The Children's Place, Inc.
Q2 2018 Earnings Call Transcript

Published: 23 Aug 2018

[Operator:]

Good morning, and welcome to The Children's Place's Second Quarter 2018 Earnings Conference Call. On the call today are Jane Elfers, President and Chief Executive Officer; Mike Scarpa, Chief Operating Officer; and Anurup Pruthi, Chief Financial Officer. The Children's Place issued a second quarter 2018 earnings press release earlier this morning, and a copy of the release and presentation materials for today's call have been posted on the Investor Relations section of the company's website. [Operator Instructions]. Before we begin, I would like to remind participants that any forward-looking statements made today are subject to the safe harbor statement found in this morning's press release as well as 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 risks and uncertainties that could cause actual results to differ materially. The company undertakes no obligation to publicly release any revision for these forward-looking statements to reflect events or circumstances after the date hereof. In addition, to find disclosures and reconciliations of non-GAAP measures that we use when discussing our financial results, you should refer to this morning's earnings release and to our SEC filings that can be found on the Investor Relations site. After the prepared remarks, we will open the call to questions. [Operator Instructions]. And now I would like to turn the call over to Jane Elfers.

[Jane Elfers:]

Thank you, Christy, and good morning, everybody. After reviewing our Q2 results, I will review our progress on our strategic self-help growth initiatives. I will also highlight where we see additional opportunities to accelerate market share gains within our competitive set and how we intend to use our unique positioning within the kids market to leverage these opportunities over the next few years. So let's start with Q2. We set the bar very high for Q2 and we beat it. As we discussed in detail on our Q1 call, we were severely impacted by adverse weather in Q1, with 12 out of the 13 weeks of the quarter experiencing some type of adverse weather conditions across our major markets. However, we were confident that once the weather stabilized, we would realize the pent-up demand for our spring and summer product in the second quarter. For Q2, we delivered positive comp sales of 13.2%, our highest ever quarterly comp, and EPS of $0.70, $0.09 above the high end of our guidance range. We delivered positive comps every month in the second quarter. We delivered positive brick-and-mortar comps every month in the second quarter. We delivered positive digital comps every month in the second quarter. Our digital business was outstanding in Q2. We delivered a 41% increase as we continued to outmaneuver the competition and gain share in this important channel. We delivered a positive 14.2% comp in the U.S., and we delivered a positive 4.2% comp in Canada. Our key metrics ADS, UPT, conversion, ADS, transactions and, most importantly, traffic were all positive for the second quarter. I'll spend some more time on our brick-and-mortar traffic results later in my remarks, as they were truly extraordinary. I know everyone is curious as to how we performed during the critical back-to-school period, so let me spend a few minutes on that. We did a lot of research this year on back-to-school in order to set ourselves up to gain share in this key time period. After all, back-to-school only comes once a year, and if you're not prepared, you lose. According to third-party research, 62% of shoppers begin their back-to-school shopping prior to August and 64% of total back-to-school sales happens in the four weeks between mid-July and mid-August. Those stats closely mirror our business. However, this year July was even more important, as the 53rd week forced the key back-to-school week into Q2 this year from Q3 last year. This research also shows that the back-to-school customer is more likely to purchase from online retailers to offer free shipping. As you know, we introduced everyday free shipping back in February. We have a highly engaged mobile millennial shopper that we are now better able to communicate with through our recent mobile implementations and enhancements. While our digital business was outstanding every month of the second quarter, we achieved a new milestone in digital penetration in the month of July, a mid-30s penetration, driven by our digital back-to-school promotional strategy, including our ownership in key categories. The first two weeks of August have continued strong. And with the majority of back-to-school and tax-free events behind us, our comps are running positive low double digits quarter to date. Moving on, as we assess the competitive landscape in the kids wear market, particularly the specialty kids players, we continue to find ourselves uniquely positioned. The more time we spend studying the competition, the more we keep coming back to the one key differentiator between us and them. We play offense and they play varying degrees of defense. Let's talk about why this is important and how we can leverage it for market share gains for The Children's Place. For over a decade now, the kids market has shown no growth, with births down significantly since their pre-recession highs in 2007. And near term, the kids wear market is not forecasted to grow. So how's The Children's Place winning? How have we been able to not only hold on to our market share, but gain share in a shrinking market, which has seen several new players enter the kids space in the past decade combined with an unprecedented digital assault on traditional brick-and-mortar retailers? The answer, offense, through the successful execution of a comprehensive multiyear strategic growth plan focused on proven self-help initiatives that have kept us the number one pure-play children's specialty apparel retailer in the United States, with the goal to take that title global. We've been on offense for several years, focused on our four strategic growth pillars

[Anurup Pruthi:]

Thank you Jane, and good morning, everyone. In the second quarter, we generated adjusted EPS of $0.70 compared to $0.86 last year. This compares to our guidance of $0.51 to $0.61 per share. Details for the second quarter are as follows

[Operator:]

[Operator Instructions]. And your first question is from Susan Anderson of B. Riley FBR.

[Susan Anderson:]

I was wondering if you could maybe give a little bit more color on the gross margin in the quarter, the puts and takes there. How much of the e-comm shift continued to impact gross margin? And it sounds like there's a little bit lower e-comm margins, but then also I wanted to ask if e-comm operating margins are still better than the stores. And then after you've got past kind of that first quarter clearing from the bad weather, did you see merch margins go back to more normalized levels?

[Anurup Pruthi:]

Yes, Susan, its Anurup. Adjusted gross margins leveraged 10 basis points in the quarter. This is, obviously, a result of fixed cost leverage base on a very strong comp, reclassification of certain items due to the new revenue recognition rules. This was offset by lower merchandise margins and continued increase in e-comm penetration, which was very strong in the quarter, as you would note. Especially in July, we achieved a mid-30s penetration driven by our back-to-school promotional strategy in e-comm, including our ownership in key categories. Now as you know, we don't guide to gross margin, Susan, but that being said, we would expect margins in the back half of the year to improve versus the levels we have achieved in the first half of the year and have a greater flow-through of fixed expense. Also, I would step back from gross margins for a second and talk about, in the quarter, we generated over $1 of incremental EPS between our operations, our share buyback and our tax planning and, obviously, this was offset by the accelerated investments of $0.52 and the impact of the income tax rules and excess stock comp of $0.65, but the $1.01 EPS accretive result was very, very strong in the quarter.

[Operator:]

Your next question is from Adrienne Yih of Wolfe Research.

[Adrienne Yih:]

Jane, I'm going to start with a couple of sort of competition questions. So as you are seeing some of the evidence of the relaunch of product from Gymboree, are there any categories that you see in their stores that you think you can take advantage of and maybe add to the stores go forward? When do you think you will see sort of the impact of whether their initiatives launched in July work or don't work? And then if you can talk about some of the initiatives that you're doing at both Amazon and in the third-party channel, that would be great.

[Jane Elfers:]

Sure. I'll take the first part, and then I'll put -- give Mike the Amazon part of it. As far as Gymboree is concerned, as we said in the opening remarks, we were really focused on taking the share from the closed stores, but our thinking has evolved. So we're really looking at those 600 stores that are co-located with Children's Place. A portion of them are Gymboree, and as far as taking advantage of opportunities there, they seem to have dramatically changed the product from what they are known for. And if you look at any of their social media channels, I think there is also an article in The Wall Street Journal about it the week they launched. It seems to be certainly some level of their customer not happy with what they've done. So Jennifer Groves, our Head of Design, has already designed into product that is more in keeping with what that core Gymboree customer is looking for, which is really that highly curated, optimistic, bright, colorful kind of mix and match toddler product, and we'll be putting that in the stores, the mall stores, not the outlet stores, but the mall stores where we compete directly with Gymboree starting next spring. So I think there's an opportunity for us to add a different level of toddler products that we would normally do to see if we can take some of that market share from the open stores. As far as Crazy 8 is concerned, I think that has been not the greatest success story for Gymboree. Certainly, they opened it probably with the assumption that they would cannibalize Children's Place sales, but I think really what they've ended up doing is cannibalizing themselves. And as we said, I think there's only about 275 of them left. I don't think that their financial profile or their sourcing strategy allows them to compete on key items as our strategy does, which we covered in depth on the opening remarks. So I anticipate not to be surprised to see more store closings from Crazy 8. They seem to try to keep competing on key items, and I don't think that over time that will be a winning strategy, and I don't think to date it has been either.

[Michael Scarpa:]

As far as the name Amazon goes, our business with Amazon continues to perform very well. Replenishment has been the big driver of sales, and we currently have over 6,000 SKUs in the program. We think that replenishment will be a significant growth vehicle for the business over the next couple of years, as we've recently launched our seasonal basics in fashion product as part of this replenishment program during the back-to-school season. It's been early stages so far in terms of the back-to-school season response, but it's been very positive on seasonal basics in fashion and has exceeded our expectations, and we've also seen a very significant increase in the demand for basics during this back-to-school period versus a year ago. In addition, from a marketing perspective, we're controlling our brand image on the site by launching a brand store, and we are participating in their launch of Prime Wardrobe. So all very positive Amazon at this point.

[Operator:]

Your next question is from Janet Kloppenburg of JJK.

[Janet Kloppenburg:]

Jane and Anurup, maybe you could talk a little bit about any other pressures on selling margin in the second quarter. I know that the digital mix was the primary driver of the gross margin. But I'm just wondering, Jane, how you're thinking about market share pursuits? And then I'm very encouraged on the AUC outlook for the first half of next year. And given the cotton price increasing, I'm just -- increases that we're seeing, I'm wondering if you have just been able to negotiate better deals or if there were other factors influencing that outlook.

[Jane Elfers:]

Sure. I'll take the AUC part of it. I think as we discussed, Janet, in the opening remarks, I think that we're just better at what we do than a lot of our competition. We've been focused on strategic sourcing for close to a decade now. And I think when you look at how we have been able to handle, I give a lot of credit to Greg Poole, who has been with us for a long time, and he and his team who run our strategic sourcing area. We've been at the forefront of vendor consolidation and country migration and that has really served us well over time and continues to serve us well as we move into the front half of 2019. We talked a little bit about China and how we've been reducing our reliance on China for several years and then certainly advantageous wise and really being ahead and having the vision as to how to place categories -- key categories by country, all that really works together to give us an AUC that is down in the front half of 2019, which I think makes us an outlier versus any of the other competition that I've heard.

[Anurup Pruthi:]

Janet, as you've talked about on gross margins, obviously, e-comm -- e-comm's strong performance certainly had an impact on our gross margin mix, but when you step away from gross margins for a minute, I would reiterate, in our operations, we generated over $1 of incremental EPS versus last year between operating performance, the shares and tax planning. This is, obviously, offset by the accelerated investments in our transformation work and the impact of -- the income tax impact on excess share-based compensation. But I think, overall, when we look at the quarter, we deployed promotional strategies that were appropriate to win. And in the back half of the year, as I mentioned in the earlier question, we would expect gross margin levels to improve vis-à-vis the flow-through that -- on the fixed cost base that we saw in the first half.

[Operator:]

Your next question is from Kate McShane with Citi.

[Kate McShane:]

Jane, with all of your comments focused on market share gains, it sounds like you have a lot of opportunity. I just wondered how pricing and promotions come into play within the strategy. Can we anticipate you offensively discounting more? Or if the other competitors continue to struggle, does this mean we can see prolonged discounting in the space?

[Jane Elfers:]

Yes, I think that's a little bit of a complex question, but let me try to take pieces of it. I think when you look at what happened in the second quarter, we had very strong comps every month of the second quarter. May was absolutely spectacular, and margins were very strong. June was much more of a promotional month, as everyone was struggling to get rid of the hangover from a tough Q1 and also particularly in the kids market to set themselves up for the back-to-school deliveries in July. So we were not surprised by the strong business in May and June, as we had said on our Q1 call. We were pretty confident that we would see that pent-up demand realize itself in the second quarter, which we did. Really, I think, when you look at what happened in July, I think we had a lot of confidence in the preparation. We spent a lot of time getting ready for back-to-school, and we had a lot of confidence in our preparation. But I think we were even surprised at how spectacularly we did in the month of July with respect to back-to-school and, certainly, in the first two weeks of August. When you think about a mid-30s penetration in digital, that is a new record for us. And certainly, that business is extremely promotional in those last two weeks of July and the first two weeks of August, as we're going after big key categories like short-sleeve graphics, like uniform, like denim, like backpack. That's really what makes up the bulk of that business. So to see such an outsized performance in the month of July on digital as well as in the stores, I think that, that probably -- not probably, but that had an influence on the margins in Q2. I think as you look forward into the balance of the year, as Anurup alluded to, I think you're going to see that merchandise margin stabilize, particularly as we get out of these highly promotional categories. I do think, on the other hand, to answer the question, I think there's a lot of market share opportunity out there from our competitive set. Not only have we been focused on these self-help initiatives for several years, which have really put us in a great position and allowed us to positive comp for the last couple of years, but now we can keep going with our self-help initiatives, but I think we can take advantage of the self-inflicted opportunities from our competitors. So if you'd break it down, I think Gymboree is our number one opportunity. We discussed it in in depth in the opening remarks, but we're still co-located with a lot of their stores. And I think with the digital tools we have coming on and some of the abilities we have in our sourcing models as evidenced by our lower AUCs, I think where we need to compete with them or where we feel like competing with them will help us realize those market share opportunities. We will, certainly, take advantage of those in the back half of the year. I think overall, when you look at what happened to us and when you look at where we're projecting the back of the year and where we're giving guidance on the full year, I think that those promotional opportunities are assumed within that guidance and that we're confident, based on our strong sourcing arm in our company and our preplanned promotions, that we will be able to deliver that guidance that we spoke about this morning and take advantage of those competitive opportunities.

[Operator:]

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

[Marni Shapiro:]

Back-to-school was fantastic. Can you just talk, Jane, a little bit about back-to-school for a minute? You guys had an outsized direct business, obviously. And could you just talk a little bit more in detail? Did you see a good split between pure buying online, shipping to home versus things like, I think, you call it ROPIS and BOPIS and all those kind of iterative elements of the direct business?

[Jane Elfers:]

No, we really haven't seen any of those elements significantly impact our business. We have a very small BOPIS business right now. The business we do have has a nice attachment rate. But as far as omni-channel initiatives, BOPIS is small because we offered free shipping every day. And I think a lot of people use BOPIS as their free shipping tool because our competitors don't offer free shipping every day. So I think they're more reliant on that, and they use the hook of calling that free shipping. What is coming up for us in January is Buy Online, Ship to Store. I think that's when we'll have more opportunity there. When you look at our digital business, I think there's still a lot of runway as far as digital is concerned. And when you answer your question about back-to-school, where it came from, we had a mid-30s penetration in the month of July, highly driven by back-to-school, but our brick-and-mortar comps and our brick-and-mortar traffic in that period was also outstanding. So when you look at the two pieces of back-to-school, there is a basics piece and then there is fashion piece. The fashion part of back-to-school, particularly in the growth side of the business, has been absolutely outstanding. So to have those two pieces, basics and fashion, firing on all cylinders at the same time is really what is driving this outsized comp and really has given us spectacular results. Toddler is meaningless for us during this period, and we spend a tremendous amount of time and effort, making sure that our floors sets and our penetrations are really highly geared into big kids. And we have been -- as kind of getting back to a little bit what I mentioned in my opening remarks, we have been laser-focused on making sure that our big kids assortment resonate with the kid as well as the mom, and we've been very, very successful in size extension. So you can really see right now in the business everything we've been working on coming together beautifully, whether it's the digital transformation, whether it's the increase in the customer file, whether it's the basic product we bought into, whether it's the big kids fashion, how we setup the floors, and then I would be remiss if I didn't mention Kevin Low and his field team what they were able to accomplish during tax free. They were in every single market for the past six weeks making sure that we were completely and fully set, and we had an absolutely spectacular tax-free result, by far the best we've had since we've been here. So it's really a combination of everything coming together.

[Operator:]

And this does conclude today's Q&A session. Thank you for joining us today. If you have further questions, please call Investor Relations at 201-453-6693. You may disconnect your lines at this time, and have a wonderful day.