Jane Elfers - CEO, President & Director Michael Scarpa - COO & EVP Anurup Pruthi - CFO & SVP.

Susan Anderson - B. Riley FBR, Inc. Adrienne Yih - Wolfe Research Janet Kloppenburg - JJK Kate McShane - Citigroup Marni Shapiro - The Retail Tracker.

Good morning, and welcome to The Children's Place's Second Quarter 2018 Earnings Conference Call. On the call today are Jane Elfers, President and Chief Executive Officer; Mike Scarpa, Chief Operating Officer; and Anurup Pruthi, Chief Financial Officer.

The Children's Place issued a second quarter 2018 earnings press release earlier this morning, and a copy of the release and presentation materials for today's call have been posted on the Investor Relations section of the company's website. [Operator Instructions].

Before we begin, I would like to remind participants that any forward-looking statements made today are subject to the safe harbor statement found in this morning's press release as well as the company's SEC filings, including the Risk Factors section of the company's annual report on Form 10-K for its most recent fiscal year.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially. The company undertakes no obligation to publicly release any revision for these forward-looking statements to reflect events or circumstances after the date hereof.

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

And now I would like to turn the call over to Jane Elfers..

first, an ERP upgrade; and second, an upgrade of our order management system. And looking ahead to 2019, we plan to implement several key capabilities, including a new point-of-sale system in conjunction with the rollout of Save the Sale functionality to all stores, along with the implementation of a single pool of inventory.

These digital initiatives and the balance of our digital road map will further separate us from our competition.

Our digital transformation is critical to our continuing to drive sales, gain market share and expand operating margins through improved acquisition, retention and engagement strategies as we work towards our 12% operating margin target for 2020. Now let me provide you an update on our private label credit card performance.

For Q2, we continue to make excellent progress on this key strategic initiative. Our private label credit card strategy is another example of a self-help initiative that is foundational to our digital transformation. We went through a very detailed analysis of our private label credit card on our last call.

We mentioned that the lifetime value of a private label credit card member is over 15x more than that of a non-loyalty member. For Q2, our private label credit card penetration increased to 23% of sales from 21% last year, and our private label credit card file increased 25% versus last year.

Together, with our provider, we believe that based on our unique business model, we can achieve a 30% private label credit card penetration by 2020. In the interest of time, I'll end here, but there are many more examples of how our strategic focus and our vision have kept us on offense in a very complex retail environment.

We believe we have significant runway ahead of us by continuing to execute on our self-help growth initiatives, and we also believe we are well positioned to gain market share from our competitors. We are looking forward to continuing to deliver for our shareholders as we move through the back half of this year and beyond.

And now, I'll turn it over to Anurup..

net sales increased by $75.1 million, or 20.1%, to $448.7 million during the second quarter 2018 from $373.6 million during the second quarter 2017.

This increase was primarily driven by a positive comparable retail sales increase of 13.2%, approximately $22 million resulting from the calendar shift related to the 53rd week in fiscal 2017 and approximately $5 million due to the new revenue recognition rules. U.S. comp sales increased 14.2%. Canada comp sales increased 4.2%.

Our key metrics were all positive, total ADS, UPT, transactions, conversion and, most importantly, store traffic. AUR was down slightly in the quarter.

Adjusted gross margin leveraged 10 basis points to 34.5% of sales as a result of the fixed cost leverage based on the strong comp, the reclassification of certain items due to the new revenue recognition rules offset by lower merchandise margins, with continued increase in e-commerce penetration.

E-commerce had very strong revenue growth of 41% in the quarter and continued its upward trajectory to represent a higher percent of our total net sales. For the quarter, e-commerce represented 26% of total net sales versus 22% last year.

As you know, while e-commerce operates at a lower gross margin rate due to higher fulfillment costs, it is accretive to operating margin, and a significant increase in digital penetration is a key component of our 12% operating margin target by 2020. Adjusted SG&A leveraged 150 basis points to 27.3% due to the strong comp.

SG&A was $122.5 million in the quarter compared to $107.6 million last year, including approximately $12 million incremental dollars of investments in our transformation initiatives and approximately $5 million increase driven by the reclassification of certain items due to the new revenue recognition rules, partially offset by lower incentive compensation expenses.

Depreciation was $16.6 million for the quarter. Adjusted operating income was $15.7 million compared to $5.1 million last year or 3.5% of sales versus 1.4% of sales last year. Our adjusted tax rate was 21% versus negative 226% last year.

The impact of the accounting rules related to the income tax impact on share-based compensation was $0.03 in the second quarter compared to $0.68 last year, as the majority of share vesting occurred in Q1 this year versus Q2 last year. For the first half, the income tax impact on share-based compensation was $0.85 versus $0.86 last year.

Let me discuss the key components of our second quarter EPS. The operating results associated with our 13.2% comp, excluding the impact of our accelerated investments, generated $0.90 in incremental EPS. The EPS benefit from the shares we repurchased, including the accelerated share repurchase program, was $0.06.

A lower tax rate generated an incremental $0.05 in EPS due to the new tax legislation and ongoing tax planning. This adds up to $1.01 in incremental EPS over last year.

This is offset by -- the EPS impact of the income tax on share-based compensation was $0.65 lower compared to fiscal 2017, and the impact of our -- of the acceleration of our investment and higher depreciation was $0.52. This resulted in EPS of $0.70 in the second quarter. Moving on to the balance sheet.

Our cash and short-term investments at the end of the quarter were $106 million compared to $258 million last year, reflecting the impact of $190 million in cash repatriated in the first half of this year, which was utilized to fund accelerated share repurchase program and working capital.

We ended the quarter with $89.3 million outstanding on our revolver compared to $54.5 million last year. Inventory was up 18% at the end of the quarter, in line with our guidance.

Cash flow from operating activities was $11 million in the first half compared to $71 million in 2017, driven by the timing of inventory purchases and lower operating income.

We repurchased $25.4 million of stock in the second quarter, inclusive of the repurchase of shares surrendered to cover tax withholdings associated with the vesting of equity awards. A total of 440,000 shares were repurchased or retired in the quarter.

This includes 237,000 shares that were retired as a final settlement of the accelerated share repurchase program. For the first half of the year, we have repurchased approximately $188 million of stock.

This equates to approximately 1.5 million shares repurchased in the first half, of which approximately 1 million shares was due to the accelerated share repurchase program. We made dividend payments of approximately $8 million, or $0.50 per share, in the second quarter versus $7.1 million last year, or $0.40 per share.

Before we move on to guidance, we want to reaffirm our fiscal 2020 financial target of a 12% adjusted operating margin and $12 in adjusted EPS. We are targeting adjusted operating margin in the range of 8.5% to 8.7% in 2018, a range of 10% to 10.5% in 2019 and 12% in fiscal 2020.

We expect total net sales to be approximately $2.1 billion by 2020 based on a mid-single-digit comp growth in 2018, '19 and '20, in addition to growth in our international and wholesale businesses.

This growth will be primarily driven by our digital business, which we expect to grow at a compound annual growth rate in the low 20% range, increasing our digital penetration to approximately 35% of total net sales by 2020.

Based on the expected growth in our digital penetration, a long-range plan incorporates slightly negative comps in our brick-and-mortar channel. However, we have seen positive -- we have been positive in this channel for the last 2-plus years.

In addition, the remaining 109 stores that we plan to close by the end of 2020 as part of our fleet optimization program have been running low negative single-digit comps. This gives us further confidence in our ability to continue to generate positive low single-digit brick-and-mortar comps.

Also with our average lease life of 2.5 years and more than 1,000 lease events through 2020, we have the flexibility to close additional doors as business dictates in order to further drive productivity and comp performance.

As we have previously discussed during the 2018 to 2020 period, we expect to invest approximately $50 million in incremental SG&A or nonrecurring SG&A or less than 1% of our total sales over this three year period versus our 2017 baseline, consisting of $30 million in 2018, $15 million in 2019 and the remaining $5 million in 2020.

We expect CapEx to be approximately $250 million over this three year period, with the majority attributed to our transformation initiatives.

And based on our continued strong cash flow generation and consistent shareholder program -- consistent shareholder return program, further aided by the ability to repatriate excess cash with the new tax legislation, our projections include $0.5 billion in share repurchase during the period of 2018 to 2020, which does not contemplate us incurring any debt to do so.

Now let me take you through detailed full year 2018 and Q3 guidance. Full year 2018 guidance. Based upon our strong results in the second quarter, we are increasing our full year guidance for fiscal 2018 for adjusted EPS to a range of $8.09 to $8.29 from a range of $7.95 to $8.20.

We expect that this will result in operating margins in the range of 8.5% to 8.7% for the full year. As a result of the strong sales results in Q2, we now expect total net sales for the year to be approximately $1.945 billion to $1.955 billion, with comp sales growth of mid-single digits compared to fiscal 2017.

We project digital penetration to grow from approximately 23% to 26% of net sales. The total revenue guidance includes the impact of the new revenue recognition rules. Due to these new accounting standards, total revenues, gross margin and SG&A will all increase by approximately $19 million in fiscal 2018.

The reclassification of certain items due to the new revenue recognition rules has no impact on adjusted EPS and comp sales. We now expect our adjusted tax rate to be approximately 15% for the year as compared to 20% in 2017 as a result of the positive impact of the new tax legislation and ongoing tax planning initiatives.

This tax rate for 2018 represents our current best estimate and will be subject to change as we evaluate the many aspects of the new tax law in future regulatory updates. We expect weighted average shares for 2018 to be approximately 17 million shares. Let me discuss the key components of our EPS guidance for 2018.

The operating results associated with our planned mid-single-digit comp, excluding the impact of our accelerated investments, are now expected to generate $0.95 to $1.15 in incremental EPS. We now expect $0.47 EPS benefit from the shares we expect to repurchase, associated with the accelerated share repurchase program and other share repurchases.

We expect that a lower tax rate will now generate an incremental $0.46 in EPS due to the new tax legislation and ongoing tax planning. And we now expect EPS resulting from the income tax impact on share-based compensation to be $0.03 lower compared to fiscal 2017.

This adds up to a range of $9.76 to $9.96 in EPS in fiscal 2018, an incremental $1.85 to $2.05 over last year. This will be partially offset by the negative $1.67 impact of the acceleration of our investments and higher depreciation, resulting in EPS guidance of $8.09 to $8.29 for fiscal 2018. Let me now discuss some additional key metrics.

Our CapEx is expected to be approximately $75 million to $85 million for the year. We expect to close 40 to 45 stores in 2018. By the end of fiscal 2018, we expect to have 210 to 215 store closures completed of our target of 300 store closures by 2020.

As our digital penetration grows, the flexibility provided by average lease term of less than three years enables us to continue to evaluate the opportunity for additional store closures. Third quarter guidance. For Q3, we are guiding to EPS in the range of $2.97 to $3.07 compared to adjusted EPS of $2.58 in Q3 2017.

Total sales for the quarter are projected to be $504 million to $509 million, inclusive of an expected $13 million negative impact resulting from the calender shift. We project operating margin to be in the range of 13.3% to 13.6% in the third quarter compared to 14% in 2017. Let me discuss the key components of our EPS guidance for Q3 2018.

The operating result associated with our planned mid-single digit comp, excluding the impact of our accelerated investments and higher depreciation, are expected to generate $0.29 to $0.39 in incremental EPS. We expect a $0.32 benefit from a lower tax rate associated with the new tax legislation.

We expect a $0.20 EPS benefit from the shares we expect to repurchase associated with the accelerated share repurchase program and other share repurchases. We expect EPS resulting from the income tax impact on share-based compensation to be $0.03 lower compared to Q3 fiscal 2017.

This adds up to a range of $3.36 to $3.46 in EPS in Q3 2018, an incremental $0.78 to $0.88 over last year.

This will be partially offset by the negative $0.39 impact in Q3, resulting from the $8 million investment in incremental SG&A in our transformation initiatives and $2 million in higher depreciation compared to last year, resulting in EPS guidance of $2.97 to $3.07 for Q3 2018.

We expect inventory at the end of the third quarter to be up mid-single digits compared to last year in line with sales. At this point, we will open the call to your questions..

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

I was wondering if you could maybe give a little bit more color on the gross margin in the quarter, the puts and takes there. How much of the e-comm shift continued to impact gross margin? And it sounds like there's a little bit lower e-comm margins, but then also I wanted to ask if e-comm operating margins are still better than the stores.

And then after you've got past kind of that first quarter clearing from the bad weather, did you see merch margins go back to more normalized levels?.

Yes, Susan, its Anurup. Adjusted gross margins leveraged 10 basis points in the quarter. This is, obviously, a result of fixed cost leverage base on a very strong comp, reclassification of certain items due to the new revenue recognition rules.

This was offset by lower merchandise margins and continued increase in e-comm penetration, which was very strong in the quarter, as you would note. Especially in July, we achieved a mid-30s penetration driven by our back-to-school promotional strategy in e-comm, including our ownership in key categories.

Now as you know, we don't guide to gross margin, Susan, but that being said, we would expect margins in the back half of the year to improve versus the levels we have achieved in the first half of the year and have a greater flow-through of fixed expense.

Also, I would step back from gross margins for a second and talk about, in the quarter, we generated over $1 of incremental EPS between our operations, our share buyback and our tax planning and, obviously, this was offset by the accelerated investments of $0.52 and the impact of the income tax rules and excess stock comp of $0.65, but the $1.01 EPS accretive result was very, very strong in the quarter..

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

Jane, I'm going to start with a couple of sort of competition questions.

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

Sure. I'll take the first part, and then I'll put -- give Mike the Amazon part of it. As far as Gymboree is concerned, as we said in the opening remarks, we were really focused on taking the share from the closed stores, but our thinking has evolved. So we're really looking at those 600 stores that are co-located with Children's Place.

A portion of them are Gymboree, and as far as taking advantage of opportunities there, they seem to have dramatically changed the product from what they are known for. And if you look at any of their social media channels, I think there is also an article in The Wall Street Journal about it the week they launched.

It seems to be certainly some level of their customer not happy with what they've done.

So Jennifer Groves, our Head of Design, has already designed into product that is more in keeping with what that core Gymboree customer is looking for, which is really that highly curated, optimistic, bright, colorful kind of mix and match toddler product, and we'll be putting that in the stores, the mall stores, not the outlet stores, but the mall stores where we compete directly with Gymboree starting next spring.

So I think there's an opportunity for us to add a different level of toddler products that we would normally do to see if we can take some of that market share from the open stores. As far as Crazy 8 is concerned, I think that has been not the greatest success story for Gymboree.

Certainly, they opened it probably with the assumption that they would cannibalize Children's Place sales, but I think really what they've ended up doing is cannibalizing themselves. And as we said, I think there's only about 275 of them left.

I don't think that their financial profile or their sourcing strategy allows them to compete on key items as our strategy does, which we covered in depth on the opening remarks. So I anticipate not to be surprised to see more store closings from Crazy 8.

They seem to try to keep competing on key items, and I don't think that over time that will be a winning strategy, and I don't think to date it has been either..

As far as the name Amazon goes, our business with Amazon continues to perform very well. Replenishment has been the big driver of sales, and we currently have over 6,000 SKUs in the program.

We think that replenishment will be a significant growth vehicle for the business over the next couple of years, as we've recently launched our seasonal basics in fashion product as part of this replenishment program during the back-to-school season.

It's been early stages so far in terms of the back-to-school season response, but it's been very positive on seasonal basics in fashion and has exceeded our expectations, and we've also seen a very significant increase in the demand for basics during this back-to-school period versus a year ago.

In addition, from a marketing perspective, we're controlling our brand image on the site by launching a brand store, and we are participating in their launch of Prime Wardrobe. So all very positive Amazon at this point..

Your next question is from Janet Kloppenburg of JJK..

Jane and Anurup, maybe you could talk a little bit about any other pressures on selling margin in the second quarter. I know that the digital mix was the primary driver of the gross margin. But I'm just wondering, Jane, how you're thinking about market share pursuits? And then I'm very encouraged on the AUC outlook for the first half of next year.

And given the cotton price increasing, I'm just -- increases that we're seeing, I'm wondering if you have just been able to negotiate better deals or if there were other factors influencing that outlook..

Sure. I'll take the AUC part of it. I think as we discussed, Janet, in the opening remarks, I think that we're just better at what we do than a lot of our competition. We've been focused on strategic sourcing for close to a decade now.

And I think when you look at how we have been able to handle, I give a lot of credit to Greg Poole, who has been with us for a long time, and he and his team who run our strategic sourcing area.

We've been at the forefront of vendor consolidation and country migration and that has really served us well over time and continues to serve us well as we move into the front half of 2019.

We talked a little bit about China and how we've been reducing our reliance on China for several years and then certainly advantageous wise and really being ahead and having the vision as to how to place categories -- key categories by country, all that really works together to give us an AUC that is down in the front half of 2019, which I think makes us an outlier versus any of the other competition that I've heard..

Janet, as you've talked about on gross margins, obviously, e-comm -- e-comm's strong performance certainly had an impact on our gross margin mix, but when you step away from gross margins for a minute, I would reiterate, in our operations, we generated over $1 of incremental EPS versus last year between operating performance, the shares and tax planning.

This is, obviously, offset by the accelerated investments in our transformation work and the impact of -- the income tax impact on excess share-based compensation. But I think, overall, when we look at the quarter, we deployed promotional strategies that were appropriate to win.

And in the back half of the year, as I mentioned in the earlier question, we would expect gross margin levels to improve vis-à-vis the flow-through that -- on the fixed cost base that we saw in the first half..

Your next question is from Kate McShane with Citi..

Jane, with all of your comments focused on market share gains, it sounds like you have a lot of opportunity. I just wondered how pricing and promotions come into play within the strategy.

Can we anticipate you offensively discounting more? Or if the other competitors continue to struggle, does this mean we can see prolonged discounting in the space?.

Yes, I think that's a little bit of a complex question, but let me try to take pieces of it. I think when you look at what happened in the second quarter, we had very strong comps every month of the second quarter. May was absolutely spectacular, and margins were very strong.

June was much more of a promotional month, as everyone was struggling to get rid of the hangover from a tough Q1 and also particularly in the kids market to set themselves up for the back-to-school deliveries in July. So we were not surprised by the strong business in May and June, as we had said on our Q1 call.

We were pretty confident that we would see that pent-up demand realize itself in the second quarter, which we did. Really, I think, when you look at what happened in July, I think we had a lot of confidence in the preparation. We spent a lot of time getting ready for back-to-school, and we had a lot of confidence in our preparation.

But I think we were even surprised at how spectacularly we did in the month of July with respect to back-to-school and, certainly, in the first two weeks of August. When you think about a mid-30s penetration in digital, that is a new record for us.

And certainly, that business is extremely promotional in those last two weeks of July and the first two weeks of August, as we're going after big key categories like short-sleeve graphics, like uniform, like denim, like backpack. That's really what makes up the bulk of that business.

So to see such an outsized performance in the month of July on digital as well as in the stores, I think that, that probably -- not probably, but that had an influence on the margins in Q2.

I think as you look forward into the balance of the year, as Anurup alluded to, I think you're going to see that merchandise margin stabilize, particularly as we get out of these highly promotional categories. I do think, on the other hand, to answer the question, I think there's a lot of market share opportunity out there from our competitive set.

Not only have we been focused on these self-help initiatives for several years, which have really put us in a great position and allowed us to positive comp for the last couple of years, but now we can keep going with our self-help initiatives, but I think we can take advantage of the self-inflicted opportunities from our competitors.

So if you'd break it down, I think Gymboree is our number one opportunity. We discussed it in in depth in the opening remarks, but we're still co-located with a lot of their stores.

And I think with the digital tools we have coming on and some of the abilities we have in our sourcing models as evidenced by our lower AUCs, I think where we need to compete with them or where we feel like competing with them will help us realize those market share opportunities.

We will, certainly, take advantage of those in the back half of the year.

I think overall, when you look at what happened to us and when you look at where we're projecting the back of the year and where we're giving guidance on the full year, I think that those promotional opportunities are assumed within that guidance and that we're confident, based on our strong sourcing arm in our company and our preplanned promotions, that we will be able to deliver that guidance that we spoke about this morning and take advantage of those competitive opportunities..

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

Back-to-school was fantastic. Can you just talk, Jane, a little bit about back-to-school for a minute? You guys had an outsized direct business, obviously.

And could you just talk a little bit more in detail? Did you see a good split between pure buying online, shipping to home versus things like, I think, you call it ROPIS and BOPIS and all those kind of iterative elements of the direct business?.

No, we really haven't seen any of those elements significantly impact our business. We have a very small BOPIS business right now. The business we do have has a nice attachment rate. But as far as omni-channel initiatives, BOPIS is small because we offered free shipping every day.

And I think a lot of people use BOPIS as their free shipping tool because our competitors don't offer free shipping every day. So I think they're more reliant on that, and they use the hook of calling that free shipping. What is coming up for us in January is Buy Online, Ship to Store. I think that's when we'll have more opportunity there.

When you look at our digital business, I think there's still a lot of runway as far as digital is concerned.

And when you answer your question about back-to-school, where it came from, we had a mid-30s penetration in the month of July, highly driven by back-to-school, but our brick-and-mortar comps and our brick-and-mortar traffic in that period was also outstanding.

So when you look at the two pieces of back-to-school, there is a basics piece and then there is fashion piece. The fashion part of back-to-school, particularly in the growth side of the business, has been absolutely outstanding.

So to have those two pieces, basics and fashion, firing on all cylinders at the same time is really what is driving this outsized comp and really has given us spectacular results.

Toddler is meaningless for us during this period, and we spend a tremendous amount of time and effort, making sure that our floors sets and our penetrations are really highly geared into big kids.

And we have been -- as kind of getting back to a little bit what I mentioned in my opening remarks, we have been laser-focused on making sure that our big kids assortment resonate with the kid as well as the mom, and we've been very, very successful in size extension.

So you can really see right now in the business everything we've been working on coming together beautifully, whether it's the digital transformation, whether it's the increase in the customer file, whether it's the basic product we bought into, whether it's the big kids fashion, how we setup the floors, and then I would be remiss if I didn't mention Kevin Low and his field team what they were able to accomplish during tax free.

They were in every single market for the past six weeks making sure that we were completely and fully set, and we had an absolutely spectacular tax-free result, by far the best we've had since we've been here. So it's really a combination of everything coming together..

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