The Children's Place, Inc.
Q2 2019 Earnings Call Transcript

Published: 21 Aug 2019

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to The Children’s Place Second Quarter 2019 Earnings Conference Call. This call is being recorded. If you object to our recording of this call, please disconnect at this time. It is now my pleasure to turn the floor over to Anthony Attardo, Director of Investor Relations, to begin.

[Anthony Attardo:]

Good morning, and welcome to The Children’s Place 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 press releases earlier this morning, and copies of the releases 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.

[Jane Elfers:]

Thank you, Anthony, and good morning, everybody. Today, I’ll provide an update on three strategic areas of focus that uniquely position us to capture a greater share of the estimated $600 million of sales ceded each year by poorly positioned competitors. First, I’ll discuss our progress with respect to the Gymboree integration, and offer a deeper dive into our Gymboree brand strategy. Second, I’ll update the status of our digital transformation. And third, I’ll discuss our competitive pricing advantage. So first, let’s start with Q2 results. Despite the adverse impact from weather comparisons and the likely pull-forward of demand into Q1’s liquidation of approximately 800 Gymboree and Crazy 8 stores, our EPS results were at the top end of our guided range. Amidst lingering pressure from the Q1 Gymboree liquidation, we delivered a 3.8% comp decrease in Q2 versus a 13.2% comp increase last year. Sales for the quarter met our expectations, however, traffic remained weaker than anticipated, which led to a late quarter increase in promotional activity across the sector. Although we exited the quarter with seasonal carryover inventory down double-digit, we believe it’s prudent to assume an elevated promotional environment for the back half of 2019. Shifting to the Gymboree integration. A key component of our ongoing strategy to uniquely position ourselves to secure a greater portion of the estimated $600 million of annual sales, ceded by the group of children’s apparel market share donors, is our focus on relaunching the Gymboree brand in spring 2020. In late June, we relaunched the Gymboree website, which was immediately well received by the passionate Gymboree customer base. The loyal Gymboree moms instantaneously found their way to the site and traffic and engagements by meaningfully on social media with visits and commentary surging post-launch.

[Mike Scarpa:]

Thank you, Jane, and good morning, everyone. Today I will provide an update on our fleet optimization, and our international and wholesale businesses before reviewing our financial results in our outlook. First, an update on our fleet optimization. We closed 13 locations in the quarter, resulting in 226 overall closures toward our plan to close 300 locations by the end of 2020. Through the second quarter, we have closed 15 of the 40 to 45 planned store closures for 2019. We also opened three locations in the quarter as part of the 25 stores we plan to open in highly productive centers over the next two years based on our detailed analysis of Gymboree store sales. It is important to note, we will continue to be a net closure of stores. Our real estate team continues to strategically limit our exposure to the troubled outlet channel, and we ended the quarter with outlet exposure that represents only 13% of our store base. Our fleet optimization strategy has resulted in a highly optimized outlet store base with nearly two-thirds of our outlets in better centers and only four stores located in what we classify as dying outlet centers. We strategically limited our outlet exposure and optimized to the most productive centers, knowing that the outlet channel was particularly at risk of cannibalization from digital growth. The outlet channel was born out of a need to give the consumer direct access to brands and providing her value in doing so. Today, the consumer can easily find that access in those values online where we maintain a strong position. We believe that we – that by limiting the risk, by maintaining a full price to outlet store ratio at nearly seven to one, which is among the highest in our peer universe, with several of our competitors closer to two to one, which means that 30% to 40% of their store base remains in outlets. This provides us with a meaningful competitive advantage. International and wholesale. In wholesale, we are soliciting interest among both existing and potential new wholesale partners in anticipation of the Gymboree brand relaunch, with the intent to possibly provide exclusive access to the Gymboree brand. We believe that the Gymboree brand will provide potential partners with a steady flow of highly coveted millennial traffic, which is difficult to find in today’s retail environment. Additionally, Gymboree represents a highly attractive demographic with an average income of over $95,000 per year. We’re excited about the wholesale potential for the Gymboree brand and look forward to providing additional updates. We opened 18 new international points of distribution in the quarter, and had 225 international points of distribution in 19 countries, opened and operated by our eight franchise partners at quarter end.

[Operator:]

Thank you. Our first question comes from the line of Dana Telsey of Telsey Advisory Group.

[Dana Telsey:]

Good morning, everyone. As you think about the integration of the Gymboree and you think about the gross margin in the upcoming third quarter, how are you thinking about gross margin go forward and the opportunity for market share gains that you see? And then just lastly, on the logistics issues, on that – where you just talked, Mike, about the shipping times. What are you seeing in terms of incremental supply chain and logistics costs and that impact on the margin? Thank you.

[Mike Scarpa:]

Sure. Dana, though we don’t specifically guide to gross margins. We expect margins to continue to be under pressure in Q3 as inventories remain elevated in the sector, which is resulting in a promotional environment that – we’re anticipating it’s going to continue through year end. The environment remains a competitive as retailers continue to battle for market share in a sector that is not growing. Though we expect improvement in margins in Q4 versus last year, we’re still forecasting continued pressure from those elevated inventories and store closures. As far as the distribution issues are – and supply chain costs, we had indicated last quarter that we did a pretty comprehensive network analysis and made the decision to utilize the 3PL to assist us beginning in holiday of 2019. We thought that this was the most cost-efficient and effective alternative available. We’re utilizing currently our ship-from-store BOPIS and the BOSS omni-channel fulfillment capabilities to supplement our DC capacity as we get ready to transition over to the holiday time frame. Our sense is that 98% of our orders from the back-to-school will season will be delivered within our 10-day shipping – 10-day business shipping window. We expect that supply chain cost could be on the average of about $1.5 million higher in Q3 based on some of the expedited shipping that we are doing. And then there’s just – I also want to indicate that from a systems perspective our systems are running fine, and we have not encountered any system snafu’s as a result of high demand.

[Operator:]

Our next question comes from the line of Jen Redding of Wedbush Securities.

[Jen Redding:]

Hey guys. I was just wondering if you can give some color quarter-to-date 14% comp, increase – is that then less promotional or is that then promotional driven, or – I’m trying to figure out if you just – cause it look to us like promotion’s kind of pullback. So maybe they have and do you think they’re just going to get more promotional if you could speak to that. And also, if you could tell us, if you’re able to say who the third-party shipping partner is? Thanks.

[Jane Elfers:]

Sure, Jenn. It’s Jane. As far as quarter-to-date comps, we said on the call in our prepared remarks that we are running up 14% quarter-to-date. I think it’s a result of our several factors. Number one, our inventories are very clean entering the quarter as we said our carryover inventories are down double digits. We have extremely strong back-to-school assortments that are focused on two key things, basics and Wear Now. If you look at our assortments on the floor, we pretty significantly pulled back on the longer sleeves product versus where we were last year. And we’re very, very much into Wear Now shorter sleeve product that’s more appropriate for the time frame and mom is clearly, responding to that. We have a strong marketing strategy in place, which is clearly working. And I think, overall, we can pretty clearly say that mom is choosing us for her back-to-school needs. I think it’s also important to recall that the 14% quarter-to-date consolidated comp that we’re running, the lion share of back-to-school and almost all of tax rate is behind us. We’re also up against a similar double-digit positive comp for the same period last year. So I think it’s even more impressive when you look it in on a two-year stack. I think from a promotional environment, what we’ve seen is – we were out early with our projections when we were looking at Q2. Post our call, lot of people came on talking about their inventories, which were kind of out-of-whack versus where their sales were. We still see from some of the people that we’ve heard from and anticipate we’ll hear from in the next couple of weeks that inventory growth is running ahead of expected sales growth in the sector. So I think for us, really the posture we’re taking is that it’s realistic and prudent to expect increase promos beyond Q2 based on the inventory levels of the competitive set and kids. And just honestly, I think we’d rather guide to an elevated promotional environment and be wrong. That’s really where we’re at right now.

[Mike Scarpa:]

And as far as our third-party logistics provider, we use – we’re utilizing Radial, who is also our third-party logistics provider in Canada, pretty well-established company with roughly 12 million square feet of warehouse and logistics capabilities. So we’re pretty pleased so far with the integration and looking forward to the holiday 2019 season.

[Operator:]

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

[Susan Anderson:]

Hi, good morning. Thanks for taking my question. I guess just a follow up on the promotional environment. I was curious where you’re seeing the most competition from? Is it within the mall, I guess from the department store, which I would suspect has elevated inventory or other specialty retailers? Or are you also seeing kind of the mass players get very aggressive in the kids business? And then also, I was curious, what your expectations are from merch margin in third quarter?

[Jane Elfers:]

Yes. I think from a competitive environment, it’s really coming from all three that you said. We’ve certainly heard specialty inventories were elevated, particularly people on their Q1 calls, forecasting into Q2. So we’ve seen inventory growth outpace sales growth from almost every one of our specialty competitors. We’ve certainly seen in the department stores but they don’t specifically call out kids. And from a promotional environment, the mass guides are obviously going after back-to-school in the big way as well. It’s a very important time period for everybody so promotionally out there, it’s aggressive. But I really just think the inventory spread is really what we’re looking at, and we just want to be realistic and prudent if not conservative into the back half of the year and just make sure that we’re really feeling good about our guidance and what we anticipate could be an elevated environment. Mike also spoke to Q4. There’s been some specialty stores that have announced significant amount of closures that will happen at the end of 2019, so we’ve taken that into account. And also as Mike said in October, we had an extremely strong October last year based on the pull up of cold weather. And we’re not anticipating in our guidance that, that weather pattern is going to mirror last year. So we really try to take everything into account.

[Mike Scarpa:]

And from a Q3 perspective on merch margin, I’ll just point you to our Q2 merch – overall margins. We’ve indicated that our merch margin was down modestly. So the increase of the e-comm penetration and something leverage around fixed expenses drove the majority of the deleverage of gross margins on Q2. We would expect some other situation in Q3.

[Operator:]

Our next question comes from the line of Tiffany Kanaga of Deutsche Bank.

[Tiffany Kanaga:]

Hi, thanks for taking our questions. Considering that August is the toughest comparison of the quarter. Can you help us bridge the GAAP between the implied deceleration to your 3% to 4% full quarter comp guidance? And additionally, can you provide a quarter-to-date breakdown between stores and online, considering the social media posts about the heavier e-commerce sort of volume? And how are you working to address the negative customer reaction to longer shipping times to keep her loyalty?

[Mike Scarpa:]

So from a overall perspective on Q3 and comps, we’ve seen increases in comps in both stores and e-comm from the run rate from Q2 and obviously, the metrics have improved also. We’re constantly reaching out to our customer base and reminding them of the shipping window. We’ve gotten some nice responses back, indicating that packages are being received on a timely basis. And as I indicated, we expect over 98% to be delivered within that window. We are incurring additional costs to expedite some of these shipments. It’s a situation that we’re dealing with and we think it’ll be solved once we get into our third-party in the holiday 2019. I will correct your first question around the toughest comparison being August; October actually was our toughest comparison where we saw double-digit comp increases in October versus what we saw in August and September, which were – while they were positive, they weren’t to that extent.

[Operator:]

Our next question comes from the line of David Buckley of Bank of America, Merrill Lynch.

[David Buckley:]

Good morning. Thanks for taking my question. Few questions. First on Tiny Collections; any information you can share on the performance on the quarter? Second, how much of your inventory increase is related to earlier shipments – related to tariffs? And then last, the implied fourth quarter guide has a significant amount of margin recapture baked in. Now what gives you the confidence in the guide, given the increased promotional environment you’re seeing now? Thank you.

[Jane Elfers:]

Sure. As far as Tiny Collections is concerned, we sold through the summer delivery well. We were happy with the results and probably saw an approximate 20% AUR increase versus where the TCP branded goods are running. We just delivered this past week our back-to-school assortment, so it just hit online and it’s just hit in stores. So we’re excited to see what happens with that. We think it looks great. And now I’ll pass it over to Mike to talk about the inventory increase due to the tariffs and the margin recapture in Q4.

[Mike Scarpa:]

Sure. David, as we said, inventories were up about 5.4% at the end of the second quarter, including the accelerated shipments of the Chinese goods, which accounted for approximately 20% of the increase. We had also made the decision to accelerate shipments of certain basic products to ensure that we were well positioned for back-to-school, and that was the majority of the increase. As we indicated, carryover goods were down double digits compared to the prior year. As you look at to Q4, we had a couple of things going on last year. Our gross margins overall were down roughly 550 basis points, and a big part of that was the liquidation, the advance liquidation that we did on certain holiday goods as we anticipated and then heard of the Gymboree and Crazy 8 bankruptcies. So our sense is based on the way bought units for holiday and where we expect our inventory positions to be at the end of the year that we should get to see a chunk of that comeback. So we’re confident in where we’re guiding to at this point, though we never really specifically, guided the gross margin.

[Operator:]

Our next question comes from the line of John Morris of D.A. Davidson.

[John Morris:]

Thanks. Jane, I want you to know, going back to your outlook and anticipation, which is probably pretty prudent that competitors around you are pretty high in inventory. I’m wondering; help us try to understand what you might be seeing or some hypotheticals on why it’s so high competitively out there? And they’re bent towards promotions at this point. Is it more of a delta than usual? Just wondering if you can kind of shed some light given your sector experience, what you think is going on there.

[Jane Elfers:]

Yes. What I think it is and what we talk about internally is that we think there is some euphoria by some of our competitive said about one-year ago in 2018, when they started to see some positive trends in the business. And as you know, kids has brought so much further out than other categories based on the lower AUC and the markets that we source from. So we think that this inventory that needs to be worked through, through the balance of the year. And I think inventories – retailers usually learn by looking in the rearview mirror. And I think by the time we get into the end of Q4 and into the early part of 2020, you’re going to see retailers pulling back in our sectors significantly on inventories. But I think, right now, as we said, it’s prudent to consider them to be elevated for the back half of the year. And we’re just kind of set on making sure that our guidance is covered for what we anticipate will continue to be elevated inventories.

[Operator:]

Our next question comes from the line of Paul Lejuez of Citi Research.

[Kelly Crago:]

Hi, this is Kelly on for Paul. I just want to clarify, so you talked pretty positively around the quarter-to-date trends and the 14% comp is obviously very strong. But – is that been driven by higher promotions or are you just anticipating that as we get to the low period post back-to-school that we’ll see an uptick in promotions across-the-board?

[Jane Elfers:]

Yes. I mean we’re – like we said, we have 14% comp up against the similar comp from last year. So pretty impressive on the two years stack, driven by back-to-school forward product. As we said, our inventories are clean. So we’re driving this on back-to-school assortment that are focused on basics and Wear Now. Business is really, really strong right now. We are just going to be, as we said on our prepared remarks and during this Q&A session, we want to be very prudent. As far as the balance of the year is concerned, we’re up against a big October with the cold weather. We feel very good about where our inventories are positioned in Q3 and coming out of Q4. And we just want to make sure that the guidance covers what could continue to be an elevated promotional environment.

[Operator:]

And ladies and gentlemen, we have time for one more question. Our final question will come from the line of James Chartier of Monness, Crespi, Hardt.

[James Chartier:]

Good morning. Thanks for taking my question. Could you just talk about the omni-channel fulfillment. What percentage of sales for back-to-school are being fulfilled from ship, from store? And then just overall, what the omni-channel fulfillment is for you guys? And then where do you want ship from store to be for holiday and back-to-school going forward? Thanks.

[Mike Scarpa:]

Yes. So on a go-forward basis; we’re looking at holiday 2019 for ship for stores would be roughly in the, call it, the 2% to 4% range of overall orders. We’re using it slightly higher today based on our order quantities that we have. But our sense is that we’ll have a third-party logistics provider in place in holiday of 2019 to avoid utilizing ship from store to any great extent. So were we – there is split shipments and what it does to the stores associate during the key selling period. Currently, it’s being indicated earlier, really pleased with BOSS and the results of BOSS and the attachment sales and how that’s driving store traffic and business. So we’ve seen it is high as – over 20% in some cases, it’s probably down to about 15% basis right now. So we’re pretty pleased with that, overall.

[Operator:]

And thank you for joining us today. If you have further questions, please call Investor Relations at 201-453-6693.