Robert J. Vill - The Children's Place, Inc. Jane T. Elfers - The Children's Place, Inc. Michael Scarpa - The Children's Place, Inc. Anurup Pruthi - The Children's Place, Inc..

Jay Sole - Morgan Stanley & Co. LLC Stephen Albert - Bank of America Merrill Lynch Susan K. Anderson - FBR Capital Markets & Co. Adrienne Yih - Wolfe Research LLC Janet J. Kloppenburg - JJK Research Dana Lauren Telsey - Telsey Advisory Group LLC Marni Shapiro - The Retail Tracker LLC.

Good morning, and welcome to The Children's Place Second Quarter 2017 Conference Call. After the speakers' remarks, there will be a question-and-answer session. At this time, I will turn the call over to Mr. Bob Vill, Group Vice President, Finance..

Thank you for joining us this morning. With me here today are Jane Elfers, President and Chief Executive Officer; Mike Scarpa, Chief Operating Officer; and Anurup Pruthi, Chief Financial Officer. A copy of our press release can be found on our website.

Before we begin, I would like to remind participants that any forward-looking statements made today are subject to the Safe Harbor statement found in this morning's press release as well as in the company's SEC filings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially.

The company undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date hereof.

In addition, to find disclosures and reconciliations of non-GAAP measures that we use when discussing our financial results, you should refer to this morning's earnings release and to our SEC filings that can be found on our Investor Relations site. After the prepared remarks, we will open the call to questions.

We ask that each of you limit yourself to one question so that everyone will have an opportunity. I will now turn the call over to Jane Elfers..

New Jersey and Florida. With the success of this pilot, we will be rolling out focus to our entire U.S. store fleet by the end of August. The re-architecture of our digital platform has continued with the successful launch of three of our five digital releases.

These initial releases have begun the migration to our new digital platform while updating several key capabilities including our checkout process. The final two releases are scheduled to be completed by the end of September. Included in these last set of releases is the re-launch of our mobile app.

The app will provide a platform for a host of new capabilities and features. So in summary, we were and are ahead of the curve with respect to our fleet optimization initiatives.

We built off-mall early and we are proactively closing underperforming stores and optimizing our real estate portfolio, leaving us maximum flexibility and leverage to react to the significant and rapid changes in the retail real estate landscape.

We are intensely focused on a Personalized Customer Contact Strategy, which we believe is our single biggest opportunity. We view the digital disruption in the industry as a major opportunity for The Children's Place as we have the perfect customer for our personalization initiative.

A mobile millennial mom who is ready to digitally engage with us through our various omni-channel initiatives, and we also have the luxury of a built-in Gen Z customer, which will serve us well in the years to come.

Our biggest mall-based competitor announced bankruptcy and is liquidating the first 25% of their stores in fiscal 2017, the majority of them in thriving A and B centers. We are the best positioned to profit from Gymboree's bankruptcy announcement.

And in locations where we are directly co-located with their liquidation events, we have already seen a pickup in sales and traffic. Product has always been our number one priority, and we believe we have the best children's wear product team in the industry. We have deep talent and expertise in sourcing, production, design and merchandising.

And we are confident that our brand will continue to strongly resonate with our customer. We were an early partner of Amazon. We are one of their top children's wear vendors, we have a strong relationship and we continue to work together to service growth opportunities.

We have minimal debt and a pristine balance sheet, which provides us with maximum financial flexibility. And most importantly, we've had a forward-looking strategy in place for several years that has created significant value for our shareholders, and we're looking forward to continuing to deliver strong results in 2017 and beyond. Thank you.

And now I'll turn it over to Mike..

one, a sales transfer rate in excess of 20%; two, our ability to successfully negotiate rent reductions for a significant percentage of our expiring leases; and three, lease flexibility, with the majority of the lease renewals being one to two-year deals, ultimately reducing our average lease term to less than three years.

This program will ultimately result in a decrease in total fleet square footage of over 1 million square feet or 20%, along with an expansion in operating margin of 200 basis points. Now, I will turn it over to Anurup..

Thank you, Mike. Good morning, everyone. In the second quarter, we delivered adjusted EPS of $0.86 compared to an adjusted loss per share of $0.01 last year and the high end of our guidance of $0.75, an $0.11 beat the versus high end of our guidance.

The $0.86 in adjusted EPS included a $0.68 tax benefit due to the new accounting rules for the income tax impact on share based compensation. While our high-end guidance of $0.75 assumed a $0.70 tax benefit. Excluding the impact on taxes from the new accounting rules, we outperformed the high end of our guidance by $0.13.

Details for the second quarter are as follows. Net sales increased 0.6% to $374 million. Comparable retail sales increased 3.1% on top of a positive 2.4% comp in the second quarter of 2016. We continue to see a significant increase in the penetration of our e-commerce sales. U.S. comp sales increased 4.2%. Canada comp sales decreased 5.3%.

Our merchandise margin rate increased for the tenth consecutive quarter. Adjusted gross margin leveraged 100 basis points to 34.4% of sales compared to our guidance of flat to 20 basis points of leverage. This was our tenth consecutive quarter of merchandise margin increase.

We benefited from continued strong product acceptance, a lower AUC along with AUR expansion in the quarter. This gross profit leverage includes the impact of the increased penetration of our e-commerce business which runs at a lower gross margin rate. Adjusted SG&A leveraged 30 basis points compared to last year to 28.8%.

The leverage was primarily a result of decreased store expenses including lower store compensation expenses and credit card fees partially offset by increased expenses related to the investment in our transformation initiatives and increased administrative compensation expenses. Depreciation was $16 million for the quarter.

Adjusted operating income was $5.1 million, leveraging 140 basis points to 1.4% of net sales, moving on to the balance sheet. Our cash and short-term investments at the end of the quarter were $258 million compared to $246 million last year. We ended the quarter with $55 million outstanding on our revolver compared to $44 million last year.

Inventory continues to be in excellent condition, up 4.9% at the end of the quarter. Our strong cash flow and liquidity profile provides us with the financial flexibility to continue to fund our strategic initiatives and repurchase shares and pay dividends to shareholders.

We generated $71 million in cash flow from operating activities in the first half compared to $75 million in the first half last year.

We repurchased $57 million in stock in the first half consisting of shares repurchased and shares surrendered to cover tax withholdings associated with divesting of equity awards and paid $14 million in dividends in the first half 2017. Since 2009, the company has returned over $829 million to its investors through share repurchases and dividends.

Now let me take you through our Q3 and full year guidance. This guidance excludes certain costs or events that are set forth in our non-GAAP adjustments included in this morning's press release. Third quarter guidance, for Q3 we are guiding to adjusted EPS in the range of $2.41 to $2.46.

We expect that comparable retail sales will increase low single-digits. We expect adjusted gross margin to leverage 30 basis points to 50 basis points as percentage of net sales. We expect adjusted SG&A will de-leverage 30 basis points to 50 basis points as a percentage of net sales, reflecting the accelerated investment in our digital initiatives.

Our third quarter guidance assumes that depreciation will be approximately $17 million. We project adjusted operating margin as a percentage of net sales to be flat to leverage approximately 20 basis points.

We are guiding inventory to increase mid to high single-digits at the end of the third quarter compared to last year due to the timing of receipts.

Moving on to full year guidance, as a result of our operating outperformance in the second quarter of $0.13, we are increasing our full year adjusted EPS guidance to $7.23 to $7.33 per share compared to our previous guidance of $7.10 to $7.20.

Consistent with our previous full year guidance, we expect an $0.89 benefit due to the new accounting rules related to the income tax impact on share-based compensation. Excluding this benefit, adjusted full year EPS guidance is projected to increase 17% to 19% compared to adjusted EPS of $5.43 last year.

Let me provide you with details of our full year guidance. We expect comparable retail sales for the year to increase approximately 3%. We expect total net sales for the year to be in the range of $1.83 billion to $1.84 billion inclusive of the impact of the 53rd week. We expect adjusted gross margin to leverage 20 basis points to 40 basis points.

We expect adjusted SG&A to leverage 20 basis points to 40 basis points. Our full year guidance assumes that depreciation will be approximately $66 million to $67 million. We project adjusted operating margin to be in the range of 9.2% to 9.4%, an increase of 70 basis points to 90 basis points compared to 2016.

We expect our adjusted tax rate to be approximately 23% for the year, inclusive of the impact of the new accounting rules for share-based compensation. We expect apparel AUC to be down low single-digits for the year compared to 2016. Our CapEx is expected to be approximately $60 million for the year.

We expect to open two stores and close approximately 35 stores to 40 stores in 2017. At this point, we'll open the call to your questions..

Your first question is from Jay Sole with Morgan Stanley..

Great. Good morning. Jane, thank you so much for all the interesting insights on malls and Gymboree and Amazon and your personalization effort.

Can you talk a little bit about some of your initiatives to target a slightly older kid, maybe something like similar junior size 16 initiative and maybe some of the things that are, kind of, percolating in that area?.

Sure. We started size 16 online a couple of years ago, and it was such a great success that we decided to open it up to all the stores and all the channels for last back-to-school, so last year's back-to-school. We have details in the past that we think it's probably a $50 million opportunity.

What we're working on now is we're seeing really good success in the apparel. Obviously, it's only in big kids, in boys and girls. And so what we've been doing now is we've been really looking at the adjacent categories in accessories and shoes, the categories that are sized.

And we're looking at what's the opportunity to continue to upsize sizing on those ancillary categories, so that I think will be a big help to us as we continue to go forward.

We're also seeing size 14 and 16 continue to be a bigger, bigger piece of our business, so we think that we're taking share from some of our mall-based competitors that are focused on an older kid..

Your next question is from Stephen Albert with Bank of America Merrill Lynch..

Good morning. I was curious more around your strategy in terms of trying to capture share from the 216 Gymboree stores that were slated for closure where you overlap.

How much in terms of incremental marketing do you expect to outlay to capture that customer who may not have shopped you before? And what sort of flow-through do you expect to achieve on those captured sales?.

Well, as we said in our prepared remarks that we're seeing very positive sales traffic and I'll even add merchandise margin in the stores where we are co-located compared to the liquidation period. We're focusing both in mall signage as well as digital.

And from a digital perspective, we're looking at opportunities around capturing Gymboree's customers. And from a return perspective, our thought is digital marketing is fairly cheap, and the returns that we get are quite, quite good..

Your next question is from Susan Anderson with FBR Capital Markets..

Hi. Good morning. Thanks for taking my question and nice job on the quarter.

Anurup, I was wondering if you could talk about just some more color on the gross margin and what drove the upside versus your original expectations? And then with the new systems going in place for the second half, is there a continued opportunity for upside to gross margin? And then Jane, on the product, it continues to look great.

Just wondering if there's anything new or different you could talk about for back-to-school? I know last year, you did a great job of having more wear-now product, which looks like the same case is here, but wondering if there's anything else new? Thanks..

Sure. I'll start with a product side. As we mentioned in the prepared remarks, we did go after the key item basics that worked so well for us during back-to-school, and they're really off to a great start. So they really – when you look at the quarter, last quarter and second quarter, July was a really, really strong month for us.

And we really started to see towards last two weeks of July, the business really starts to pick up with back-to-school. So that investment not only washes but in certain sizes is paying off for us, and it will continue to pay off for us for the balance of third quarter.

The other thing that you may have noticed in the stores is that the assortments do continue to be a little bit more wear-now than they were last year, so we're letting short-sleeve products live a little longer than we did last year.

And we're really holding off on things like sweaters and the heavier products until we really get into the month of September. And also, if you noticed in our stores, the clearance levels are very, very low.

And I think that's really giving the regular-priced product, if you will, the back-to-school product a nice chance to really sell and not be distracted by clearance selling..

Susan, as far as margin goes, as Jane talked about, overall product acceptance continue to be very strong. And strategically, the complexion of our product assortment was to our benefit from a margin perspective in Q2. In addition, continued benefit of inventory management systems, it was a lower promotional quarter in terms of year-over-year.

A lower AUC and a higher AUR all contributed to a very, very strong gross margin performance. In spite e-commerce, in terms of its penetration, continued to have a very strong quarter. So we drove these gross margin results because of the factors I mentioned before.

But going forward, we do expect as you see in our guidance, more modest gross margin rate expansion and as our digital initiatives continue to ramp up. But overall, as in Q1, we expect this model to continue to result in operating margin expansion and operating profit growth..

Your next question is from Adrienne Yih with Wolfe Research..

Good morning. Congratulations, great quarter..

Thank you..

So, Jane, I guess can you talk about when will you be active with the sort of digital and personalization investments that you're making now? I think last quarter you did see more of the financial impact of it in 2018.

But I guess should we think about the back half of this year as being an investment phase? And then Mike or Anurup, I'm looking at the stock reaction to what I think is a really solid quarter first on the margin side.

And I'm thinking that the total sales coming in $4 million light versus the Street, part of that is the non-comp sales that your closing stores. And so I'm wondering if you can help us number one, if you could actually helped give us your store closing pattern by quarter, so people were actually modeling in the non-comp loss of sales.

And then, when you look at the total sales over the four-year period, it's about – if you think about the 20% transfer rate, it's a loss of north of $150 million to gain 200 basis points op margin lift.

And, so, I just worry that we're going to be in this constant, like, your margins are going up, and we won't be modeling the sale reduction correctly? Sorry if that's a long-winded way, but I'm just looking at the stock reaction to what you just put up and it's – I think it's – I don't think it's the right reaction if we're looking at profitability.

Thank you..

Okay. Well, I'll take the digital platform piece of it. We had said on our last call that we think Personalized Customer Contact Strategy is our single biggest opportunity and we had given the starting point of the opportunity of $200 million.

What we had said on the last call is that we would be putting the systems and processes in place through the balance of 2017 and into 2018, and looking to fully recognize – go forward as of 2019. But as far as when we're going to start seeing the payback, we're already seeing the payback.

So if you look at the digital releases that we've done, three out of five we're seeing the payback. If you look at BOPIS that we put in, in the two stores, significant payback and it's rolling out to all stores by the end of this month.

When you look at the mobile app and some of the digital things that are going to happen by the end of September, as far as features and functionalities, those will start to impact us immediately.

If you look at what we did with the PLCC and the MPR launch last October, as Mike has spoken about I think on every conference call, that's been a real, real plus to our business.

We've already started to put our insights lab together, and we've already started to test into marketing and test into personalization, that's already starting to work for us. When you look at some of the things that we've done to move the e-com business forward, that started to work for us.

And even when you look at something like we mentioned on the call when it comes to Gymboree, we didn't have any digital tools before to really go after customers or acquire customers from competitors that were closing stores.

And when you see what's happening with our business in the locations where we're co-located, not only are we seeing a lift in sales and traffic, but we're also seeing a pretty significant lift in margins and outpacing the margin increase in the rest of the chain. So we'll update you every quarter going forward.

But this is going to be an iterative process, but all positive..

And Adrian, one other thing on your question about expense investment. As we noted in our Q1 call, of our $0.21 operating outperformance, we reinvested $0.10 of that into the back half of the year. In our overall SG&A construct, which as you would note, the first half is leveraged nicely. We continue to invest in our transformation initiatives.

And that's just very much – and with the guidance now of 9.2% to 9.4% of operating margin versus 5.6% in 2014, 380 basis points. That has also seen a significant ramp-up in our e-commerce penetration. We were at 17% 2 years ago. We noted last year, we closed at about 20%. It wouldn't surprise us if we were in the mid-20% range this year or so.

So the idea, the purpose and the strategy has been about delivering the results while we continue to invest, and that's what we're focused on.

And then Mike...?.

Yes, from a store closure perspective, we've been fairly consistent over the last couple of years in terms of when our stores close. Roughly two-thirds of our store closures happen in the fourth quarter and actually happen at the January 31 period.

So, I don't know why the Street was surprised that we'd be closing a handful of doors in Q1 as we did in Q2 and we'll probably shut a few more in Q3. But again, two-thirds of it happens in the fourth quarter, usually at the end of the year..

Your next question is from Janet Kloppenburg with JJK Research..

Good morning, everyone and congratulations on a nice quarter..

Thanks..

I was wondering if you could just talk a little bit about the Canadian comp that came in lighter than expected, and I'm wondering what impacted that and how we should think about comps in Canada going forward? Also, I wondered about the investment in the personalization and customization and what impact that have made on SG&A as we move forward? Should we look for those investments to ramp? And are there other efficiencies that can offset it? And just longer term, on the double-digit operating margin goal, how much of that will come from further gross margin opportunity? I'm looking at a model which tells me that gross margin peak around 41%.

I might be wrong with that, Jane, but that's what I have. And I'm just wondering if you think you can get back there, or if it will be a combination of gross margin, maybe the 40% and some SG&A leverage? Thank you..

Sure. I'll take that Canada part. We have been consistently cutting receipts back in Canada now for about three years due to FX pressures and several other economic concerns over the past few years. And Q2 is a traditionally, kind of, tricky quarter for us that there's not a significant catalyst to get mom to buy.

And if the weather doesn't cooperate, it can be a tough/unpredictable, if you will, quarter. So when you look at Canada, the weather up there is very similar versus the United States where you have opportunity to have West Coast weather versus East Coast weather versus South weather.

So when you look at Q2 for us in Canada, when we looked at our strategy to buy Q2 receipts for Canada, we were super conservative due to the fact that there is no catalyst. It's a tricky, unpredictable quarter, and that the weather can really constrain us.

And at the end of the day, we really just pared the receipts back too far in Canada, and we just really ran out of fuel towards the end of the quarter to really drive top line. So lesson learned.

We're in a better position going forward into Q3 with the addition of basics buy and the emphasis we put on key items, and then obviously with back-to-school being such a huge catalyst for us, we're invested to a better degree up there going into Q3. And that's assumed in our guidance, the trend reversal up there for next quarter..

Janet, as far as digital initiatives go, as we noted in our prepared remarks as well and the quarter is a microcosm of the issue is that we've had – we were able to have significant leverage in our store expenses, credit card fees due to our new initiatives around PLCC.

And the entire management team is obviously extremely focused on expense management. While at the same time, we continue to invest in our digital initiatives. So more on that to continue as we – as Jane articulated in her prepared remarks, we continue to focus on driving that. You would also note in our CapEx guidance.

That also includes investment in necessary systems and capabilities, omni-channel, personalization and the like.

And as far as future in terms of – as far as – in terms of the future in terms of the model, certainly, as we talked about, we would expect as the e-com and digital penetration continues to increase that the gross margin expansion might moderate somewhat. But our real focus is on operating margin.

As you know, guidance for this year is a 9.2% to 9.4% versus the 8.5% the year prior, 6.4% in 2015 and so on. So, that's really what we're focused on..

Your next question is from Dana Telsey with Telsey..

Hi. Good morning, everyone and congratulations..

Thank you..

Last quarter you mentioned the hiring of Pam Wallack working on merchandising. Just how is that going, contributions there, and what do you expect? And then also, merchandise margin is so impressive. What are the levers go forward of that merchandise margin expansion, and how do you see that evolving? Thank you..

Sure. Pam is off to a great start. As we have mentioned on the last call, she has deep experience in children retailing. She's one of the best children's wear merchants in the country and has a very successful track record.

She knows a ton of the people at The Children's Place together with Jen Groves, our Head of Design and several other people in design. And she knows a lot of the other executives in the other areas in Children's Place as well. So she's hit the ground running.

She has already made an impact, and she's working on the product for summer of next year and then focused also on sourcing and opportunities there as well. So, great..

From a margin perspective, obviously we're pleased with our inventory management systems. We put in our assortment planning tool and allocation replenishment system about two years ago. And obviously, you layered them in over that time period, but you can see the impact that it's had overall on our gross margins.

We're up about 230 basis points over that period of time, and we've had 10 consecutive quarters of merchandise margin expansion. We, think there's more benefits to come with these systems as we continue to enhance the existing systems we have and we continue to work on new tools such as steering, size and pack and order planning and forecasting.

So we said that we expect more merchandise margin to continue to expand in the back half of the year and we will continue that with the inventory management tools that we continue to put into place and all the digital initiatives that Jane spoke about earlier and all the omni-channel opportunities that we have that we can see further expansion into 2018 and 2019..

Ladies and gentlemen, we have reached the allotted time for questions today. Our final question will come from Marni Shapiro with The Retail Tracker..

Hi everybody, congratulations..

Thank you..

So, I'm curious just a little bit on the timing because it sounds like you're doing a lot of work with the consumer digital marketing.

And if we think about, as we come through 2017 and into 2018 if you could just provide some kind of general time line of sort of when you're going to flip the switch on all of the stuff so we can have an idea, when we could see the real push?.

Yeah. I don't really think of it, Marni, as flipping a switch. It's not really, kind of, curtains up on this. This is going to happen over time into the back half of 2017, and then certainly in 2018 there's going to be a tremendous amount of functionality systems, process, tools that are going to be going online.

So, what we think about it as – as we think about as the investment through 2017, the investment through 2018 and then really as we move forward into 2019, really it'll be fully ready with a Personalized Customer Contact Strategy.

Having said that, these things are going to iterate, so we're always going to be working on our e-commerce site, we're always going to be working on our app. We're always going to be working on digital releases. We're always going to be working on fine-tuning our customer contact strategy and our PLCC program and our MPR program.

We'll be working online to up-sell. We'll be working with digital platforms to drive more traffic to the stores. We'll be working on acquisition. We'll be working on the retention. We'll be working on engagement.

And all the work that we're doing now, the groundwork we're laying through the segmentation, through the insights lab is all working towards our best-in-class, Personalized Customer Contact Strategy..

Thank you, ladies and gentlemen for joining us today. If you have further questions, please call Bob Vill at 201-453-6693. Thank you. And you may now disconnect..