Ladies and gentlemen, thank you for standing by and welcome to The Children's Place Second Quarter 2020 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.

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 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 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 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 would like to turn the call over to Jane Elfers.

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 omni-channel capabilities necessary to fulfill our strong online demand. Increased digital adoption accelerated by COVID-19 continued 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 omni-channel customers at a rate of approximately three times the pre-pandemic rate, and increased our app downloads by 115%. And according to NPD data through June, we're 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 products, 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 by the end of fiscal 2021 with 200 in fiscal 2020, inclusive of the 102 permanent store closures we executed during the first half of 2020, and 100 closures in fiscal 2021, bringing our total fleet to approximately 625 stores by the end of fiscal '21. Since the onset of the pandemic in March, we have focused on internally modeling and externally discussing the potential short-term headwinds of COVID-19 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.

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 $369 million versus last year's $421 million. 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 seven days in the quarter, sales growth was up mid-single digits through the end of 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 decreased 760 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 significantly higher levels of ship-from-store activity due to strong digital demand. Adjusted gross margin excluded approximately $27 million in charges, primarily due to occupancy charges related to stores temporarily closed due to COVID-19. We did resume rent payments on a modified basis in Q2 as stores began to reopen. Adjusted SG&A was approximately $104 million versus $116 million last year and deleveraged 60 basis points to 28.1% of net sales, primarily as a result of the deleverage 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-19 pandemic. Adjusted SG&A excludes approximately $11 million in certain items, primarily related to approximately $9 million in charges due to incremental COVID-19 expenses in stores, along with store closing costs. The adjusted operating loss for the quarter was $25 million versus operating income of $6 million last year and deleveraged 820 basis points to negative 6.8% of sales. Our adjusted tax rate was 22.2% versus 15.9% last year. Moving onto the balance sheet, our cash and short-term investments ended the quarter at $36 million as compared to $72 million in Q1. We ended the quarter with $251 million outstanding on our revolving credit facility compared to $235 million 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% from 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 million in cash flow from operations in the second quarter compared to $2 million in cash generated in Q2 of last year. Historically, the Company generates the majority of its annual cash flow in the back half of the year. Capital expenditures in Q2 were approximately $9 million. 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 initiatives. We permanently closed 98 locations in the quarter, bringing our total store closures to 102 for the first half of fiscal 2020. We opened two locations in Q2 and ended the quarter with 771 of our 824 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 due to COVID-19, we have significantly increased our plans for store closures and continue to target approximately 300 store locations to close in fiscal 2020 and 2021. We remain on track with our target to close approximately 200 store locations in fiscal 2020, including 102 locations closed in the first half of 2020, and approximately 100 additional stores that we are targeting to close in fiscal 2021, resulting in approximately 625 store locations by year-end fiscal 2021. By the end of fiscal 2021, 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 2022 with less than an estimated 25% of our total revenue in traditional malls. 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-19 pandemic. With over 90% of our major U.S. market 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 adversely impacting our total net sales in Q3 by an estimated 10% when combined. First, 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. 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 11 am and we are required to close at 7 pm. We normally generate approximately 15% of our sales after 7 pm. 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.

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

Good morning, everyone. Hope everyone is safe and healthy. As you think of these upcoming third quarter and inventory planning. Mike, you said to build an inventory in uniform and basics. How do you think of that inventory build? How much should it be? How you're thinking about the margins? And Jane, when you think about the shift to digital, what learnings are you 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.

Sure. Thanks, 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 moms were 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, 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 715, both online and in stores, they switch over to back-to-school with a heavy focus on basics. 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.

And from an overall inventory perspective, we ended the quarter with inventories down about $5 million or 1%, but our carryover inventories were roughly half of what it was a year ago. So, we entered into 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 uniforms 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, a certainty on the timing as they returned to in-person learning happens, and we have no plans at this time to be in a position to mark that inventory down.

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

Mike, can you just talk about 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.

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 e-commerce demand from our store inventory. We did roughly 55% of our e-commerce shipping from 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, we 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 of our e-com business 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.

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

Jane, a couple of questions for you. So holiday, obviously everybody's 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 the stores for events and planning inventory flows for holiday? And then number two, could you also give us an update on the Gymboree aspects in the launch there? And then Mike, just a couple of housekeeping questions, I assume you're seeing the ATV size go up, baskets go up on fewer shopping encounters? And then on merchandise margin, I understand the pressure on the gross margin from shipping, delivery, etc. On the merchandise margin given that you're expecting to have less carryover inventories and expecting to build that inventory at the end of the third quarter, when do we see merchandise margin flat or the positive inflection? Thank you very much.

Let me start off. As for Gymboree 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 de-emphasized the amount of dressy products that we placed in the back half of 2020, particularly for holiday due to COVID-19. As we know, holiday dress-up is a key part of the Gymboree business. So, we're not anticipating a big pop there, but they're very happy with the deliveries we've had; the feedback continues to be good for mom, and we'll be introducing mostly casual collections in early September. From a Children's Place point of view, from an inventory perspective to start with that for holiday, we did a significant pullback on dresses and dress-up products when we placed our holiday buy in anticipation that COVID-19 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. Looking at Q4, we are being extraordinarily cautious as we think about Q4. We think that, as you mentioned, the promotional environment will be heightened. It'll be sustained throughout the entire quarter. We think that the holiday sales will start earlier, as retailers try to spread out the demand, if you will. There is definitely a customer aversion to shopping in store. I think there's going to be significant pressure on Black Friday that might not be well understood right now. We're hearing a lot about closing on Thanksgiving, which we are as well, but I don't think that there’s a conversation around Black Friday itself. We anticipate a significantly reduced Black Friday event. We're not even sure if there will be a traditional in-store Black Friday this year. Certainly not appropriate to have door busters and drive large amounts of traffic into the stores. We think families will be reticent to pack the malls on Black Friday and some of those big December weekends. So, we think that's definitely a jeopardy from the store's point of view. You certainly have the freight surcharges that Mike spoke about. You're looking at an unnaturally high percentage of online business in Q4. 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. The freight surcharges are going to hurt there on the margin lines. We don't know about COVID spikes or if there will be more temporary store closures throughout Q4, and then you throw on top of that the uncertainty around the presidential election. So, just overall, proceed with caution.

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 were predominantly driven by the 98 stores that we liquidated and closed in the quarter, along with a higher penetration of e-commerce compared to last year. Margins actually, merchandise margins increased in our e-commerce business in the second quarter. In the third quarter, our point of view is that we can continue to see slightly elevated merchandise margins for both our retail and e-commerce business though. When you look at the penetration of e-commerce, we anticipate that it'll be hiring where it was a year ago, so that could dilute the merchandise margins overall. 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.

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

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, did you see an opportunity to perhaps take market share after those stores are gone when you look into next year? Thank you.

Sure, Jay. I assume you're talking about Justice. As far as Justice is concerned, they had 828 stores and their strategy was to liquidate 710 of those stores, or 86%, which would leave them with 118 stores and a website. All of those 710 liquidations are complete as of last week, so that liquidation is completely behind us. From a co-located perspective, we were co-located with 464 of those Justice stores, or 56% of the stores. Of those 464 stores, 388 of them are now liquidated, which is 83% of them, leaving us with 76 remaining co-locations. From a market share point of view, obviously, Justice was focused on the sizes 4 to 20 girls, which has a major overlap with us, particularly in the 4 to 10 age range and their market share in 2019. The total market share in ages 0 to 10 in 2019 was about 26.5 billion and they were 1.7% of that.

Next question comes from Paul Lejuez of Citi.

I'm just curious if you can talk about the cost to add some of these stores, maybe the ones that you've already closed in the first half, what you've got coming in the second half and what you've got on the way in '21? And then can you also talk about the stores that remained open? Are you trying to work down rent rates? Please talk about any success that we might be having on that front? And also just totally separate, can you just remind us the average basket size online versus in-stores? And what your return rates look like online versus in-store? Thanks.

From a fleet perspective, we've built tremendous flexibility into the portfolio. We have about 65% of our fleet with lease actions by the end of 2021. We have about 35% of 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 stores 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. From a return rate perspective, we're in the low single digits as far as returns go.

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

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, I was curious if you were able to mix in 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 in fashion for back-to-school. Again, just like we did for holiday, we got out of a lot of the dress-up products for things like first-day outfits, so 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 any back-to-school meaningful business until spring '21 at the earliest. So, we're not looking for anything to happen in the latter half of the year or in the fourth quarter to drive back-to-school sales. We believe that the spring '21 event at the earliest. Regarding holiday product, we had not placed holiday product at the start of the pandemic, so we were able to pull back on the dress-up product. We're able to focus on activewear and casual wear across our age ranges and sizes. We also have a major push this year around sleepwear, particularly holiday sleepwear, which is off to a very strong start. We put a lot of money behind sleepwear and 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 canvassed every one of our states and cities and all store managers starting about six weeks ago, and we get daily updates on that. What we've come back with is that as of yesterday, 47% of our markets are virtual, 35% are a hybrid model, 11% are parents' choice, and that parent's choice includes either virtual or hybrid. It does not include going back full-time in-person. So, we have 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%. The TBD includes Boston, Rhode Island, and several cities in West Virginia. As far as your question about uniforms, a lot of our stores are located near major cities, many inner cities, and those schools are very much uniform-based schools that require uniforms. 93% of our markets are in either virtual or hybrid, which is having a significant impact on our sales. When you look at Canada, we’re at almost 90% in-person learning. When you look at our business there, as Mike mentioned, it's only down single digits. It's a very different story with how we're selling back-to-school product.

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

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

Sure. From an overall SG&A perspective, we continue to look at structure both from a corporate perspective and a store perspective. We expect that SG&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, we expect to have some savings on that line also. Just to note though, in the third and fourth quarters of last year, we had some incentive compensation reversals 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&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 million in operations versus last year where we had two million. For the first half of the year, we basically used about $83 million in cash, roughly about $100 million difference compared to where we were a year ago and the previous year. Our expectation is that we're going to end Q3 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 in the second quarter.

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

Hey, guys, a couple of quick ones, and then Jane, maybe one broader one. Would you guys consider shipping hurdles 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 factories?

Yes, I think we've had an AUC tailwind for the last couple of years, and particularly with looking into '21 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. That's why we thought it was obviously very important for us to work through our inventories and our swing inventory so we wouldn't be carrying them on the balance sheet or sitting in overseas factories. That way, we'd be able to provide our vendors not only with continued 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. Our customers are 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. The surcharges are something that UPS is taking advantage of, and so, we'll have to live with that for Q4. Hopefully, we'll figure out as we get into Q4 2021 how to mitigate that.

Thank you for joining us today. If you have further questions, please call Investor Relations at 201-453-6693. That does conclude the Children's Place second quarter 2020 earnings conference call. You may now disconnect your lines and have a wonderful day.