Childrens Place, Inc. Q2 FY2022 Earnings Call

Good morning and welcome to The Children's Place Second Quarter 2022 Earnings Conference Call. On the call today are Jane Elfers, President and Chief Executive Officer; Rob Helm, Chief Financial Officer; and Josh Truppo, Vice President, Financial Planning and Analysis. At this time, all participants are in a listen-only mode. 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. As a reminder this conference is being recorded. The Children's Place issued its second quarter 2022 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. 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-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. It is now my pleasure to turn the call over to Jane Elfers.

Thank you and good morning, everyone. Our Q2 sales and profitability fell well short of our internal expectations due to a significant miss to our retail sales projections in the period from early June through early July. The combination of an unexpected and meaningful increase in promotional activity from our key competitors and the widely reported inflation-driven consumer slowdown put significant downward pressure on our fashion AURs and margins during the quarter. AUR ended the quarter flat versus our projection of up mid-single digits. Our fashion AUR was down negative mid-single digits, a significant miss from our internal projections, while our basics AUR was a positive low teens as planned. In addition, a $6 million unplanned expense late in the quarter further pressured our margins. This expense was required to address unplanned inbound supply chain disruptions. We had to address a significant imbalance in our channel inventories caused by this disruption, the majority of which stemmed from the rapid backup of our East Coast ports, as other retailers scrambled to move their shipments from the West Coast. Rob will cover these two issues in more detail during his prepared remarks. Moving on to Digital. Digital represented 47% of our retail sales in Q2 versus 45% in 2021 and 30% in 2019. US e-commerce traffic held up well during the quarter at positive 7% versus last year. As planned, Canada e-commerce traffic was down due to the lapping of the temporary store closures last year. We continue to deliver industry-leading Digital results supported by the combination of our structural reset since the pandemic, our increased marketing investments and our focus on optimizing our channel results. Digital is our highest operating margin channel and based on the strength of our Digital business and our increased investments in this channel, Digital is projected to represent 50% of our 2022 retail sales. Looking ahead, we are projecting Digital to represent approximately 60% of our total retail sales by the end of full year 2024 versus 33% of retail sales in 2019, almost doubling our Digital penetration in only five years. And when you factor in our growth expectations for Amazon, our projected Digital penetration grows beyond 60% of total consolidated revenue by the end of full year 2024. With back to digital marketing, we are focused on investing in top-of-funnel brand awareness. We are realizing positive early results with a 4% increase across the customer base in acquisition, retention and reactivation for the second quarter. Acquisition was particularly strong, with Digital acquisition of positive 13% and store acquisition of positive 1%, despite the lower store base versus last year. 76% of our transactions occurred on a mobile device during Q2. Our mobile app continues to drive strong customer engagement, especially among our loyalty members, who represent 95% of our mobile app transactions. Our mobile app customer spend frequency is 10% higher than non-app customers and basket sizes of customers transacting on our app is 15% higher than our non-app customers. Our current back-to-school campaign is focused on fostering children's education and making important resources accessible. We partnered with actor, author and philanthropist, Kevin Hart for our back-to-school campaign. Since our launch on July 26, we have garnered over 33 billion impressions across almost 500 print, broadcast and digital outlets. This campaign is packed with rich photo and video content that is being syndicated and amplified across both earned and paid digital media. In addition, early results showed robust engagement with over 9.8 million completed video views and strong clicks to site. We continue to see strength in partnering with celebrities and influencers, both micro and macro, to drive brand awareness and consideration across key product categories. With respect to Q3, we have already seen positive search trend increases for our holiday and special moments assortments. Results, quarter-to-date show a 90% increase over last year in site searches, across our Halloween and Holiday Christmas sleepwear assortments. Our consistently superior merchandise offerings and our ongoing brand campaigns targeted at these special product assortments have established The Children's Place as a market leader in holiday product offerings, further driving brand loyalty and traffic. We believe that our increased and targeted back-to-school marketing efforts are already having a positive impact on our third quarter sales. Our quarter-to-date sales trend is above our trend for the last two weeks of July. Total retail sales are running down 11% versus 2021 and up 11% versus 2019. And our AUR is currently running up positive high single digits, higher than our back half AUR outlook now assumes, based on the uncertain environment. Our basics business continues to be very strong, and with respect to our fashion assortments our customers responding to the combination of our significantly increased back-to-school marketing efforts and our curated back-to-school fashion assortments. Digital traffic is up over 5% quarter-to-date versus last year and quarter-to-date Digital sales are running down 5% versus last year, higher than we had anticipated, considering our record-shattering August last year. As we have shared, August historically represented about 35% of our Q3 retail sales. Last year, August represented just over 40% sales, an outsized percentage to the typical third quarter, due to the combination of pent-up demand, the return to in-person learning and the child tax credit stimulus. This year, we're projecting August sales to represent about 38% of the quarter, due to the continued growth in our e-commerce business, which generates significantly higher basket sizes. Moving on to Amazon. Our Amazon business was outstanding in the second quarter. Amazon is delivering very strong results from the inventory and marketing investments we have made and our partnership continues to strengthen. As I mentioned, due to the East Coast port congestion late in the quarter, we had to overspend in our DC to provide Amazon with the necessary inventory to continue to support their outsized trend coming into and out of Prime Day. We had outstanding Prime Day results and our sales have continued to build every week since Prime Day. We believe that the Amazon customer is a higher-income customer and advantage as our core TCP customer is feeling significant pressure from the unprecedented inflationary environment. Amazon launched our iconic Gymboree brand on their website in late July. Amazon supported the Gymboree brand launch with several key traffic-driving placements across amazon.com, including the back-to-school, Amazon Fashion, kids fashion and new arrivals landing pages, as well as the Amazon homepage gateway. Early results are encouraging and we look forward to building this exclusive partnership for years to come. Moving on to Gymboree. In addition to launching Gymboree on Amazon in Q2, we are very pleased with the early reads on our Gymboree back-to-school product launches. For the second quarter, we experienced an $0.18 increase in spend per customer versus last year. We also know that the Gymboree customer is a higher-income customer than our core TCP customer which we believe will be an advantage as we continue to scale this brand. We introduced Gymboree Uniform product for the first time in Q2 which drove significant revenue, site search volume, strong social sentiment and ad click engagements that continue to grow each week. The Gymboree customer let us know last year that she wanted holiday product earlier in the season, so we launched our first holiday collection on July 28. Since the launch, this holiday collection drove a 3x increase in search terms year-over-year and it was the top visited collection on our home page. We are confident that Gymboree will continue to be an increasingly important part of our growth strategy. In closing Rob will walk you through our Q3 and full year '22 outlook during his prepared remarks. From a high-level perspective, when compared to 2019 pre-pandemic levels although we are now anticipating the consolidated sales will be down approximately 8% versus 2019, we also anticipate that operating income will be up positive mid-teens versus 2019 and EPS will be up approximately 30% versus 2019. With the multiple headwinds we are currently facing, these results would only be possible due to the structural reset to our business model since the start of the pandemic. We have a clear focus on continuing to maintain the significant double-digit AUR increases, we have realized since the start of the pandemic which will benefit our gross margin when cotton costs normalize. We will continue to build upon our e-com freight optimization strategies. We will continue to secure occupancy savings as our leases expire and our top priority will remain growth in Digital our highest operating margin channel. Now I'll turn it over to Rob.

Thank you, Jane and good morning, everyone. After I review our Q2 results I will provide our Q3 and full year '22 outlook. For the fiscal second quarter, our operating results fell short of our expectations and we delivered an adjusted loss per share of $0.89 versus earnings per share of $1.71 in 2021 and $0.19 in 2019. Net sales decreased by $33 million or 8% to $381 million versus $414 million in Q2 2021 and decreased $39 million or 9% versus $420 million in Q2, 2019. Our US net sales decreased by $48 million or 13% to $313 million versus $361 million last year and our Canadian net sales decreased by $2 million or 5% to $35 million versus $37 million last year. Comparable retail sales were negative 8.7% versus Q2, 2021 and positive 2.2% versus Q2, 2019. Our Q2 net sales were negatively impacted by the slowdown in consumer demand driven by the unprecedented levels of inflation particularly with respect to the significant increases in fuel and food prices, combined with increased promotions across our competitive set. As we shared on our last call, our AUR plan for the second quarter, was up mid-single digits to offset AUC increases. However, starting in June, the combination of the consumer slowdown and the elevated promotional activity across the sector, led to significant unplanned AUR pressure and our actual AUR for the quarter was flat. The combination of the lost sales resulting from the consumer slowdown and the heightened promotional environment represented a top line impact of approximately $22 million in our retail sales channels for the quarter versus our internal projections. And as we had planned, sales in the quarter were also negatively impacted by lapping the impact of the enhanced child tax credits, which started last July combined with the pent-up demand from last year's return to in-person learning, and the impact of permanent store closures, representing approximately $14 million for the quarter. Our net sales were positively impacted by our outsized sales growth in our wholesale channel with Amazon. Looking at sales by month for the quarter. As we discussed on our last call, our sales trend improved in May versus Q1, as we lap the outsized impact of stimulus and unseasonable weather. For June, sales trends further improved but were driven by the heavy promotions necessary to address our competitive set to clear through our summer fashion inventories. And in July as expected, our sales were meaningfully lower than last year as we lap the impact of the combination of pent-up demand, the return to in-person learning and the enhanced child tax credit stimulus. In terms of sales by channel, consolidated digital sales decreased 7% versus Q2 2021, with our Digital penetration growing to 47% of our total retail sales, versus 45% in 2021 and 30% of retail sales in 2019. Store net sales were down 14% versus Q2 2021. Our comp store traffic was down 4% versus Q2 2021. However, as a point of reference, store traffic remained significantly below pre-pandemic levels with comp store traffic down 32% for Q2 2022 versus Q2 2019. Adjusted gross margin decreased 1,046 basis points to 30.2% of net sales compared to 40.6% in Q2, 2021 and 33% in Q2, 2019. Approximately 610 basis points of this decrease was unplanned versus our internal projections. The slowdown in consumer demand combined with the unexpected increase in promotional activity from our key competitors pressured our top line sales and fashion AURs, resulting in lower-than-planned merchandise margins in both channels versus our internal projections. The lower merchandise margin, coupled with the deleverage in fixed expenses resulting from the lower net sales, deleveraged our gross margin rate by 460 basis points versus our original plans. Second, we experienced significant unplanned inbound supply chain delays, most notably from the rapid buildup in congestion at the East Coast ports, as well as the impact of further vendor delays. These supply chain disruptions forced us to rebalance our basic inventory primarily uniform and denim, across our channels. We had to shift large amounts of basics inventory between our channels within our DC, and our domestic supply chain, to support our strong Amazon and Digital businesses and to properly position us to deliver the significant level of basis revenue planned for Q3. These inbound delays resulted in an additional $6 million in incremental in our DC and domestic supply chain, which further impacted our gross margin by an additional 150 basis points versus our plans. While our second quarter operating results fell well short of our expectations, the combination of selling through our late spring and summer products and getting the cost to balance our channel inventory behind us, enabled us to exit the second quarter in a strong seasonal inventory position and better positioned for success in Q3, with respect to our key back-to-school basics in both our Digital and wholesale channels. As expected, the following items also impacted our gross margin in the quarter. The sales mix shift to wholesale, which operates at a lower gross margin, we had planned for outsized growth with Amazon in Q2, but we significantly overachieved our internal Amazon sales plans for the quarter driven by the strong customer response to our back-to-school basic programs. And as a reminder, while our Amazon business operates at a lower gross margin, it is accretive to our overall consolidated operating margin, delivering operating margins nearly as high as our owned digital channel. The impact of elevated and inbound freight transportation costs driven by significantly higher levels of air freight and higher container rates; and lastly, incremental duty resulting from the loss of Ethiopian AGOA trade benefits. Adjusted SG&A was $114 million, flat to last year and versus $115 million in 2019 and deleveraged 223 basis points to 29.8% of net sales compared to 27.6% of net sales last year. The deleverage was primarily the result of the decline in net sales on our fixed expenses. As planned, marketing spend was higher in the quarter inclusive of investments in brand marketing. Adjusted depreciation and amortization was $13 million in the quarter versus $14 million last year and $18 million in 2019. Adjusted operating loss for the quarter was $12 million, a decrease of $52 million versus $40 million of operating income last year and deleveraged 1,277 basis points to negative 3.1% in net sales compared to 9.7% in net sales in Q2 2021 and 1.4% of net sales in Q2 2019. Interest expense for the quarter was $2.6 million versus $4.7 million last year. The decrease in interest expense was driven by lower interest rates due to our refinancing in Q4 last year and a lower term loan balance outstanding this quarter. Our adjusted tax rate was 18%. Moving on to the balance sheet. Our cash and short-term investments ended the quarter at $28 million. We ended the quarter with $284 million outstanding revolving credit facility. Inventories ended the quarter up 34% versus last year and the increase breaks down as follows; 42% of the increase was due to higher AUCs driven by higher input costs; 24% increase was due to higher inbound freight costs; 18% of the increase resulted from elevated transit times, including the impact of the worsening port disruption on the East Coast; and the remaining 16% of the increase was driven by our investments in inventory to support our strategic growth initiatives with unit growth in place to support Amazon, Gymboree, and Sugar & Jade. Despite the slowdown in consumer demand, we were able to exit the quarter in a strong seasonal inventory position with spring and summer inventory units down 45% versus last year, better positioning us for the back half of the year. Our basic inventory which includes several key high-volume categories with limited to no markdown risk accounted for over 50% of our on-hand inventory at quarter end, which positions us for what we believe will be a continuation of the current environment throughout the back half of the year. Moving on to cash flow and liquidity, we used $34 million in cash from operations in Q2 versus cash flow of $13 million last year. Capital expenditures in Q2 were $8 million. During the second quarter, we repurchased 484,000 shares for $23 million, leaving $196 million outstanding on our current authorization. Now, I'll provide an update on our store activity in the quarter. We closed seven locations in the second quarter and we plan to close a total of 40 stores for the full year 2022. With over 75% of our store fleet coming up for lease action in the next 24 months, we continue to maintain meaningful financial flexibility in our lease portfolio. These short-term leases will continue to provide us with the flexibility to optimize our occupancy costs. We ended the quarter with 658 stores total square footage of 3.1 million square feet, a decrease of 8% compared to Q2 2021 and 31% versus Q2 2019. With respect to our fleet optimization strategy, it's important to continue to highlight that for 2022, we are planning for 50% of our retail sales to come from our stores with 50% of our store sales coming from traditional malls and 50% coming from off-mall. With our Digital business also planned an industry-leading 50% of total retail sales, we are planning for 75% of our retail sales from off-mall, strongly supporting our structural reset to a digital-first retailer. Moving on to our outlook. Based on the current environment, we are now planning for a decline of approximately 10% in net sales versus 2021 for the year. Our inventories are now better positioned by channel to meet the current demand trends. However, we anticipate that promotions will remain elevated for the back half of the year and we are continuing to proactively manage our inventory levels. We continue to benefit from our pricing and promotion reset. AURs are planned to remain significantly higher than pre-pandemic levels. However, based on the current environment, our outlook now assumes a positive low single-digit AUR increase for the back half of the year versus our original projection of positive high single-digit AUR increases. Our outlook assumes that our Amazon business continues to outperform, supported by our significant investments in both inventory and marketing. Starting with our Q3 outlook. The company expects net sales for the quarter to be approximately $500 million representing a low double-digit decrease in comparable retail sales versus Q3 2021 and a positive mid-single-digit comp increase versus Q3 2019. Adjusted operating income is expected to be approximately 14% in net sales, as compared to 20.9% in Q3 2021, primarily driven by the decrease in sales. This compares to 12.1% in Q3 2019. We anticipate third quarter adjusted earnings per diluted share to be approximately $3.95, as compared to adjusted earnings per diluted share of $5.43 in Q3 2021 and $3.03 in 2019. Our total inventories at the end of Q3 2022 are anticipated to remain elevated, primarily driven by higher raw material input costs and higher inbound transportation costs. Moving on to our full year outlook. For fiscal 2022, the company expects net sales to be approximately $1.725 billion, reflecting a low double-digit decrease in comparable retail sales versus fiscal 2021 and a positive mid-single-digit comp increase versus full year 2019. We project that e-commerce penetration will increase to 50% of total retail sales for full year 2022 versus 46% in full year 2021 and 33% in full year 2019. Adjusted operating income is expected to be approximately 7.5% of net sales, as compared to 15.1% in 2021 and 6% in 2019. We anticipate fiscal 2022 adjusted earnings per diluted share to be approximately $7, as compared to adjusted earnings per diluted share of $13.40 in 2021 and $5.36 in 2019. Our inventories at the end of Q4 2022 are anticipated to moderate from current levels. We are planning for a full year tax rate in the range of 23% to 24%. Our outlook for the balance of the year assumes lower occupancy cost versus last year due to the impact of our permanent store closures as well as the benefit of favorable lease negotiations and lower variable occupancy expense resulting from the lower planned sales. Although there has been some moderation of inbound container and transportation costs, our full year outlook does not contemplate a significant improvement from current levels. However, we are planning for significantly lower air freight costs in the back half of the year versus the first half of the year. We anticipate that the full year 2022 SG&A will be slightly lower than full year 2021 with SG&A planned to be approximately $450 million for the year. Due to the combination of the actions we were taking in response to the current environment, the benefits from our fleet optimization program and lower incentive compensation expense. We are planning significant marketing investments for the back half of the year, which we believe will continue to support TCP sales and acquisition goals, as well as support the continued momentum in our Gymboree and Amazon businesses. We're planning for lower interest expense in the back half of the year, resulting from the favorable interest rates we secured as part of the refinancing of revolving credit facility and term loan in the fourth quarter for 2021. In line with historic norms, we expect to generate significant operating cash flow in the back half of the year, providing us with the ability to continue to return capital to our shareholders and reinvest in our business. Lastly, we are planning for capital expenditures of approximately $45 million for fiscal year 2022 with $26 million remaining for the balance of the year, the majority being allocated to support digital and supply chain fulfillment initiatives.

Great. Thank you so much. Jane, I want to ask you about just AUR in sort of the context of this quarter, second quarter was sort of an unusual quarter. As you think about the AUR gains that you've been able to maintain, how would you think about just at a high level? I know you're not giving guidance for fiscal 2023, but how do you think about what the gross margin should look like in a normalized environment, once some of the supply chain stuff and maybe some of the unusual promotions from some of these competitors sort of gets back to regular levels?

I'm going to address the first part of your question and then pass it to Rob. Regarding the AUR question for Q2, we touched on it in the script, but I think it deserves a deeper look. We experienced an industry-wide slowdown in June, especially in softlines and discretionary products, which has been widely reported. What caught us off guard was the significant and unexpected increase in promotional activity from our two main competitors starting in early June and escalating through mid-June until the quarter's end. From our perspective, it's frustrating. We all saw the benefits of tightly controlled inventories last year, and it's difficult to witness a return to excessive inventories in the sector in less than a year. Additionally, what made Q2 even more frustrating was that our competitors' issues weren't specific to kids' products; one faced challenges with hard goods, while the other had problems in adult apparel. Ultimately, that didn't matter much since they are both large retailers with extensive reach and are our two biggest competitors. When they hold substantial sales in one area, it attracts customers, and while they're there, they will also shop for their kids. With such large promotional events, we had no choice but to compete on price. Historically, Q2 has been our weakest quarter for EPS and operating margin. The nature of our summer fashion products leans heavily toward commodity items since there are no major holiday products in Q2, unlike in Q1, Q3, and Q4. Most of our fashion offerings in Q2 consist of commodity categories like shorts, mix and match items, and graphic tees, which dominate our sales until the second week of July when we transition to back-to-school products. With competitors selling these commodity items at drastically reduced prices and our AUCs at decade highs, we faced significant challenges. Our planned total AUR for the quarter was set for mid-single digits, with fashion planned for low-single increases, the lowest we see all year, while basic AUR was forecasted to rise in the low teens. We achieved our AUR targets in basics but significantly missed our fashion targets. This AUR shortfall, when compared to our retail sales projections, resulted in a nearly 500 basis point margin miss for the quarter. Looking ahead to Q3 and Q4, we believe we've mitigated risks by lowering our AUR projections for the second half of the year. We adjusted our previous AUR expectations from high singles to low singles, though we maintained our basics AUR plan since we are consistently meeting those goals. Our fashion AURs for Q3 and Q4 have also been reduced significantly. As we move forward into the latter part of this year and expect into 2023, our initial AUR this quarter is performing better, showing high single-digit growth in both basics and fashion. We attribute this resilience to our marketing efforts and the distinct fashion assortments in Q3 compared to the more commodity-focused offerings in Q2. Customers are evidently responding positively to the unique fashion products we've introduced, alongside our early holiday items for Halloween and Christmas. Looking ahead, this reinforces our need to strategically diversify our offerings, including our initiatives with Gymboree, Amazon, and Sugar & Jade. Regarding 2023 and back to Rob for more insights, cotton prices are a significant challenge for us this year, being at decade highs. However, as cotton costs begin to stabilize in the latter part of the year, we see considerable gross margin potential since, as mentioned, we have maintained significant double-digit AURs. Despite the tough conditions in Q2, we ended flat, and we aim to hold onto the substantial AUR increases achieved during the pandemic. Once cotton prices return to normal, we expect a significant boost to our gross margins in the latter half of 2023.

Jane is exactly right in the gross margin. There's, really four components. First the cotton costs, those impact our gross AUCs by high-single digits. Right now we're in the middle of our summer buy, so we'd expect some moderation in the back half of the year and benefit as those cotton costs come down. The second component is inbound transportation costs. We don't expect expedited air freight and the cost that weighed on our first half margins this year, to the degree next year. And we've seen recent moderation in container costs so we expect that for that to continue. The third component is occupancy costs. We've done really well on that over the last couple of years. And we still maintain a significant amount of financial flexibility with 75% of our leases coming up in the next 24 months. And with soft traffic we think that that positions us well for future negotiation savings. And the last piece is our focus on continuing to improve our e-commerce fulfillment.

Got it. If I can ask one more Jane just, because you mentioned the importance of continuing to focus on Amazon and the other strategic initiatives. It sounds like that Amazon business continues to evolve and improve. Can you just give us maybe dive in a little bit more and elaborate on, what you saw in Amazon in the quarter? And what's giving you confidence about that business as you move into the back half of the year and next year?

We experienced significant growth with Amazon in 2021 and entered 2022 with an ambitious plan that we have exceeded each quarter. We've again increased our targets for Amazon in the second half of the year. Our partnership with them has made substantial progress, and they are collaborating closely with us to address various opportunities on their site. They have a fragmented big kids business, and they now recognize the potential for collaboration with Children's Place to fill those gaps, especially since their inventory situation has improved. We had an exceptional Prime Day, recording a 300% increase from last year, and our sales have continued to grow consistently every week since then. In the second quarter, we put in considerable effort to address supply chain challenges on the East Coast and ensure inventory availability for Prime Day and for a strong performance in basics for August and September. Looking ahead, Amazon is continually exploring new categories. We started with the basics and are now branching into fashion. They had a successful holiday season last year with sleepwear, and their position is much stronger this year. They are also introducing outerwear for the first time and we're just beginning our work in footwear, which has seen success in the uniform category. We're strategically expanding our fashion offerings on top of our solid basics business, and we anticipate continued growth into 2023 and beyond. The partnership is exciting, and we recently launched an exclusive partnership with Gymboree, which we're eager about as well.

Good morning everyone. Jane, as you consider the transition from back-to-school to the holiday season, what insights have you gained from the macro pressures on consumers during back-to-school that might influence your holiday preparations, including timing and promotions? Additionally, regarding store traffic versus online, what changes did you observe throughout the quarter? Lastly, how is the Sugar & Jade initiative progressing in relation to your plans? Thank you.

Sure. Sugar & Jade is small, and our plan for it is also quite limited. We've been testing throughout the year to understand customer preferences. Insights from the holiday season helped shape our holiday 2023 purchases. We gained substantial knowledge in the spring and summer about the types of products customers want. It's less about outfitting with Sugar & Jade and more about the product categories. We've observed significant insights from the spring and summer that we can apply for the next spring and summer. For back-to-school, we are noticing increased demand for backpacks, fashion denim, and lounge/sleepwear. We're pleased with these insights, even though the initial plan was very modest. Store traffic improved slightly compared to the second quarter of 2021, although it was down about 4%. Compared to pre-pandemic levels from 2019, traffic remains down in the mid-30s, which is concerning. We'll continue to monitor this. We were disappointed with our Q2 results, but pleased that e-commerce traffic was up 7%, especially with a notable increase in e-commerce penetration during the last two weeks of July. As I mentioned, e-commerce traffic in Q3 is up 5%, which is surprising given the record-breaking August we experienced last year. Our focus continues to be on digital. Regarding the differences between back-to-school and holiday, we are planning to launch Christmas products earlier this year than last year. We faced supply chain issues last year that delayed the release of many Christmas items until late September or early October, which was not ideal. This year, we're aiming to launch a significant portion of our holiday products around August 25 or 28 to expedite our business. We've already launched the Gymboree holiday Christmas collection, which has been our top traffic site. Our work on emotional products has paid off; Easter was our strongest business in Q1 as customers started dressing up again. Even in Q2, despite it being a smaller part of our business, we saw continued strength in categories like woven tops for boys and key item dresses for girls, while knit categories faced a downturn. I believe this is due to consumers stocking up on knits during the pandemic, necessitating inventory clearance in Q2. Customers are returning to dress-up categories, which explains the rebound in AUR. With an earlier holiday launch, more inventory in dress-up categories than last year, and a different approach to holiday planning, we are optimistic for Q4. Last year, we faced shutdowns in December and January due to Omicron, which could explain why we expect Q4 trends to improve over Q3. We are firmly in a woven and dress-up phase, and our inventory is well-prepared for Q4.

Thank you.

We'll go next to Susan Anderson of B. Riley.

Good morning. I want to follow up on the promotions. It seems like you're quite confident about the fundamentals and that the situation is relatively stable. You believe there's no urgent need to promote. What do you see as the risk if competitors start promoting basic products for back-to-school? Would you need to follow their lead? Additionally, it appears that competitors have a solid inventory of kids' products, but other categories might be driving traffic and purchases. How do you view competitor inventory, and could that pose a risk of needing to promote more in the upcoming quarter? Finally, regarding supply chain issues, what are the chances of those resurfacing in the third quarter? Also, could you discuss expectations for freight and shipping costs in the third quarter compared to last year? Thank you.

Sure. When comparing ourselves to our two main competitors, I believe we are performing well in the basics, which has always been one of our strengths. In terms of pricing, we are competitive and, in some instances, even lower than them. I'm confident that we'll maintain our basics average unit retail price as we have throughout the year. If we can manage to maintain our position in a challenging environment like we did in the second quarter and considering the past few weeks of August, where most of our back-to-school sales occur, I believe we can keep that average unit retail where we need it. For the third quarter, we initially planned an approximately 9% increase in our average unit retail. The basics are expected to remain in the low teens, while fashion has been revised down from mid-singles to down mid-singles, resulting in a total average unit retail plan of 2. We think we've appropriately reduced the risk in fashion due to the over-promotions by our competitors. Regarding kids' inventory, it does not seem to require promotions as it doesn't appear to be a pressing issue for our competitors either. They seem to be facing challenges in other areas, such as hard goods and women's apparel. In the second quarter, our competitors became overly competitive, leading to aggressive promotions in kids' items to attract customers. We noticed significant price reductions on basics, like $2 and $3 items. By lowering our fashion average unit retail from an increase in mid-singles to a decrease in mid-singles, we are effectively reducing that risk. In terms of supply chain challenges in the second quarter, we strategically utilized East Coast ports for nearly a decade, which served us well, especially with the issues on the West Coast during the pandemic. In 2021, we experienced fewer disruptions than most due to our strategic port usage. However, we encountered delays when our competitors moved their receipts from the West Coast to the East Coast ports, leading to an unprecedented backlog, particularly at Savannah, which is critical for us. This resulted in many of our July basic deliveries being stranded for over four weeks, some of which have yet to arrive. Consequently, we had to spend more than planned to rebalance our inventory in distribution centers. We shifted inventory to support trends on platforms like Amazon and digital channels, which also increased our distribution costs due to higher freight and labor expenses for e-commerce shipments at lower average unit retail, impacting basket sizes, all connected to the over-promotions. Looking ahead to the third and fourth quarters, we do not anticipate recurring supply chain costs since our merchandise will be arriving. We remain in close communication with our logistics team, and as of yesterday, there were 35 vessels anchored at Savannah, marking a significant improvement. The Georgia Port Authority has projected a return to normal operations by mid to late September, allowing us to manage future inventories without issues. We have visibility into incoming shipments through week 39, and everything appears manageable, so we do not expect to face similar scrambling in our distribution centers as the East Coast ports stabilize and other retailers shift back to the West Coast now that conditions have improved.

Hi. Thanks. This is Kelly on for Paul. Just curious if we could circle back on the composition of your inventory. I think you said spring/summer units are down 45% versus last year. Does that mean, you do not have much carryover excess spring/summer inventory to get through at this point? In other words, you're sort of – you entered the back-to-school season pretty clean from an inventory perspective. And sorry, if I missed this how much are your total units up year-over-year?

Yes. That's exactly what it means Kelly. Our spring/summer is down 45%. The predominant driver in our inventory increases are increased AUCs and higher costs. That accounted for nearly just over 60% of the increase. From a unit inventory perspective, we have a small amount of – tiny amount of growth and that's really relative to our strategic growth initiatives Amazon Gymboree and Sugar & Jade.

Hey, guys.

Good morning.

Good morning. I just wanted to clarify, Jane you've talked a lot about sort of the basics business versus the fashion business versus the dressy, three different things in your store. But it sounds like your customer is responding to those either need pockets, so back-to-school uniforms or emotional pockets so holidays or family event. Can you just talk about her resistance or penchant to come in or be online and buy those items versus the other? And I guess, what falls in that other pocket because you then clarify the difference between wovens and knits. So it doesn't sound like it's across the board on the fashion. It sounds like she is being very specific and mindful in what she's shopping for if I could put it that way?

Yes. Marni 100% agreed that she has been very specific and mindful from a basic point of view 100% agreement, she's still stocking up on those. She needs them for back-to-school. They've been a very strong part of our business from July 15 onward. They always are a much bigger part of our business this time of year. And we're very happy with what we've seen. We mentioned the AUR. We feel very good about where we planned, where we're actually coming in and the AUR associated with that. When you go uniform obviously would be included in that uniform denim backpacks those types of things. When you look at the emotional product, and you go online and you see things like apple picking and harvest and the plats that we bring in and the family looks, and all those things. She is clearly responding to those as well, which is why I think that the fashion AUR is holding up a lot better in Q3 than it did in Q2. And then you get to the resistance categories. And so what I would call the resistance categories and this has been year-to-date. We'll have to see what happens in the back half would be the knit categories. And so the T-shirts, the mix and match, those types of things, sleepwear have all been subpar performers in the first half of the year, because when you saw how they outperformed in 2021, I think that there would naturally be a pullback. And so you think about as you move into Q3 and Q4 for us what are those categories and the things that come to mind right away for me is the long sleeve knits and active bottoms which are two big, big categories for us in Q3 and Q4. And so those are the types of things that we have to watch carefully and we have to watch to make sure that we're not overpromising ourselves on AUR, because those are categories that we have to wait and see, if mom is going to start to buy those again, or if she's going to still think that she's got enough knits to last her and she's going to continue to go for woven tops and into woven bottoms. I think the other thing that is going to have to happen, before those specific net categories that I'm talking about get back on track again is definitely a weather change. I do not anticipate the mom is going to start stocking up on any type of knit category until she needs to. And so I think when we see the weather change, which we'll hopefully see in mid-September – mid to late September, we'll really have a much better idea of how knits in general as a category is going to perform through Q4 in the back half of the year.

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