earlier in the season, so we launched our first holiday collection on July 28th. Since launch, this holiday collection drove a three times increase in search terms year over year, and it was the top visited collection on our homepage. We are confident that Gymboree will continue to be an increasingly important part of our growth strategy. In closing, Rob will walk you through our Q3 and full year 22 outlook during his prepared remarks. From a high-level perspective, when compared to 2019 pre-pandemic levels, although we are now anticipating that consolidated sales will be down approximately 8% versus 2019, we also anticipate that operating income will be up positive mid-teens versus 2019, and EPS will be up approximately 30% versus 2019. With the multiple headwinds we are currently facing, these results would only be possible due to the structural reset to our business model since the start of the pandemic. We have a clear focus on continuing to maintain the significant double-digit AUR increases we have realized since the start of the pandemic which will benefit our growth margin when cotton costs normalize. We will continue to build upon our e-comm freight optimization strategies. We will continue to secure occupancy savings as our leases expire, and our top priority will remain growth in digital, our highest operating margin channel. Now I'll turn it over to Rob.

Thank you, Jane, and good morning, everyone. After I review our Q2 results, I will provide our Q3 and full year 22 outlook. For the fiscal second quarter, our operating results fell short of our expectations and we delivered an adjusted loss per share of 89 cents versus earnings per share of $1.71 in 2021 and 19 cents in 2019. Net sales decreased by 33 million or 8% to 381 million versus 414 million in Q2 2021 and decreased 39 million or 9% versus 420 million in Q2 2019. Our U.S. net sales decreased by 48 million or 13% to 313 million versus 361 million last year. And our Canadian net sales decreased by 2 million or 5% to 35 million versus 37 million last year. Comparable retail sales were negative 8.7% versus Q2 2021 and positive 2.2% versus Q2 2019. Our Q2 net sales were negatively impacted by the slowdown in consumer demand, driven by the unprecedented levels of inflation, particularly with respect to the significant increases in fuel and food prices, combined with increased promotions across our competitive set. As we shared on our last call, our AUR plan for the second quarter was up mid-single digits to offset AEC grid increases. However, starting in June, the combination of the consumer slowdown and the elevated promotional activity across the sector led to significant unplanned AUR pressure, and our actual AUR for the quarter was flat. The combination of the lost sales resulting from the consumer slowdown and the heightened promotional environment represented a top-line impact of approximately 22 million in our retail sales channels for the quarter. versus our internal projections. And as we had planned, sales in the quarter were also negatively impacted by lapping the impact of the enhanced child tax credits, which started last July, combined with the pent-up demand from last year's return to in-person learning, and the impact of permanent store closures representing approximately $14 million for the quarter. Our net sales were positively impacted by our outside sales growth in our wholesale channel with Amazon. Looking at sales by month for the quarter, as we discussed in our last call, our sales trend improved in May versus Q1 as we lapped the outsized impact of stimulus and unseasonably cold weather. For June, sales trends further improved, but were driven by the heavy promotions necessary to address our competitive set to clear through our summer fashion inventories. And in July, as expected, our sales were meaningfully lower than last year as we lapped the impact of the combination of pent-up demand, the return to in-person learning, and the enhanced child tax credit stimulus. In terms of sales by channel, consolidated digital sales decreased 7% versus Q2 2021, with our digital penetration growing to 47% of our total retail sales versus 45% in 2021 and 30% of retail sales in 2019. Store net sales were down 14% versus Q2 2021. Our comp store traffic was down 4% versus Q2 2021. However, As a point of reference, store traffic remains significantly below pre-pandemic levels, with comp store traffic down 32% for Q2 2022 versus Q2 2019. Adjusted gross margin. Adjusted gross margin decreased 1,046 basis points to 30.2% of net sales, compared to 40.6% in Q2 2021 and 33% in Q2 2019. Approximately 610 basis points of this decrease was unplanned versus our internal projections. The 610 basis point unplanned decrease in gross margin breaks down as follows. First, the slowdown in consumer demand combined with the unexpected increase in promotional activity from our key competitors pressured our top line sales and fashion AURs resulting in lower than planned merchandise margins in both channels versus our internal projections. The lower merchandise margin coupled with the deleverage in fixed expenses resulting from the lower net sales, deleverage our gross margin rate by 460 basis points versus our original plans. Second, we experienced significant unplanned inbound supply chain delays, most notably from the rapid buildup in congestion at the East Coast ports, as well as the impact of further vendor delays. These supply chain disruptions forced us to have to rebalance our basic inventory, primarily uniform and denim, across our channels. We had to shift large amounts of basic inventory between our channels within our DC and our domestic supply chain to support our strong Amazon and digital businesses and to properly position us to deliver the significant level of basics revenue plan for Q3. These inbound delays resulted in additional six million in incremental costs in our DC and domestic supply chain, which further impacted our gross margin by an additional 150 basis points versus our plans. While our second quarter operating results fell well short of our expectations, The combination of selling through our late spring and summer products and getting the cost to balance our channel inventory behind us enabled us to exit the second quarter in a strong seasonal inventory position and better position for success in Q3 with respect to our key back to school basics in both our digital and wholesale channels. As expected, the following items also impacted our gross margin in the quarter. The sales makeshift to wholesale, which operates at a lower gross margin We had planned for outsized growth with Amazon in Q2, but we significantly overachieved our internal Amazon sales plans for the quarter, driven by the strong customer response to our back-to-school basics programs. And as a reminder, while our Amazon business operates at a lower gross margin, it is accretive to our overall consolidated operating margin, delivering operating margins nearly as high as our own digital channel. The impact of elevated inbound freight transportation costs driven by significantly higher levels of air freight and higher container rates. And lastly, incremental duty resulting from the loss of the Ethiopian AGOA trade benefits. Adjusted SG&A. Adjusted SG&A was $114 million flat to last year and versus $115 million in 2019. Indeed, leveraged 223 basis points to 29.8% of net sales compared to 27.6% of net sales last year. The deleverage was primarily the result of the decline in net sales on our fixed expenses. As planned, marketing spend was higher in the quarter, inclusive of investments in brand marketing. Adjusted depreciation and amortization was $13 million in the quarter versus $14 million last year and $18 million in 2019. Adjusted operating loss. Adjusted operating loss for the quarter was $12 million, a decrease of $52 million versus $40 million of operating income last year. and deleveraged 1,277 basis points to negative 3.1% of net sales compared to 9.7% of net sales in Q2 2021 and 1.4% of net sales in Q2 2019. Interest expense. Our adjusted interest expense for the quarter was 2.6 million versus 4.7 million last year. The decrease in interest expense was driven by lower interest rates due to our refinancing Q4 last year and a lower term loan balance outstanding this quarter. Tax rate. Our adjusted tax rate was 18%. Moving on to the balance sheet, our cash and short-term investments ended the quarter at $28 million. We ended the quarter with $284 million outstanding on our revolving credit facility. Inventories ended the quarter up 34% versus last year, and the increase breaks down as follows. 42% of the increase was due to higher AECs driven by higher input costs. 24% of the increase was due to higher inbound freight costs. 18% of the increase resulted from the elevated transit times, including the impact of the worsening port disruption on the East Coast. And the remaining 16% of the increase was driven by our investments in inventory to support our strategic growth initiatives, with unit growth in place to support Amazon, Gymboree, and Sugar and Jade. Despite the slowdown in consumer demand, we were able to exit the quarter in a strong seasonal inventory position. with spring and summer inventory units down 45% versus last year, better positioning us for the back half of the year. Our basics inventory, which includes several key high volume categories with limited to no markdown risk, accounted for over 50% of our on-hand inventory quarter end, which positions us for what we will believe to be a continuation of the current environment throughout the back half of the year. Moving on to cash flow and liquidity, we used $34 million in cash flow operations in Q2 versus cash provided of $13 million last year. Capital expenditures in Q2 were $8 million. During the second quarter, we repurchased 484,000 shares for $23 million, leaving $196 million outstanding on our current authorization. Now I'll provide an update on our store activity in the quarter. We closed seven locations in the second quarter, and we plan to close a total of 40 stores for full year 2022. With over 75% of our store fleet coming up for lease action in the next 24 months, we continue to maintain meaningful financial flexibility in our lease portfolio. These short-term leases will continue to provide us with the flexibility to optimize our occupancy costs. We ended the quarter with 658 stores and total square footage of 3.1 million square feet, a decrease of 8% compared to Q2 2021 and 31% versus Q2 2019. With respect to our fleet optimization strategy, it's important to continue to highlight that for 2022, we're planning for 50% of our retail sales to come from our stores, with 50% of our store sales coming from traditional malls and 50% coming from off mall. With our digital business also planned at an industry leading 50% of total retail sales, we are planning for 75% of our retail sales from off mall, strongly supporting our structural reset to a digital first retailer. Moving on to our outlook. Based on the current environment, we are now planning for a decline of approximately 10% in net sales versus 2021 for the year. Our inventories are now better positioned by channel to meet the current demand trends. However, we anticipate that promotions will remain elevated for the back half of the year, and we're continuing to proactively manage our inventory levels. We continue to benefit from our pricing and promotion reset. AURs are planned to remain significantly higher than pre-pandemic levels. However, Based on the current environment, our outlook now assumes a positive low single-digit AUR increase for the back half of the year versus our original projection of positive high single-digit AUR increases. Our outlook assumes that our Amazon business continues to outperform, supported by our significant investments in both inventory and marketing. Starting with our Q3 outlook, the company expects net sales for the quarter to be approximately $500 million. representing a low double-digit decrease in comparable retail sales versus Q3 2021 and a positive mid-single-digit comp increase versus Q3 2019. Adjusted operating income is expected to be approximately 14% in net sales as compared to 20.9% in Q3 2021, primarily driven by the decrease in sales. This compares to 12.1% in Q3 2019. We anticipate third quarter adjusted earnings per diluted share to be approximately 395 as compared to adjusted earnings per diluted share of 543 in Q3 2021 and 303 in 2019. Our total inventories at the end of Q3 2022 are anticipated to remain elevated, primarily driven by higher raw material input costs and higher inbound transportation costs. Moving on to our full year outlook, For fiscal 2022, the company expects net sales to be approximately $1.725 billion, reflecting a low double-digit decrease in comparable retail sales versus fiscal 21 and a positive mid-single-digit comp increase versus full year 2019. We project that e-commerce penetration will increase to 50% of total retail sales for full year 2022 versus 46% in full year 21 and 33% in full year 2019. Adjusted operating income is expected to be approximately 7.5% of net sales as compared to 15.1% in 21 and 6% in 2019. We anticipate fiscal 2022 adjusted earnings per diluted share to be approximately $7 as compared to adjusted earnings per diluted share of $13.40 in 21 and $5.36 in 2019. Our inventories at the end of Q4 2022 are anticipated to moderate from current levels. we were planning for a full year tax rate in the range of 23 to 24%. Our outlook for the balance a year assumes lower occupancy costs versus last year due to the impact of our permanent store closures, as well as the benefit of favorable lease negotiations and lower variable occupancy expense resulting from the lower plan sales. Although there has been some moderation of inbound container and transportation costs, our full year outlook does not contemplate significant improvement from current levels. However, We are planning for significantly lower air freight costs in the back half of the year versus the first half of the year. We anticipate that the full year 2022 SG&A will be slightly lower than full year 2021, with SG&A planned to be approximately $450 million for the year. Due to the combination of the actions we are taking in response to the current environment, the benefits from our fleet optimization program, and lower incentive compensation expense. We are planning significant marketing investments for the back half of the year. which we believe will continue to support our TCB sales and acquisition goals, as well as support the continued momentum in our Gymboree and Amazon businesses. We're planning for lower interest expense in the back half of the year, resulting from the favorable interest rates we secured as part of the refinancing or revolving credit facility and term one in the fourth quarter for 2021. In line with historic norms, we expect to generate significant operating cash flow in the back half of the year, providing us with the ability to continue to return capital to our shareholders and reinvest in our business. Lastly, we are planning for capital expenditures of approximately $45 million for fiscal year 2022, with $26 million remaining for the balance of the year, the majority being allocated to support digital and supply chain fulfillment initiatives. Thank you. And now we will open the call to your questions.