The Children’s Place - Earnings Call - Q2 2021

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by, and welcome to The Children's Place Second Quarter twenty twenty Earnings Conference Call. 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 speakers' remarks, there will be a question and answer session.

It is now my pleasure to turn the floor over to Anthony Attardo, Director of Investor Relations to begin.

Speaker 1

Good morning, and welcome to The Children's Place's conference call. On the call today are Jane Elfers, President and Chief Executive Officer and Mike Scarpa, Chief Operating Officer and Chief Financial Officer. The Children's Place issued a press release earlier this morning and copies of the release and presentation materials for today's call have been posted on the Investor Relations section of the company's website. After the speakers' remarks, there will be a question and answer session. 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 ks 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. And with that, I'd like to turn the call over to Jane Elfers.

Speaker 2

Thank you, Anthony, and good morning, everyone. We generated a 118% increase in our digital channel in Q2. We have clearly benefited from our digital transformation investments, which provided us with the omnichannel capabilities necessary to fulfill our strong online demand. Increased digital adoption accelerated by COVID-nineteen continues to drive online sales to an increasingly greater share of our overall sales, representing a long term market share opportunity. Importantly, our digital growth came from both existing and new customers.

Since March, we have increased new customers to our digital file by approximately 175%, converted our store only customers to omnichannel customers at a rate approximately three times the pre pandemic rate and increased our app downloads by 115%. And according to NPD data, through June, we were the only pure play children's retailer to gain market share year to date. With respect to inventory, the teams did a great job selling through our spring and summer product, and we are entering Q3 seasonal carryover inventory down approximately 50%. Importantly, we have zero pack and hold on our balance sheet or sitting in overseas factories, which allows us to continue to take full advantage of what we believe will be a favorable AUC environment in 2021. With respect to fleet optimization, the next phase of our fleet optimization initiative leverages our lease flexibility to accelerate store closings.

We are targeting 300 store closures through the end of fiscal twenty twenty one with 200 in fiscal twenty twenty, inclusive of the 102 permanent store closures we executed during the 2020 and one hundred closures in fiscal twenty twenty one, bringing our total fleet to approximately six twenty five stores by the end of fiscal twenty twenty one. And lastly, since the onset of the pandemic in March, we have focused on internally modeling externally discussing the potential short term headwinds of COVID-nineteen as they relate to our business, particularly the impact of continued remote learning through the back half of the year and the pressure on Q4 due to reduced holiday traffic and a sustained promotional environment. At the same time, we've remained focused on the long term by accelerating our digital and fleet optimization strategies in support of market share opportunities that have been and will continue to be created by the pandemic. And now I'll turn it over to Mike.

Speaker 3

Thank you, Jane, and good morning, everyone. I'll start by reviewing our Q2 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 some insight on our current business. Starting with our Q2 results.

In the fiscal second quarter, we generated an adjusted EPS loss of $1.48 Net sales decreased approximately 12% to three sixty nine million dollars versus last year's $421,000,000 E commerce sales increased 118% to approximately 71% of total net sales as online accelerated following store closures in March. Despite our stores being closed for over half of the selling days in the quarter, sales growth was up mid single digits through the June, when school districts across the country began moving to remote or hybrid learning models, which we believe meaningfully impacted sales in July. Last year, July represented approximately 39% of total Q2 sales. Adjusted gross margin. Adjusted gross margin decreased seven sixty basis points to 25.4% of net sales.

Merchandise margins were down slightly in the quarter as a result of liquidation sales at stores permanently closed during the quarter. Merchandise margins in our digital business increased in the quarter. The gross margin decrease was primarily the result of higher fulfillment costs related to meaningfully higher levels of ship from store activity due to strong digital demand. Adjusted gross margin excluded approximately $27,000,000 in charges, primarily due to occupancy charges related to stores temporarily closed due to COVID-nineteen. We did resume rent payments on a modified basis in Q2 as stores began to reopen.

Adjusted SG and A. Adjusted SG and A was approximately $104,000,000 versus $116,000,000 last year and de leveraged 60 basis points to 28.1 of net sales, primarily as a result of de leverage of fixed expenses resulting from the decline in sales, partially offset by a reduction in operating expenses associated with actions taken in response to the COVID-nineteen pandemic. Adjusted SG and A excludes approximately $11,000,000 in certain items, primarily related to approximately $9,000,000 in charges due to incremental COVID-nineteen expenses in stores along with store closing costs. Adjusted operating income. Adjusted operating loss for the quarter was $25,000,000 versus operating income of $6,000,000 last year and delevered eight twenty basis points to negative 6.8% of sales.

Tax rate. Our adjusted tax rate was 22.2% versus 15.9% last year. Moving on to the balance sheet. Our cash and short term investments ended the quarter at $36,000,000 as compared to $72,000,000 in Q1. We ended the quarter with $251,000,000 outstanding on our revolving credit facility compared to $235,000,000 outstanding on our revolving credit facility in Q1.

The changes reflect funding to support operations and seasonal working capital needs. Inventory management continues to be a top priority for us and we exited the quarter with inventories down approximately 1% to last year and with seasonal carryover inventory down by roughly half, allowing us to enter the important back half with current seasonal inventory. Based on current sales trends, we anticipate a build in inventory levels in Q3 versus last year, primarily in uniform and basics. The company plans to feature its back to school assortment for an extended period of time, permitting parents to shop later when there's additional certainty on the timing of a return to in person learning. Moving on to cash flow and liquidity, we used approximately $43,000,000 in cash flow from operations in the second quarter as compared to 2,000,000 in cash generated in Q2 of last year.

Historically,

Speaker 4

the company generates the majority of its annual cash flow in the back half of the year. Capital expenditures in Q2 were approximately $9,000,000

Speaker 3

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 98 locations in the quarter, which brings our total store closures to 102 for the first half of fiscal twenty twenty. We opened two locations in Q2 and ended the quarter with seven seventy one of our eight twenty four locations open to the public with the remaining stores largely in California anticipated to open as local health guidelines allow. As e commerce demand has accelerated, partly as a result of COVID-nineteen, we have significantly increased our planned store closures and continue to target approximately 300 store locations to close in fiscal twenty twenty and 2021. We remain on track with our target to close approximately 200 store locations in fiscal twenty twenty, including the 102 locations closed in the 2020 and approximately 100 additional stores that we are targeting to close in fiscal twenty twenty one, resulting in approximately six twenty five store locations by year end fiscal twenty twenty one.

By the end of fiscal twenty twenty one, we continue to expect to greatly reduce our reliance on our brick and mortar channel, resulting in a smaller, more profitable store footprint and positioning us to enter fiscal twenty twenty two with less than an estimated 25% of our total revenue in traditional malls.

Speaker 4

Outlook.

Speaker 3

Due to the continued level of uncertainty in the current business environment, we are not providing guidance for 2020. However, we think it is important to provide some insight with respect to our current business. The company is providing total net sales in lieu of comparable retail sales metrics, given the impact on the current business environment due to the continued number of store closures related to the COVID-nineteen pandemic. With over 90% of our major US markets adopting either 100% remote or hybrid learning models for the start of the school year, our back to school sales have been significantly impacted. Approximately 70% of our Q3 sales are normally generated in August and September with the majority of those sales coming from back to school apparel and accessories.

In addition to the significant negative impact on our sales from remote and hybrid learning models, there are three other notable factors that are adversely impacting our total net sales in Q3 by an estimated 10% combined. First, the 147 permanent store closures that we are still up against from 2019 and 2020. Second, over 50 stores are still temporarily closed in California and New York due to state and local mandates. And third, a majority of our stores are in malls that are subject to operating hours dictated by the mall owners. In most of these locations, we cannot open before 11AM and we are required to close at 7PM.

We normally generate approximately 15% of our sales after 7PM. Taking all of these factors into account, we are anticipating our total net sales for the third quarter to be in the range of negative 25% to negative 30%. To help with the loss of in person learning into perspective, our Canadian business is trending down single digits quarter to date, with close to 90% of Canadian schools returning to full time in person learning, the opposite of The United States. Looking ahead, we are planning for our business to be adversely impacted in Q4, particularly as it pertains to the continuation of significantly reduced store traffic and the expectations of a heightened and sustained promotional environment as retailers start their holiday events earlier and with more urgency. At this point, we will open the call to your questions.

Speaker 0

Thank you. At this time, I would like to remind everyone, if you would like to ask a question, please press star then the number one on your telephone keypad. Our first question comes from the line of Dana Telsey of Telsey Advisory Group.

Speaker 5

Good morning, everyone. Hope everyone is safe and healthy. As you think of the upcoming third quarter and inventory planning, Mike, you said a build in inventory in uniform and basics. How do you think of that inventory build? How much should it be?

How are you thinking about the margins? And Jane, when you think about the shift to digital, what learnings you're getting in terms of what consumers are buying anything different? And how you're managing fulfillment and shipping costs? Is there a leverage point on that fulfillment and shipping costs? Thank you.

Speaker 2

Sure. Well, Dana. I hope you're well as well. From a digital perspective of what's selling, in Q2, we had a very strong performance in digital. And I think when you look at our assortments in Q2, they directly mirrored what mom was looking for.

She was looking for casual products. She was looking for comfortable products. And I think we had spoken about it when we were on the call in June, that a lot of that business was driven by graphic tees and mix and match and shorts and things that kids were wearing as they were home and not in school, and obviously with the weather change. When you look at what happens to our inventory starting at 07:15, both online and in stores, they switch over to back to school with a heavy focus on basics. And so, I would say that while our online business is doing better than our brick and mortar business, our online business is still very much struggling as the assortments are really pitched to the back to school basics.

Speaker 3

And from an overall inventory perspective, we ended the quarter with inventories down about $5,000,000 or 1%, but our carryover inventories were roughly half of what it was a year ago. So we entered Q3 in really good shape. Based on the current sales trends that we're seeing, we do expect inventories to build during the quarter, primarily in uniform and basics. We could see our inventories up low double digits at the end of Q3 based on our projection for sales. We will be featuring our back to school assortments for an extended period of time, which will permit parents to shop later as certainty on the timing of the return to in person learning happens.

And we have no plans at this time to be in a position to mark that inventory down.

Speaker 0

Your next question comes from the line of Jim Chartier of Monness, Crespi and Hart.

Speaker 6

Good morning. Thanks for taking my question. Mike, can you just talk about the how your e commerce fulfillment looks for back to school and beyond? And what your plan is for ship from store going forward? And then how that should help improve the e commerce margins for the back half?

Thanks.

Speaker 3

Sure. Obviously, we pointed out that the major hit on our gross margin line was the ship from store fulfillment that we did in the second quarter, fulfilling ecom demand from our store inventory. We did roughly 55% of our ecom shipping from in perspective of ship from store. So obviously, a very unproductive way to move that inventory, but obviously we had the demand online to do that. As we go into the third quarter, see third and fourth quarters, see that the ship from store will be a much more reasonable percentage overall.

We normally plan ship from store in the 3% to 5% range. So from the third quarter perspective, we think our margins will continue to improve on a basis points differential versus last year, similar to what happened in Q2. But we think Q4 could be a different story. Q4, particularly as it pertains to significantly reduced store traffic will result in a higher penetration And we believe this, along with the establishment of surcharges on the shipping of e commerce packages imposed by both UPS and USPS, will result in pressure on margins in the fourth quarter.

Speaker 0

Your next question comes from the line of Adrienne Yih of Barclays.

Speaker 7

Good morning. Everybody is well as well. Jane, a couple of questions for you. So holiday, obviously, everybody is talking about an earlier shopping experience by the consumer, more concentrated, perhaps a big change in Black Friday. Can you talk about how you are staffing the stores, planning store events, and planning the inventory flow, so for holiday?

And then number two, could you also give us an update on the Gymboree aspect and the launch therein? And then, Mike, just a couple of housekeeping questions. I assume you're seeing the ATV size go up, baskets go up on a fewer shopping, you know, encounters. And then on merch margin, I understand the the pressure on the gross margin from shipping, deleverage, etcetera. On the merch margin, given that you're expecting that you have less carryover inventory and you're expecting to build that inventory at the end of the third quarter, when do we see merch margin flat or the positive inflection?

Thank you very much.

Speaker 2

Sure. Okay. Well, let me start off. As far as Gymboree is concerned, the response to each new Gymboree collection that we've put out there has been very positive. It's still a small part of the business.

We significantly deemphasized the amount of dressy product that we placed in the back half of twenty twenty, particularly for holiday due to COVID-nineteen. And as we know, holiday dress up is a key part of the Gymboree business. So we're not anticipating to see a big pop there. But they're very happy with the deliveries we have had. The feedback continues to be good from mom, and we'll be introducing mostly casual collections in early September.

From a children's place point of view, from an inventory point of view, to start with that, with holiday, we did a significant, significant pullback on dresses and dress up product when we placed our holiday buy in anticipation that COVID-nineteen would continue and that social get togethers would be minimized. So that is, I think, a positive. Certainly from a margin point of view is that it's fashion product and with a higher AUR. So that's a significant pullback. I think from just looking at Q4, we are being extraordinarily cautious as we think about Q4.

We think that, as you mentioned, that the promotional environment will, be heightened. It will be sustained throughout the entire quarter. We think that the holiday sales will start earlier, as retailers try to spread the demand out, if you will. There is definitely a customer aversion to shopping in store. And I think that there is going to be significant pressure on Black Friday that might not be well understood right now.

I think you're hearing a lot of people say that they're going to close on Thanksgiving, which we are as well. But I don't think that they've really addressed Black Friday itself. We anticipate that there will be a significantly reduced Black Friday event. We're not even sure if there'll even be a traditional in store Black Friday this year. Certainly, appropriate to have doorbusters and driving large amounts of traffic into the store.

And we think families will be very reticent to pack the malls on Black Friday and in some of those big December weekends. So we think that's definitely a jeopardy from a store's point of view. You certainly have the freight surcharges that Mike spoke about. So you're looking at an unnaturally high percentage of online business in Q4. And that has been a growing percent of our business.

But like I said, it's going to be an unnaturally high percent of our business. So the freight surcharges are going to hurt there on the margin lines. We don't know about COVID spikes or are there going to be more temporary store closures throughout Q4. And then you throw on top of it the uncertainty around the presidential election. Just overall proceed with caution.

Speaker 3

And just from a merchandise margin perspective, our merchandise margins in the second quarter were pretty much in line with our expectations. They were just down slightly and they were predominantly driven by the 98 stores that we liquidated and closed in the quarter along with a higher penetration of ecom compared to last year. Margins actually merch margins actually increased in our ecom business in the second quarter. In the third quarter, our point of view is that we can continue to see slightly elevated merch margins for both our retail and ecom business. So when you look at the penetration of ecom, we anticipate that it will be higher than where it was a year ago.

So that could slightly dilute the merch margins overall. And then from an inventory perspective, I did indicate that the build was in uniform and basics. And at this point in time, as I mentioned, we do not have any plans to mark that down and we'll leave that at our normal selling price as we continue on through the quarter.

Speaker 0

Your next question comes from the line of Jay Sole of UBS.

Speaker 4

Great. Thank you so much. I just want to ask you about one of your competitors who caters more to an older female is closing a whole lot of stores. Can you just talk about how that's impacted the business lately? More importantly, do you see an opportunity to perhaps take market share after those stores are gone when you look into next year?

Thank you.

Speaker 2

Sure, Jay. I assume you're talking about Justice. So as far as Justice is concerned, they had eight twenty eight stores. And their strategy was to liquidate seven ten of those stores or 86%, which would leave them with 118 stores and a website. All of those seven ten liquidations are complete as of last week.

So that liquidation is completely behind us From a co located perspective, we were co located with four sixty four of those Justice stores or 56% of the stores. And of those four sixty four stores, three eighty eight of them are now liquidated, which is 83 of them, leaving us with 76 remaining colocations. From a market share point of view, obviously Justice was focused on the size four to twenty girl, which has a major overlap with us, particularly in the four to ten age range. And their market share in 2019 the total market share in zero to 10 in 2019 was about $26,500,000,000 and they were 1.7% of that.

Speaker 0

Your next question comes from the line of Paul Lejuez of Citi.

Speaker 8

Hey guys, thanks. Just curious if you could talk about the cost to get out of some of these stores, maybe the ones that you've already closed in first half, what you've got coming in second half and what you've got on the way in F 'twenty one? And then can you also talk about the stores that remain open? Are you trying to work down rent rates? Please talk about any success that you might be having on that front.

And also just totally separate, could you just remind us average basket size online versus in stores and what your return rates look like online versus in store? Thanks.

Speaker 3

From a fleet perspective, we've built tremendous flexibility into the portfolio. And we have basically leased about 65% of our fleet has lease actions by the end of twenty twenty one. We have about 35% lease events happening in the remainder of 2020 and about 30% happening in 2021. Further to this, we have built in co tenancy protections that we've negotiated in roughly half of our store leases. So that gives us a further opportunity to potentially close doors or leverage further rent reductions.

From an average basket size, we've seen the average basket size from an e commerce perspective continue to increase through the second quarter versus a year ago. And from a return rate perspective, we're in the low single digits as far as returns go.

Speaker 0

Your next question comes from the line of Susan Anderson of B. Riley.

Speaker 2

Hi, good morning. Thanks for taking my question. Jane, I'm just curious on the uniform sales. I think a lot of private schools are going back or at least a hybrid model. I'm just curious if you've seen any less pressure there versus your regular back to school product.

And then I guess in the first half looking out to the back half, I know you planned down the back half inventory. Just curious how much you originally did plan back to school down? And were you originally planning on schools returning to in person learning? And then also, was curious if you were able to mix in kind of more of a casual or basic assortment for back to school that's more conducive to the at home environment? Thanks.

Sure. Thanks, Susan. From a back to school perspective, to start with inventory, where we pulled back was fashion for back to school. And again, just like we did for holiday, we got out of a lot of the dress up product for like first day outfits and things like that so that we could protect the margin. As Mike has mentioned a few times on the call this morning, the product that we're carrying is basic driven and so it's not a margin risk.

It's not going to be product that we're going to liquidate. We're going to sell that product when the catalyst for back to school comes. Just as an aside, I'd like you guys to know that we don't anticipate that there will be a catalyst to drive back any back to school meaningful business until spring twenty twenty one at the earliest. So we're not looking for anything to happen in the later half of the year or in fourth quarter to drive back to school sales. We think that's a spring twenty twenty one event at the earliest.

As far as, holiday product is concerned, we had not placed holiday product at the start of the pandemic, so we were able to pull way back, as we mentioned earlier, on the dress up product, and we are able to focus on activewear and casualwear across our age ranges and our sizes. And we also have a major, major push this year, which you can see online around sleepwear and particularly holiday sleepwear, which is off to a very, very strong start. So we put a lot of money behind sleepwear and a lot of money behind holiday sleepwear in particular. From an in person learning, versus remote versus hybrid, I'd like to just run you guys through how we came up with what, our percentages are. We went out to every one of our stores and we went out to every one of our states and every one of our cities and canvassed every one of our store managers starting about six weeks ago.

And we get a daily update on that. And really what it's based on is like I said, every state and then every major city within every state. And what we've come back with is that 40 as of yesterday, 47% of our markets are virtual, 35% are a hybrid model, 11% are Parent's Choice, and that Parent's Choice is either virtual or a hybrid. Parent's Choice does not include going back full time in person. So we've got 93% of our markets in either virtual, hybrid or Parent's Choice.

We have in person at 4% of our markets, and we have TBD at 3%. And that TBD includes Boston, Rhode Island, all cities, and then some three cities in West Virginia is really what we're down to on the TBD. As far as your question about uniform, most of our stores are a lot of our stores are located near major cities, and a lot of inner cities. And those schools, are very much uniform based schools and require uniforms. And as I said, 93% of our markets are either in virtual or hybrid, which is, having an obviously significant impact on our sales.

When you look at Canada, we're at almost 90% in person learning. And when you look at our business there, as Mike mentioned, down only single digits, it's a very different story up there with how we're selling back to school product.

Speaker 0

Your next question comes from the line of David Buckley of Bank of America.

Speaker 8

Morning. Thanks for taking my questions. Mike, how should we think about SG and A levels in the second half of this year? And then just given your cash burn increase in the second quarter, can you discuss your outlook for cash flow in the third quarter? And with your current liquidity position, is there a need to increase your borrowing capacity?

Thanks.

Speaker 3

Sure. So from an overall SG and A perspective, we continue to look at our structure both from a corporate perspective and a store perspective. And we expect that SG and A in those two buckets of payroll from stores and corporate will continue to be down in the back half just like they were in the first half. We also think that as we look at some of the activities that we're doing around external consultants, etcetera, we expect to have some savings on that line also. Just to note though, in the third and fourth quarter of last year, we had some incentive compensation that we did a couple of reversals of accruals for our long term incentive plan.

So that's going to come into place in the second half of the year versus the savings that you're seeing in the first half. But we do expect SG and A to be lower in the third quarter compared to where it was a year ago. From a liquidity perspective, as I mentioned, we used about $43,000,000 in operations versus last year where we had two. For the first half of the year, we basically used about $83,000,000 in cash, roughly about $100,000,000 difference compared to where we were a year ago and where we were in the previous year. Our expectations are that we're going to end 3Q at a similar cash and ABL level and we will generate cash in the fourth quarter.

So we think we'll end the year in a better position than we ended the second quarter.

Speaker 0

We have time for one more question. Your final question will come from the line of Marni Shapiro of The Retail Tracker.

Speaker 9

Hey guys. I have a couple of quick ones and then Jane maybe one broader one. Would you guys consider shipping hurdles to offset some of the costs to shipping for the back half of the year especially around holiday because you have free shipping usually? And could you just confirm the conversation around favorable AUC in 2021? Is that reflecting a decrease in demand generally and so, the ability to negotiate with the factories?

Speaker 2

Yes. I think we've been had AUC tailwinds for the last couple of years and particularly with looking into 2021 with the demand where it's going to be in light of all the bankruptcies and uncertainty around COVID. We're already seeing a favorable AUC environment for 2021. And that's why we thought it was obviously very important, for us to work through our inventories and our spring inventories, so we wouldn't be carrying them on the balance sheet or sitting in overseas factories. So we'd be able to provide our vendors not only with continual order flow, but also to take advantage of that AUC environment.

From a shipping point of view, we have no intention of changing our free shipping. I think that certainly our customer is under pressure with everything that's going on. It's a major competitive advantage of ours. It has allowed us to grow our digital business exponentially over the years, and we have a very high basket. So we don't really see an issue there.

Obviously, these surcharges are UPS is taking advantage of the situation that they can take advantage of, and so we're going to have to live with that for Q4. And hopefully, we will figure out as we get into 2021 how to mitigate that.

Speaker 0

Thank you for joining us today. If you have further questions, please call Investor Relations at (201) 453-6693. This does conclude The Children's Place second quarter twenty twenty earnings conference call. You may now disconnect your lines, and have a wonderful day.