PLCE - NASDAQ

Good morning, and welcome to The Children's Place Third Quarter 2022 Earnings Conference Call. On the call today are Jane Elfers, President and Chief Executive Officer; Sheamus Toal, Chief Financial Officer; Maegan Markee, Senior Vice President, Digital Marketing; and Josh Truppo, Vice President, Financial Planning and Analysis. [Operator Instructions] As a reminder, this conference is being recorded. The Children's Place issued its third quarter 2022 earnings press release earlier this morning and a copy of the release and presentation materials 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. I would like to welcome Sheamus Toal, our Chief Financial Officer to the call. Sheamus has more than 25 years of financial and operational management experience. Sheamus is a strategic leader with a proven track record of delivering financial and operational improvements and is respected as a highly collaborative business partner. On behalf of the entire senior leadership team we are thrilled to welcome Sheamus to The Children's Place.

Thank you, Jane. Good morning, everyone. As you may know, I joined the company last week and I wanted to take this opportunity to thank Jane and the Board for their trust in me. I am so excited to be part of The Children's Place family and I strongly believe that we are well positioned for future operating margin and EPS growth. As a parent, I have been a long-time Children's Place customer, and I know firsthand that this is an amazing brand with outstanding recognition. We clearly have superior product and a strong value proposition, which when combined with our customer-centric focus and digital dominance, creates significant opportunity for future growth. I am excited to partner with Jane and the talented senior leadership team that she has assembled to further enhance shareholder value. I truly believe that the best is yet to come for our strong brands.

Thank you, Sheamus. I'd also like to welcome Maegan Markee, our Senior Vice President of Marketing to the call this morning. In addition to leading our marketing organization, Maegan also leads our Amazon initiative, both of which she will discuss later in the call. I want to start off by highlighting and recognizing our entire team for 2 key company-wide accomplishments. First, we published our 2021 ESG report on October 31, and we are proud of the progress we have made on the company's environmental initiatives, including our science-based goals to reduce greenhouse gas emissions and our measurable targets to increase the use of more sustainable raw materials in our products and to reduce the use of water and chemicals in our global supply chain. In addition, we are particularly proud of our industry-leading gender diversity across every level of our organization from our sales associates to our Board of Directors, a key differentiator in the marketplace that we believe gives us a competitive edge. 85% of our customers are women and 87% of our workforce are women. Our women-led company many of whom are mothers deeply understand the wants and needs across our diverse customer base, allowing the voice of our customer to be at the forefront of our decision-making. Second, we are very proud of our newest brand, PJ Place, which launched online on October 12. PJ Place is the ultimate sleepwear destination and PJ Place as 2 key growth components, both of which provide us with additional market share opportunities. Maegan will cover PJ Place in her prepared remarks. I want to thank our entire organization for all their hard work on successfully delivering these 2 important initiatives. Moving on to results. Top line sales for the quarter slightly exceeded our projection. August top line performed in line with expectations and represented approximately 39% of our retail sales for the quarter. Post Labor Day sales were soft, but we experienced a significant top line lift later in the month of September and through mid-October as a result of the combination of cooler weather across the northern parts of the country and the launch of 3 powerful celebrity marketing campaigns. Sales significantly decelerated the last 2 weeks of October. Gross margin was approximately 300 basis points below our internal expectations due to transitory supply chain cost pressures, including elevated freight, distribution and transportation costs. Unlike many other retailers, we did not experience significant supply chain cost pressure in the back half of 2021. So we are currently experiencing our largest year-over-year supply chain cost increases. From an AUR perspective, we were encouraged by our ability to pick up 4% in AUR for the quarter versus our internal projections of an approximately 2% increase, even with the heightened promotional environment. This speaks to the strength of both our product assortment and our marketing efforts and is a positive sign for the future as we continue to see cotton prices normalize. Moving on to our digital-first strategy. Digital represented 50% of our total retail sales in Q3 versus 48% in 2021 and 37% in 2019. We're very proud of our industry-leading digital penetration, and we're excited about our digital growth opportunities in 2023 and beyond. E-commerce traffic held up well during the quarter, at positive 6% versus last year. We continue to deliver industry-leading digital results supported by the combination of our structural reset during the pandemic our increased marketing investments and our focus on optimizing our channel results. Our Digital acquisition for the quarter was approximately 60%, a metric we are very focused on as our millennial mom continues to prefer to shop for her kids online versus in stores. Every quarter, we cite our comp store traffic metrics versus 2019, and they are consistently significantly down versus pre-pandemic levels with store traffic in Q3 down 23% versus Q3 2019. The millennial moms shift to digital was happening long before the pandemic. And now as we're about to enter our third year since the pandemic first hit, the preference for online shopping by our millennial mom has only increased. Maegan will provide more detail on our millennial mom in her prepared remarks that will further validate that our decision in the early stages of the pandemic to significantly accelerate both our digital transformation and our store closures, resulting in almost 1/3 of our stores closing since the start of the pandemic was clearly the right strategic move for us based on our customers' strong preference for online shopping. Importantly, in order for us to take full advantage of our millennial moms preference for digital purchasing the intense focus and success that we have had in shifting our primary acquisition channel to digital from stores in a remarkably short period of time is a key strategic shift. Continuing to rely on our stores who are experiencing multiyear declines in traffic as our primary acquisition vehicle when the overwhelming majority of our customer base is a millennial mom, who prefers the digital shopping experience would not have positioned us for future success. Our millennial moms’ clear preference for the ease and convenience of shopping for her kids online is here to stay and we believe our rapid and successful shift to make digital our primary acquisition channel gives us an important competitive advantage as we work to acquire and retain millennial moms and begin to market to the oldest of the Gen

Thank you, Jane. Based on our decision at the start of the pandemic to accelerate our digital transformation and significantly accelerate our store closure program, we knew we needed to also accelerate our marketing transformation at the same time in order to be ready to take advantage of what we believed would be a significantly bigger and stronger digital business coming out of the pandemic. We invested in the team, enhanced our process and upgraded our tools in order to emerge from the pandemic with a strong digital marketing strategy in place. We began the journey by restructuring our marketing organization across 4 key areas: customer centricity, marketing mix optimization, resources and branding. First, customer centricity. For any retailer, it is important to have a deep understanding of your customer. For us, given our high natural churn as our customer is constantly sizing out of our product, it is absolutely critical that we keep up with the wants, needs, behaviors and expectations of our increasingly digitally savvy customer. The millennial mom makes us the largest and fastest growing share of our customer base. She was born between 1980 and 1995, and she's between 27 and 42 years old. Approximately 80% of new moms in the U.S. are millennials, and over 70% of millennial moms have school-aged kids. The percentage of millennial moms is projected to continue to increase for the next 2 decades. The millennial mom values speed and ease when shopping for her kids. Millennials are the most socially connected generation in history and spend an average of 8.9 hours a day consuming media and over 17 hours a week on social networks. They favor Facebook and Instagram and have an average of 3.5 social media accounts. Younger millennials and Gen

Thanks, Maegan. As you can clearly tell by listening to Maegan, we are very excited about the results we are achieving through our increased and targeted marketing efforts and we're even more excited about how we can leverage these learnings to drive results in 2023 and beyond. We're also very pleased with our continued strong results from our Amazon partnership. Through the collective efforts of our entire team and with the help of many of our best-in-class outside providers, we have successfully made the transition to a digital-first retailer, and we're not looking back. Looking ahead, we have reduced our top and bottom line expectations for the fourth quarter due to the combination of an increasingly challenging macroeconomic environment and continued supply chain cost pressure. Sales for the first 2 weeks of November were below expectations, and we anticipate that the record levels of inflation impacting our core consumer will continue to result in lower demand this holiday season. We are now planning for a significantly heightened promotional environment in the fourth quarter and we are focused on rightsizing our inventory levels during the quarter and anticipate that due to our planned actions, our inventory will be better positioned ending Q4 at up approximately high single digits. I'll now turn it over to Josh.

Thank you, Jane, and good morning, everyone. After I review our Q3 results, I will provide our Q4 and full year outlook. For the fiscal third quarter, we delivered an adjusted earnings per diluted share of $3.33 versus $5.43 in 2021 and $3.03 in 2019. Net sales decreased by $49 million or 9% to $509 million versus $558 million in Q3 2021 and decreased $16 million or 3% versus $525 million in Q3 2019. Our U.S. net sales decreased by $60 million or 13% to $417 million versus $478 million last year, and our Canadian net sales decreased by $7 million or 14% to $46 million versus $53 million last year. Comparable retail sales were negative 10% versus Q3 2021 and positive 7.6% versus Q3 2019. Our Q3 net sales were negatively impacted by the continued slowdown in consumer demand, driven by the unprecedented levels of inflation combined with increased promotions across our competitive set. As we discussed in our Q2 call, 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 impacted this year's key back-to-school selling season and the impact of permanent store closures representing approximately $14 million for the quarter. Our net sales were positively impacted by outsized sales growth in our wholesale channel with Amazon. And as Maegan discussed, our successful marketing strategies contributed to our sales beat versus our projection. Our sales by channel were the following: Consolidated digital sales decreased 8% versus Q3 2021 with our digital penetration growing to 50% of our total retail sales versus 48% in 2021 and 37% of retail sales in 2019. Store net sales were down 18% versus Q3 2021. Our comp store traffic was down 6% versus Q3 2021. However, as a point of reference, store traffic remains significantly below pre-pandemic levels with comp store traffic down 23% for Q3 2022 versus Q3 2019. Adjusted gross margin decreased 910 basis points to 34.8% of net sales compared to 43.9% in Q3 2021 and 37.8% in Q3 2019. While our previous outlook had assumed a 600 basis point decrease in gross margin, we incurred an additional 300 basis point decline driven by higher transitory supply chain costs in the quarter, including higher container costs and air freight, which has peaked in the back half of 2022. The 900 basis points decrease versus Q3 2021 was primarily driven by the following items: First, the sales mix shift to wholesale, which operates at a lower gross margin. We had planned for an increase in our Amazon business in Q3 2022 versus Q3 2021. As a reminder, while our Amazon business operates at a lower gross margin, it is accretive to our consolidated operating margin, delivering operating margins nearly as high as our own digital channel. Second, the impact of elevated inbound freight transportation costs, driven by higher levels of air freight and higher container rates. As a reminder, unlike many others, we incurred minimal supply chain cost pressure in 2021 due to being in a strong inventory position. Therefore, supply chain costs are more significantly impacting us in 2022 with the peak of those costs happening in Q3 and Q4. With that being said, container costs are moderating, and we will begin to see relief in 2023. While the supply chain continues to negatively impact our results, these elevated costs are transitory in nature and we believe that signs are pointing to the light at the end of the tunnel for the post-pandemic supply chain challenges, which are expected to moderate throughout 2023. Last, we were impacted by lower merchandise margin versus Q3 2021, driven by significantly higher AUCs that were partially offset by higher AUR. On the positive front, despite lower merchandise margin versus last year, our merchandise margin exceeded our internal expectations, which was driven by higher AUR in the quarter. Over the last few quarters, we have discussed the importance of the structural reset to our business model and P&L since the start of the pandemic. One of the key pillars of that reset is our pricing and promotional strategy. Our ability to hold AURs above pre-pandemic levels will continue to have a benefit on the business and drive improved margins. Unlike the transitory supply chain costs, we believe that our pricing and promotion reset is a permanent structural change that will continue to drive our merchandise margins higher versus pre-pandemic levels. We believe that this reset will have an outsized impact as record high cotton prices decrease and supply chain costs moderate. In Q3, we had planned for a 2% AUR increase year-over-year. Our actual AUR increase was 4%. As a reminder, in Q2, our AUR was flat. As discussed on our last call, the major driver of our flat Q2 AUR was our fashion AUR, which was down negative mid-single digits. In Q3, our fashion AUR turned flat. This, combined with our continued double-digit increase in basics AUR resulted in the overall 4% increase for the quarter. Adjusted SG&A was $105 million versus $115 million last year and $117 million in 2019, and deleveraged 10 basis points to 20.7% of net sales compared to 20.6% of net sales last year. The deleverage was driven by the decline in net sales on our fixed expenses and was partially offset by lower incentive compensation expenses and a reduction in discretionary spend. As we have continued to experience gross margin pressure from the supply chain, we have and will continue to take actions to reduce discretionary spending. As planned, marketing spend was higher in the quarter, inclusive of investments in brand marketing. Adjusted depreciation and amortization was $12 million in the quarter versus $14 million last year and $18 million in 2019. Adjusted operating income for the quarter was $59 million, a decrease of $58 million versus $117 million of operating income last year and deleveraged 930 basis points to 11.6% of net sales compared to 20.9% of net sales in Q3 2021 and decreased 50 basis points versus 12.1% of net sales in Q3 2019. Our adjusted interest expense for the quarter was $3.8 million versus $4 million last year, and our adjusted tax rate was 20.8%. Moving on to the balance sheet. Our cash and short-term investments ended the quarter at $19 million, and we ended the quarter with $265 million outstanding on our revolving credit facility. Additionally, we made progress on inventory levels during the quarter. We ended Q3 with $549 million of inventory or up 24% versus last year compared to our Q2 ending inventory of $616 million or up 34% versus last year. The increase in inventory versus last year is driven by higher costs including higher AUC driven by cotton and higher inbound transportation costs. Our basics inventory, which includes several key high-volume categories with limited to no markdown risk accounted for approximately 50% of our on-hand inventory at the end of the quarter. Moving on to cash flow and liquidity. We generated $36 million in cash from operations in Q3 versus $71 million last year. Capital expenditures in Q3 were $12 million. During the third quarter, we repurchased 434,000 shares for $18 million leaving 178 million outstanding on our current authorization. Year-to-date, we have purchased 1.6 million shares, which represented approximately 12% of our total outstanding share count. Now I will provide an update on our store activity in the quarter. We did not close any locations in the third quarter, and we now plan to close between 40 to 50 stores for full year 2022. We continue to carefully evaluate our store fleet and close lower-volume unprofitable stores. With over 75% of our fleet coming up for lease action in the next 24 months, we are maintaining 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 and total square footage of 3.1 million square feet, a decrease of 7% compared to Q3 2021 and 30% versus Q3 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 at 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. Now let me take you through our outlook for Q4 and fiscal 2022. Moving on to our Q4 outlook. Our revised Q4 outlook reflects significant headwinds, the biggest of which is the macroeconomic environment and continuation of record inflation. While inflation has impacted our business all year, this is the first holiday shopping season experiencing this 40-year high inflation. As we have said previously, the average income demographic of our core customer is one that is the most heavily impacted, particularly by elevated food and fuel prices. Our revised outlook reflects these current economic conditions and the likelihood of a challenging season. Additionally, we are now planning for a significantly heightened promotional environment in the fourth quarter, and we are focused on rightsizing our inventory levels during the quarter. We now anticipate that due to our planned actions, our inventory will be better positioned at approximately up high single digits ending Q4. It's important to note the vast majority of our current on-hand inventory has been impacted by the higher freight and supply chain costs. Therefore, we will continue to experience these higher costs as we sell through that inventory in Q4. The company now expects net sales for the fourth quarter to be in the range of $460 million to $470 million representing a low teens percent decrease in comparable retail sales versus Q4 2021 and an approximately flat comp versus Q4 2019. Adjusted operating income is expected to be in the range of 2.5% to 3.3% of net sales as compared to 12.1% in Q4 2021, primarily driven by the decrease in sales and gross margin. This compares to 6.9% in Q4 2019. We anticipate fourth quarter adjusted earnings per diluted share to be in the range of $0.50 to $0.75, as compared to adjusted earnings per diluted share of $3.02 in Q4 2021 and $1.85 in 2019. We anticipate that the Q4 2022 gross margin rate will experience a similar year-over-year decrease as Q3. Approximately half of this decrease will be driven by elevated freight and supply chain costs, while the other half will be driven by the rightsizing of inventory levels and the significantly heightened promotional environment. We continue to plan for higher marketing investments in Q4, which we believe will continue to support our sales and acquisition goals, as Maegan discussed earlier. We are planning for capital expenditures of approximately $10 million for the quarter, the majority being allocated to support digital and supply chain fulfillment initiatives. Moving on to our full year outlook. For fiscal 2022, the company now expects net sales to be in the range of $1.713 billion and $1.723 billion, reflecting a low double-digit decrease in comparable retail sales versus fiscal 2021 and a positive low single-digit comp increase versus full year 2019. We project that e-commerce penetration will increase to approximately 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 in the range of 4.7% to 4.8% 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 in the range of $4.05 to $4.30 as compared to $13.40 in 2021 and $5.36 in 2019. We are planning for a full year tax rate of approximately 23%. Thank you, and we will now open the call to your questions.

[Operator Instructions] We'll take our first question from Dana Telsey of Telsey Advisory Group.

Welcome Sheamus. Nice to see you again or hear you again.

Thanks, Dana.

Would love to get some more color as you see the current environment and the consumer. Is there a difference whether it's online, whether it's urban areas, suburban areas, malls? Whether it's rural? How are you seeing the consumer, how did it differ? And then on supply chain, how do you think about supply chain costs and the progress for you guys going forward into '23?

Sure. Well, I think from the -- as far as stores versus online, we are certainly seeing significant traffic challenges in all of our stores. Our outlets are performing slightly better in Q3 than our stores did, and we think that probably has something to do with the inflationary pressure on our consumer and seeking out deals in the outlet centers. As Maegan discussed and I discussed in the prepared remarks, the digital business has held up very well. We had increased traffic. So we're feeling good about where digital is headed. As far as supply chain, we are under significant supply chain cost pressures, and we've been calling these out all year. Again, in Q3, we had 300 basis points, as Josh called out of additional unplanned quote unquote, if you will, “supply chain costs”. And I think in looking at The Children's Place, when you look at what happened to us last year, we had very, very little supply chain pressure. And unlike most, if not all, other retailers in our competitive set, we didn't call out supply chain cost pressure in 2021 because of our inventory position. As if you remember, we were in really good shape with basics going into the back half of 2021 because we had them from the year before when the pandemic hit and kids didn't go back to school. So we weren't scrambling for containers. We weren't scrambling to put our goods on airplanes. And like I said, we were in a strong inventory position. So it is really, really showing up this year in the gross margin, how these costs are really kind of rocking us. And so we don't have the cushion from last year. We don't have a cushion of having spent $50 million on air last year. And so we're really, really seeing those peak costs now. This is the peak year, certainly for the AUC from cotton and for the input costs, and this is the peak year for supply chain costs. The good news is the cotton is moderating and the good news is the supply chain costs are moderating. And it's getting into the back half of '23, we're going to see significant progress on both those 2 fronts. We're going to live with these supply chain costs into Q4, which Josh mentioned. We're looking at another 900 basis points of gross margin pressure in the quarter, pretty much evenly split between merch margin, pressure from the competitive environment and what we anticipate to be a much, much more promotional environment, what we've seen in the last 2 weeks of October. Certainly, in the first 2 weeks of November is a significantly changed consumer and a significantly changed promotional environment. So we are going to focus on moving through our inventory and ending the quarter clean with no pack and hold, and we are going to continue to absorb supply chain costs in the quarter. So that's really how we see it. Like I said, the good news is both of them are abating. And when we get to the back half of '23, I think that we'll be on a much better path towards higher margin and EPS results.

We'll take our next question from Jim Chartier of the Monness, Crespi, Hardt.

I understand the level of freight inflation. But just as kind of surprised I guess, why were you so surprised by the level of cost? It seems like something you would have had visibility into in August? So just hoping you can provide more detail on what happened in the last 3 months and then why this was such a surprise?

Yes, Jim, I think as I called out in my prepared remarks, out of the 900 basis points, there's about 300 basis points that we didn't expect, a vast majority of that is the incremental freight. As Jane mentioned, we continued to navigate through what was still a very volatile supply chain environment, we incurred more freight than we had planned and sold through the merchandise that we received really at a higher level of freight. So from that perspective, that's the biggest piece of that 300 basis point decline. The other piece of that 300 basis point decline, while it's a smaller piece relates to our distribution center, again, still under the realm of supply chain but in late September, we had a significant influx of orders, and we had to move more of our orders to our third-party fulfillment, which we fulfill at a slightly higher cost. So as Jane mentioned, from a freight and supply chain perspective, we think go forward as we provided in Q4, and you saw our guidance, obviously. We have captured the cost that we feel we're going to absorb in the P&L as we continue to sell through the higher freight inventory and again, really get aggressive to end 2023 -- I'm sorry, end 2022 in a rightsized and really clean inventory position.

Okay. And I guess -- I mean, do you -- I mean, a lot of companies lock in freight costs, container costs on an annual basis. I guess, how are you approaching that? And are you going to negotiate an annual rate next year? And then when would that happen?

Yes. So we're seeing in the market as others are supply chain costs moderating now. Obviously, that doesn't impact our inventory that we're going to sell through in '22 and even to an extent in the first part of 2023, but we are starting to capitalize on the slightly lower container cost which we are seeing out in the market. And as Jane mentioned, really, when we're going to see the significant impact of those moderating supply chain cost is going to be in the back half of 2023.

Okay. And then just on Amazon, what do you think the growth rate is going forward? And I guess where are you in terms of maximizing the potential of that opportunity?

Yes. I mean I'll let Maegan talk about the potential with Amazon and the opportunity. I think from a numbers point of view, we talked a little bit about picking up a nice chunk of business in Q3. We haven't really given the Amazon revenue metrics. So we're not going to do that today. But from an opportunity point of view, Maegan, if you want to comment on that?

Yes. I mean I think longer term, we believe there's a significant amount of growth opportunities still sitting in this partnership. There's an incredible amount of white space in the kids business in Amazon. And really until now, there hasn't been a leading brand in the kids category. Our product, the depth and breadth of our assortment is really unmatched in the industry and certainly in the Amazon marketplace. And I think when we look at the incredible return on investment that we're seeing in our marketing investments and the efficiencies that we're gaining, it's signalling significant amount of headroom for our brands. So I think at this point, we don't even really know how high is high, and we're anticipating that this business will continue to grow for all of our brands on the Amazon marketplace.

We'll take our next question from Jay Sole of UBS.

Jane, can you just talk a little bit more about the promotional environment? How much is it being driven by traffic maybe slowing and the consumer being weaker? And how much is it being amplified by just the unusual levels of inventory at all of your competitors and what they're doing and how much more promotions you have to do to get your inventory back to where you want it to be?

Yes. I think, Jay, that we really saw a drop-off in business in the last 2 weeks of October. We had a really nice trend going from the mid-September to mid-October when the colder weather hit and also driven by the marketing campaigns. And then like we said, we saw a pretty precipitous drop off in end of October. And we got more promotional. If you go on our website, you can see we're in a 60 off event, which we haven't been in all year. There is definitely heightened promotions from our competitors that we're aware of. I think at the end of the day, when you look at the last 2 weeks of October and the first 2 weeks of November and what's happened to business, you just -- it's undeniable that for our customer, at least, that dealing with the 40-year record high inflation is definitely eroding our core customer spending power, if you will. Our customer is in a position now where they're going to have to make choices between discretionary spend and essential spend. Food's up, gas is up. You guys know that. They have less savings than they did a year ago, and they have less money to allocate. So she's in a different place than she was last year when she had stimulus, there was pent-up demand, supply chain shortages, none of that is really happening this year. Savings are leaner, and we've really seen her curtail discretionary spend. So our focus in Q4 is to really end clean. We have high AUC goods right now, which you know. And you can see that's showing up quarter after quarter in the supply chain pressure. So our focus is to really to deal with the challenge of the inflation, is to ramp up our promotions to stay competitive, number 1 and stimulate more discretionary spend, if you will, from what is now an extremely price-sensitive consumer. So we see the balance of Q4 being very promotional. We'll know a lot more when we get to next year and we start to see what happens on those real promotional days of Black Friday and Cyber Monday, we anticipate going into December and seeing a low, particularly in the first part of the month and we'll see what happens in Christmas and then particularly post Christmas when the sales are on. But we are not -- hope is not a strategy, and we are not feeling that the customer is going to come roaring back this quarter. So we are going to get those inventories clean. You can see it in our guidance. We're going to move through it. We're going to stay competitive, and we're going to do what we can to, like we said, kind of see if we can get some more discretionary spend out of what is a very strapped consumer at the moment.

We'll move next to Marni Shapiro of Retail Tracker.

A lot of my questions have actually been answered, but I just have a couple of quick follow-ups. The holiday line and the Pajamas look outstanding. So this is clearly not a product issue. This is like you said pulling back. But it sounds like you're saying that the worst of your expenses are now have peaked and it's starting to abate heading into '23. If you could just confirm that's what we were hearing? And then I guess, could you talk a little bit just about the marketing costs and how we should think about this going into '23. Have -- are you seeing any abatement in the marketing costs from social media, for example, Facebook and Instagram marketing costs have gone much higher? You guys are spending more there. So can you just walk us through what that looks like in '23 as well?

Sure. I think we have answered some of those, Marni. We have a lot of macro challenges that are impacting us this year in 2022. We talked about decade high cotton prices and decade high AUCs. So the good news is cotton is moderating, and we're going to start to see that in the back half of '23 with the back-to-school buys. We're coming out of a 100-year pandemic. The good news is those effects are starting to moderate as well. We've talked pretty extensively this morning about supply chain costs, and I assume we'll continue to talk about them. But this is the peak year for them, and certainly, Q4 is the peak quarter for them. And so we will do what we need to do to get our inventories clean and start to see those supply chain costs start to moderate in 2023. We've spoken about inflation, we've spoken about where our customer is certainly. They have 1 bucket of spend and a higher and higher piece of it is going towards necessity. So we'll do what we can to stimulate the discretionary buying as we talked about. I think the good news is there's a lot more opportunities. We have a lot more long-term opportunities than we do short-term challenges. So we covered a lot of them today. We've covered it this year. We're a different company than we were before the pandemic. We've been on offense for the last 3 years. We've restructured the company and what I would consider I guess, I've been in the business for a long time, I would say that this is certainly the most challenging time I felt in retail history. And so staying on offense has been important for us. You look back at what we do from a product point of view, we've launched I guess, Maegan 3 brands since – 3, right?

Yes.

Three brands since the start of the pandemic. We've talked about making the pivot to a digital-first company. 50% of our business this year is going to come from digital, 60% by the end of '24. It's our highest operating margin channel. Our Amazon business is surging, the marketing function is working. It's measurable. We're acquiring new customers at a healthy rate. Our brand awareness metrics are exploding. We talked about today on the call pivoting to like a digital acquisition model, if you will, from a store acquisition model in what we think is a pretty remarkably short period of time, keeping up with where the millennial customer, which we spoke a lot about today, wants to be and wants to shop. Maegan brought up social media, and I'll have Josh answer your question about spend, but we've gotten a lot, lot smarter about spend. It's not about necessarily spending more, which we will be in '23, but it's about spending what we have smarter. And you look at the campaigns that we launched, and you brought it up about Christmas and you brought it up about holiday Christmas dress up in the holiday sleepwear, when you look back at the campaigns that Maegan spoke about, those are 2 of our largest campaigns of the quarter, and those are 2 of our strongest business. So we're just absolutely dominated social media across the entire kid set, which Maegan gave you the numbers on. We're holding on to the AUR increases versus pre-pandemic. So when cotton comes down in the back half, that's going to be really important that we have those double-digit increases and our product, which we don't talk about enough is -- continues to resonate with our customer and thank goodness mom loves our product. And then you look at some of the structural changes to the P&L. We've closed 1/3 of our stores. We've gotten significant occupancy out, fixed expense. So there is a lot more going for us than the short-term challenges of high cotton prices and high supply chain costs that are going to be in the rearview mirror in the back half of '23. So we're just going to keep doing what we're doing. We're going to keep focused. We're going to keep our head down. We're going to stay on offense, and we'll get through this. You want to talk about marketing spending?

Yes, sure. We have historically, and we've said this before, underfunded marketing. And to Jane's point, from a year-over-year perspective in '22, our marketing investment is not significantly higher. One thing we are doing, and Maegan talked about her third-party providers and the tools that we brought on, we're definitely getting more out of our dollar, right? We're increasing our marketing effectiveness, which obviously is a very important piece of our P&L and optimizing that marketing spend. As you move forward into 2023, we expect to take a small portion of all of these transitory costs that we're experiencing and reinvest it into marketing to really get that marketing spend up to the levels that we need to be at as a 50% digital-first retailer. So that's kind of how we're thinking about marketing investment.