The Children’s Place - Earnings Call - Q3 2021

Transcript

Speaker 0

Good morning and welcome to The Children's Place Third Quarter twenty twenty Earnings Conference Call. On the call today are Jane Elfers, President and Chief Executive Officer Mike Scarpa, chief financial officer and Rob Helm, senior vice president, finance. The Children's Place issued its third quarter twenty twenty 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 speakers' remarks, there will be questions as time allows. Before we begin, I would like to remind participants that any forward looking statements made today are subject to the Safe Harbor statements found in this morning's press release as well as in the company's SEC filings, including the Risk Factors section of the company's annual report on Form 10 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. It is now my pleasure to turn the floor over to Jane Elfers.

Speaker 1

Thank you, and good morning, everyone. Our back to school sales were significantly impacted by the move to remote and hybrid learning models across the country in response to the COVID nineteen pandemic. Post the back to school peak when our assortments converted to more casual options and the weather turned cooler, our sales improved. And for the quarter, we returned to profitability and generated positive cash flow from operations. Starting with our accelerated digital transformation.

Increased digital adoption accelerated by COVID nineteen and supported by our digital transformation and omnichannel initiatives continues to drive online sales to an increasingly greater share of our overall sales. Digital sales accounted for 44% of our q three sales, and year to date, digital sales represent 55% of our total sales. Importantly, our continued digital growth is coming from both existing and new customers. Since March, we've increased the number of new digital customers versus last year by approximately 100%, converted over 800,000 store only customers to omnichannel customers, and increased our mobile app downloads by over 60%. The customers' accelerated shift to digital provides The Children's Place with continued market share opportunities as we leverage our recent digital transformation investments and our foundational personalization of initiatives to continue to acquire new customers into our omnichannel ecosystem.

Moving on to our accelerated store closure plan. As we close stores, a key measure of the success of our digital transformation and fleet optimization strategies is our ability to retain, transfer, and convert our store only customers to ecommerce and omnichannel customers. Our ecommerce and omnichannel customers are our best customers. They shop with us more often and spend approximately three times more than our non omnichannel customers. Today, we have some very important metrics to share with you regarding our customer transfer rates.

Year to date through the September, which allows for one year of post store closure tracking, our transfer rate has increased to 31% versus our full year 2019 transfer rate of 20%. This substantial transfer rate increase further reinforces the decision we made back in March to significantly accelerate store closures by giving us even greater confidence in our ability to continue to shift a substantial portion of our stores revenue to our digital channel. Looking ahead to Q4, we're approaching the fourth quarter with heightened caution and expect both sales and profitability to be under pressure due to the numerous headwinds created by the pandemic, The meaningfully reduced demand for dress up product, significantly reduced store traffic, the recent nationwide spikes in COVID nineteen cases resulting in additional temporary store closures, social distancing requirements, and reduced mall operating hours. With respect to our digital business, to ensure on time holiday delivery, we have already been advised by our major carriers to move our standard shipping cutoff up by three days from our original date of 12/18 to 12/15 due to the capacity constraints across the domestic transportation network. In addition, the related freight surcharges imposed by our major carriers will put additional pressure on ecommerce margins during the quarter.

Lastly, and most importantly, our business model is driven by occasions and events in the lives of our customers. Historically, the multiple holiday events that occurred during q four made q four the highest sales quarter of the year, similar to the significant negative impact we experienced from the lack of an Easter or a back to school catalyst, we are experiencing the same negative impact from the lack of holiday dress up catalysts. We reduced our dress up receipts at the time of the holiday buy last April, but we now expect q four to represent historically low demand for dress up product. This is due to the pandemic driven cancellation of nearly all school related social events, including in person holiday parties, parades, concerts combined with the holiday season that provides for limited socializing through strict social distancing requirements, limited family gatherings, and mandated cancellations of large in person social events. While we continue to manage through the many short term challenges brought on by the pandemic, we remain focused on the opportunities.

We estimate that the pandemic has accelerated our long standing transformation strategy by approximately five years with respect to store closures and digital penetration. The good news is that due to the accelerated investments we made in digital transformation prior to the pandemic and the work we had done on fleet optimization over the past decade, we were prepared. We believe that our focus on scaling our digital transformation investments and accelerating store closures, further bolstered by our increased sales transfer rate, positions the company for accelerated operating margin expansion in a post COVID environment. And now I'll turn it over to Mike.

Speaker 2

Thank you, Jane, and good morning, everyone. I'll start by reviewing our Q3 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 insight on how we are approaching the fourth quarter. Starting with our Q3 results.

In the fiscal third quarter, we returned to profitability, generated positive operating cash flow and delivered adjusted EPS of 1.44 Net sales decreased approximately 19% to $426,000,000 versus last year's $525,000,000 Our sales for the first five weeks of the quarter were significantly impacted by a decrease in back to school sales across all channels due to schools adopting remote and hybrid learning models. From the August through Labor Day, we dropped over 40% in total net sales. Sales were also negatively impacted by the 151 permanent store closures during the past twelve months, as well as the extended temporary store closures in New York and California, which impacted 52 stores for a significant portion of the quarter. Immediately following Labor Day, when we passed the peak back to school selling period, our assortments converted to more casual options, the weather turned cooler, and our sales improved. After we passed the peak back to school selling period, we experienced productivity at over 90% of last year's levels for our stores that reopened.

Post Labor Day, our e commerce channel rebounded and saw sales increase of approximately 20%. Despite the negative impact from back to school, e commerce penetration increased to approximately 44 of total net sales. Our US sales decreased approximately 20% versus last year, while Canada sales only decreased approximately 5%. Canada performed better than The United States due to almost 90% of Canadian schools utilizing 100% in person learning. Adjusted gross margin.

Adjusted gross margin decreased two ten basis points to 35.7% of net sales, a significant improvement versus the margin declines we experienced in the first half of the year. Merchandise margin expanded in the quarter in both the digital and stores channel. The overall gross margin decrease was the result of the increased penetration of our e commerce business, which operates at a lower gross margin and the deleverage of fixed cost due to lower sales. Adjusted SG and A. Adjusted SG and A was approximately $104,000,000 versus $117,000,000 last year and deleveraged two ten basis points to 24.3% of net sales.

The two ten basis point decline was a result of the deleverage of fixed expenses resulting from the decline in sales and higher incentive compensation accruals, partially offset by a reduction in store expenses resulting from our permanent store closures as well as a reduction in operating expenses associated with actions taken in response to the COVID nineteen pandemic. Adjusted operating income. Adjusted operating income for the quarter was $33,000,000 versus operating income of $63,000,000 last year and deleveraged four and thirty basis points to 7.8% of sales. Tax rate. Our adjusted tax rate was 30% versus 23% last year.

Moving on to the balance sheet. Our cash and short term investments ended the quarter at $64,000,000 as compared to $36,000,000 in Q2. We ended the quarter with $179,000,000 outstanding on our revolving credit facility compared to $251,000,000 outstanding on our revolving credit facility in Q2. The decrease in the revolving credit facility and the increase in cash was due in large part to the $80,000,000 term loan financing we completed in the third quarter as well as our positive operating cash flow. The term loan provides us with additional capital and further strengthens our financial position and provides us with increased financial flexibility.

We ended the quarter with total inventory up 9.7% versus last year, driven by sales declines in key back to school categories, which accounted for the entire increase in inventory. We will continue to carry this inventory to support back to school demand whenever schools can safely reopen for in person learning. This product is basic, saleable, go forward product that is visible in our stores and on our website. Our seasonal carryover inventories are down approximately 45%. Moving on to cash flow and liquidity.

We returned to positive cash flow in Q3 and generated approximately $32,000,000 in cash flow from operations as compared to $77,000,000 in cash generated in Q3 last year. Between our cash position and revolving credit facility, we have ample liquidity to support the needs of our business for the foreseeable future. Capital expenditures in Q3 were approximately $9,000,000 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 16 locations in the quarter, which brings our total store closures to 118 for the first three quarters of fiscal twenty twenty. As e commerce demand has accelerated year to date, we have seen a significant migration of our store only customers converting to omnichannel customers, supported by the meaningful increase in our transfer rate.

This data gives us continued confidence in our accelerated store closure plans, where we are targeting 300 store closures between fiscal twenty twenty and 2021. We remain on track to close 200 store locations in fiscal twenty twenty, which includes the 118 locations closed during the first nine months of the year. The roughly 80 remaining closures are targeted for a January closure post holiday. We are targeting a 100 store closures at the end of fiscal twenty twenty one, which will result in a store fleet of approximately 625 locations entering fiscal twenty twenty two. By the end of fiscal year twenty twenty one, we will have reduced our reliance on our brick and mortar channel, resulting in a leaner, more profitable store footprint.

This will position us to enter fiscal twenty twenty two with 75% of our total revenues generated outside of traditional malls. Outlook. Due to the continued level of uncertainty in the current business environment, we are not providing EPS guidance for 2020. However, we will provide our current thinking as to the pandemic's potential impact on our business in Q4. Based on the numerous headwinds Jane outlined earlier on the call, combined with the impact of the 151 permanent store closures over the past twelve months, we would expect Q4 net sales to be at or slightly lower than Q3 levels.

Due to the pandemic, gross margins will continue to be under pressure in Q4. In addition to the factors that resulted in a two ten basis point decrease in Q3, there are two additional factors that will further deteriorate gross margin. One, we anticipate roughly 150 basis points additional gross margin dilution in the quarter due to incremental freight surcharges and capacity constraints from our major carriers. And two, we also anticipate that store closures and the related inventory liquidation will reduce gross margins by roughly 50 basis points, similar to what we saw in our Q2 when we closed 98 stores. We expect SG and A dollars to be moderately lower than last year.

As a reminder, SG and A was reduced in Q4 last year by the reversal of an incentive compensation accrual, which represents a headwind of approximately $10,000,000 or 200 basis points to the current year expense base. Inventory levels will remain elevated due to the back to school and basics product that we do not plan to liquidate and that we will continue to carry to support back to school demand for whenever schools can safely reopen for in person learning. We expect to continue to generate positive cash flow from operations in q four. Lastly, for 2021, we believe that we will be able to take advantage of what has been a favorable AUC environment so far with respect to orders, driven by lower input costs and excess manufacturing capacity. 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'd 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 3

Good morning everyone and certainly nice to see the progress. Jane as you think about post back to school season and the pickup in sales that you saw, any difference in terms of categories that you saw? What you saw digital and online? Was the average order value different? And how are you thinking about planning for the 2021 given the holiday season?

Is it uncertain as we've ever seen it? Thank you.

Speaker 1

Sure. Thanks, Dana. On q three first, to start there, you know, as predicted, we didn't see a meaningful improvement in those key back to school, categories post Labor Day. When you when I refer to those categories, I'm referring to things like polos and uniforms. You know, they just didn't pick up.

We didn't see a meaningful improvement in we didn't see a meaningful improvement in, you know, 100% in person learning either. We as I think we had mentioned on the last call, we don't see a significant catalyst for these key back to school categories until really back to school '21. You know, these these vaccines aren't approved yet, and they're not planned to be widely distributed probably until late spring or early summer. So we don't think it's prudent from our side to plan, you know, a meaningful return to in person learning prior to that time period. Having said that, you know, we did see some big positives post the back to school peak.

Notable categories would be anything knit, anything we have that knits, graphic tees, long sleeve knits, leggings, you know, anything active. Anything that's cozy and comfortable really, really spiked post Labor Day. And in addition, our outerwear business really turned on when the weather got colder. Also, sleepwear. I think we might have mentioned sleepwear on the last call.

We made a really, really big bet on sleepwear last year when we placed it. And that decision has proved to be a very good one, especially considering, you know, the impact of the pandemic and how kids are addressing. So that has really been a shining star in our business since it hit in Q3 and then certainly into Q4. Obviously, we're hoping someday sooner versus later kids get out of their PJs and go back to school and start living their lives again. So without giving away any trade secrets, I can safely say that we'll not be relying in the back half of next year on sleepwear to drive our business.

I guess the second part of your question was how are we thinking about the first half of 'twenty one? We don't have a crystal ball. Obviously, there's good news out there as far as these vaccines are concerned. So hope is on the way. But as we said, we do not see a meaningful return to school until next back to school.

And I would also tell you that we were very, very conservative when we placed Easter, because we were, you know, much deeper into the pandemic by then. And, you know, the talk was really not to, you know, assume that there would have been really a return to normalcy in the first quarter. So we think that we'll definitely have, you know, smaller business in in q one with respect to dress up product, and then I think we'll start to see things hopefully open up as we get into q two of next year. You know, what I would tell you is, you know, to give you guys some insight of kind of how we think of the whole thing. As it relates to our business, you know, the good news is that we as we mentioned in the prepared remarks, that the the pandemic has accelerated our transformation strategy really by five years.

When you look at where our digital is penetrating right now, and when you look at the amount of store closures, 300, that will be done, you know, in the next fourteen months or so. And then the other good news, which we really haven't really talked about, is that it's also accelerated, our competitors', liquidation through, massive store closure programs and and bankruptcies. And the positive to that for us is, not having to live through, drawn out liquidations and store closures for the next several years. A lot of that is getting behind us this year, which is, you know, not something we expected to happen in such a compressed time period. And I think when you take, you know, you take that in mind and you remember that our core customer is the dream customer.

You know, currently, she's a millennial, but very soon, she's gonna be Gen z. And after that, she's gonna be always the most current kinda desirable sought after customer there is due to the fact that she never ages. And then when you think about that, you know, the majority of our customers grew up wearing our clothes. So we don't have those relevancy burdens some of the other retailers have. You know, she already knows us.

She already loves us, and she already trusts us. So, you know, we've got ample liquidity. We're gonna get through the pandemic and the short term pain that comes with it, and we're gonna stay focused on the store closures and the e com acceleration. And when the virus is gone, hopefully, in the first half of next year, we're gonna merge with a vastly reduced brick and mortar present present, you know, a market leading penetration in digital. We're 55% year to date, which I don't think is anyone can come close to that.

We're gonna have a much smaller competitor base much earlier than we thought, which are gonna drive market share opportunities also earlier than we thought. We will have done a ton of work on rightsizing our p and l. And, you know, importantly, we can't forget, we're gonna have a second chance to effectively launch Gymboree. And I think all of this is really positioning us to drive accelerated operating margin expansion starting in the back half of twenty twenty one.

Speaker 0

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

Speaker 4

Hi. Sorry. Thanks for taking my question.

Speaker 1

Sure.

Speaker 4

You mentioned that the sheer opportunities. Yeah. I think last quarter, you mentioned Justice, there wasn't a significant overlap for back to school from a product standpoint. You know, what do you see in kind of post back to school in terms of potential market share gains from Justice? And and what do you expect, you know, for for holiday in terms of market share opportunity?

Speaker 1

Yeah. Thanks. Thanks, Jim. I think from a justice point of view, you know, they're down to 85 stores now where 59% of them were colocated, and they announced they plan to close all of them post holiday. So that really is you know, they were 800 or nine hundred hundred stores.

So that is a major opportunity for us. It's on the girls' side of the business. It's in the older side of the business, you know, sizes four to twenty, which is really our sweet spot, and a lot of their business is driven off knits and and dress up type product as well. So I think we do have a big opportunity there. They were 1.7% of the market share in 2019, about a $450,000,000 business.

So I think that we can pick up a good share of that in the stores that will be remaining as we exit '21 with 125 locations. A lot of those will have been locations where Justice was. And I also think, you know, there's a big online opportunity there as well on the girl side of the business in those categories, like, dress up and knits. They didn't really have a big business in, you know, key item basics. You know, that wasn't their thing, uniforms, polos, things like that.

So it's really coming out of the more casual categories.

Speaker 0

Your next question comes from Adrienne of Barclays.

Speaker 5

Good morning. Nice nice work on the progress from my from our side as well. Jane, I was actually wondering if you can actually delve a little bit deeper into the Gymboree commentary. And then for Mike, on the merch margins or the gross margins, can you give us some color into the three components of it, the merch margin expansion and the pressure from e commerce? And then the kind of components of what creates deleverage, the deleverage, where is your breakeven on that kind of broad line or the fixed cost gross margin line?

And then if we kind of drill down on that, I know you've talked about e commerce actually being off margin, EBIT margin accretive. So I think more importantly, as you shift to e commerce, that's what we really want to know, the dynamics of how much accretion we can expect from e commerce. Thank you.

Speaker 1

Sure. Thanks, Adrienne. I'll take the Gymboree part, and then I'll hand it back to Mike. You know, we we all talked about it a lot that Gymboree launched three weeks, you know, prior to the pandemic. Gymboree is a built business that, like no other, is built on occasions.

So every special occasion in our young customers' lives is what that business is built on, and we have not obviously had that catalyst. So we didn't have the catalyst around Easter time. We weren't able to celebrate fourth of July and parades, and we certainly weren't able to celebrate Halloween. And now a very important quarter in their history is really dress up and and all the holiday catalysts that come during q four. So mom is is extremely loyal.

She is really loving our products still, so we feel very strongly about that. We are getting very positive reactions from her on social media. I think we mentioned on the last call that we launched underwear. We launched Jimmy's, which was extremely well received, both of those. And really, what we're looking through is we're looking through, you know, q one again of next year because we're not planning on having a a robust Easter business in in TCP or Gymboree, and we're really looking to the back '21 to kind of, quote, unquote, relaunch Gymboree.

We still believe in it as much, if not more so, than we did before we launched it because now we have the credibility from mom that we hit the product, you know, we hit the nail on the head with the product. And, you know, we've learned a lot. We have made some adjustments in our assortments, based on her response to the response to selling and also to her commentary. And I think we had mentioned before that we thought it was eventually a $140,000,000 opportunity. So nothing has changed as far as our confidence in that brand.

Speaker 2

And from a gross margin perspective, you know, we saw merch margins up in both, our store channel and our e commerce channel probably to the tune of about 100 basis points or so. So meaning that our e com penetration and the leverage on fixed expense was slightly in excess of about 300 basis points. As you think about the fixed component in our gross margin, the key is the occupancy line, which is the biggest number there. And that continues to be refined and adjusted as we continue to shut stores and negotiate with our landlords. So at this point, I'm not comfortable giving any type of like a formula out in terms of how think about deleverage of fixed based on penetration, just based on that occupancy fluctuation.

Speaker 0

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

Speaker 6

Hi, guys. Good morning. Mike, just to clarify, on the fourth quarter gross margin, are you planning for merch margin expansion there? And then just on the e comm channel in the third quarter, it looks like your growth slowed a little bit versus the first half of the year. Was there anything specific supply chain wise or otherwise in terms of headwinds to the channel this quarter and anything that would potentially carry over into the fourth quarter?

Speaker 2

From again, from a gross margin perspective for the fourth quarter, we indicated that in addition to the factors that took place in the third quarter, which was a positive merch margin, ecom penetration into leverage of fixed, that we have that roughly 150 basis points in additional gross margin dilution due to the freight surcharges and some capacity constraints from our major carriers. Also, as we experienced in Q2 of this year when we liquidated 98 stores, obviously, we have about 80 plus stores that we We liquidate in the fourth expect gross margin dilution of roughly 50 basis points. So yes, we are expecting positive merch margins in q four.

Speaker 1

And then the only thing I'd add to that, David, is on the e commerce channel. We mentioned in the prepared remarks that, you know, the major carriers have already advised us to move that shipping cut off by three days, which we're doing. So that will certainly impact on ecom.

Speaker 2

Yeah. And we didn't really, from an ecommerce perspective, and post back to school, it was the tale of two cities because we were down 20% and basically because there was no demand for for our back to school clothing. Post Labor Day, though, as we shifted to more casual merchandise and weather got a little cooler, we saw our ecom business snap back very nicely up into the 20s. So we're pretty pleased overall with where we ended up on ecom.

Speaker 7

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

Speaker 3

Hi, good morning. Nice job on the progress in the quarter. Guess just to touch a little bit more the ecom margin, Can you talk a little bit about the operating margin differences between the stores? Is it still is ecom still higher on the op margin line, I guess, versus the stores even with the higher shipping? And then as you look to use your 3PL in fourth quarter, are you expecting a significant impact from ship from store at all?

Speaker 2

Yes. So year to date, ecomm is still accretive to our operating margin, and we continue to expect it to be accretive into the future. Obviously, we're seeing some freight surcharges built in, in Q4, but we still expect overall margins to be accretive in our ecom business. From a radio perspective, we'll be utilizing them in Q4. They'll probably represent close to 40% or so of the demand that we need to ship for Q4.

And we would expect ship from store to be at a normalized rate, which is, call it, in the high single digit range in terms of shipping for demand.

Speaker 7

And our last question will come from the line of Marni Shapiro with Retail Tracker.

Speaker 8

Hey, guys. Congrats on the progress here. Pretty impressive considering we didn't have back to school. Can you just talk can you talk a little bit, I know you have relatively low returns, and I'm curious if you've seen that change at all with the significant shift online. And if you could also talk about just the the habits of your customer online as far as average basket or, you know, transaction size and how frequently she visits online versus in store not in store today, in store in the past, I guess.

Speaker 1

Yeah. Well, as we well, first of all, on the returns, no. We have not seen, an increase in returns, which is, you know, a huge positive to our brand. We've always had a very low return rate, and to continue to see that with the outsized digital increases we've seen is, you know, certainly a positive to the p and l. As far as visiting online, we have seen higher units.

We have seen higher transactions from our customers. Our traffic has been very, very strong since the beginning of the pandemic, and we've had very, very strong conversion metrics, online as well. I think all this bodes, you know, well for the foundational changes that are happening into 2021. But what we're doing now is a lot of work as far as keeping these new customers who have come into our digital ecosystem. We need to keep them.

As we mentioned, we picked up a 100 over last year in new customers, and we converted 800,000 of our store only customers. So a big focus is retaining all those new digital customers that we've acquired since the onset of the pandemic. The timing, works really well for us. You know, we've talked about our digital transformation a lot, and we have the tools in place now to welcome these customers into our brand and, importantly, the tools to engage and retain them. So over the past year, we've, been working very hard to, really get, if you will, behavioral and life cycle data into our messaging.

So we've enhanced segmentation. We've added purchase activity. We've launched dedicated email program, with curated product. We've launched a new trigger program, which is working really well for us, that targets the customer. I think we talked about it in the last call.

Potentially, it targets the customer at every stage of their life cycle with respect to brand and the purchase funnel. There's seven stages. You would have heard of most of them, you know, abandoned cart, abandoned browse, welcome, tune in, step up, COI, you know, confirmed opt in, and there's 266 touch points across it. So it really brings in all the foundational, capabilities that we've invested in and been working on. So we feel really, really good.

You know, we're now armed with a 31% transfer rate, which is just huge, huge positive for us and a really exciting metric. And we feel like we have the tools in our toolkit to to keep these customers long term as we continue to, ramp up and accelerate this digital transformation.

Speaker 7

Thank you for joining us today. If you have further questions, please call Investor Relations (201) 558-2400 +1. This does conclude The Children's Place third quarter twenty twenty earnings conference call. You may now disconnect your lines and have a wonderful day.