Childrens Place, Inc. quarterly report, Q2 FY2019

Business context and reporting period

The Children’s Place, Inc. is a North American children’s apparel retailer operating stores, e-commerce, wholesale and franchise channels. This Form 10-Q covers the 13 and 26 weeks ended August 3, 2019. Although the request metadata labels the filing “2018 Q2,” the filing itself is for second-quarter 2019; the comparable quarter ended August 4, 2018.

At quarter-end, the company operated 961 stores and had 225 franchise-partner points of distribution in 19 countries. It acquired Gymboree and Crazy 8 intellectual property and related assets during the first quarter.

Key financial metrics

First-half operating cash flow was $23.3 million, versus $11.3 million a year earlier. Investing cash outflow was $97.5 million, including $76.0 million for the Gymboree assets and $21.8 million in capital expenditures. Financing provided $69.3 million, primarily reflecting increased revolving borrowings; cash declined $3.8 million to $65.4 million.

At August 3, 2019, revolving borrowings were $196.4 million, with $122.5 million available under the $325 million asset-based facility, which expires in May 2024. The quarter-end borrowing rate was 3.8%. Working capital was a deficit of $152.8 million. Operating lease liabilities totaled $469.5 million ($127.7 million current and $341.8 million long-term); adoption of the new lease standard also added $430.1 million of right-of-use assets.

Material changes versus comparable periods

• Q2 sales fell 6.3%; comparable retail sales declined 3.8%. First-half sales fell 5.9%, with comparable retail sales down 4.2%.
• Management attributed lower sales to weaker comparable sales, competitor liquidations and fewer stores. International sales also faced lower franchise revenue and unfavorable Canadian exchange rates.
• Q2 gross margin contracted 150 basis points; first-half margin contracted 70 basis points. The company cited fixed-cost deleverage, higher e-commerce mix and promotional pressure; e-commerce represented 28.6% of Q2 sales versus 26.2% a year earlier.
• First-half SG&A increased $1.7 million and rose to 29.3% of sales from 27.4%, reflecting deleverage and higher incentive compensation. Depreciation and amortization increased to $37.1 million from $34.0 million.
• Net income and EPS declined materially. Lower impairment charges and fewer weighted-average shares from repurchases partly offset operating pressure. The prior-year period included larger IT-system impairment charges.
• Revolving borrowings increased from $48.9 million at February 2, 2019. The balance sheet and liquidity comparisons are affected by the $76.0 million acquisition and adoption of lease accounting.

Outlook, commentary, risks and unusual items

• No full-year revenue or earnings guidance is stated in the supplied filing text. Management expected fiscal 2019 capital expenditures of approximately $65–$70 million, mainly for technology transformation, Gymboree system integration and new stores.
• Management described product, technology and digital transformation, alternate distribution channels and fleet optimization as priorities. It planned to close approximately 300 stores through fiscal 2020, including 226 already closed since the initiative began, and expected to remain a net store closer.
• The company expected increased U.S. tariffs on remaining China-sourced products, including apparel, accessories and footwear, to adversely affect results if imposed; the filing also noted 15% tariffs expected on September 1 and December 15, 2019. Tariff effects on certain other products were described as minimally adverse.
• Other cited risks include fashion and consumer-demand shifts, competition, supply-chain disruption, raw-material and energy costs, foreign exchange, weather, regulation and litigation. The company imports most merchandise from foreign countries.
• A proposed settlement in a consumer-advertising class action remained subject to court approval; a $5.0 million reserve had been recorded previously. Management stated that other ordinary-course proceedings were not expected to have a material adverse effect.
• The board declared a $0.56 per-share quarterly dividend payable October 4, 2019. The company repurchased approximately $60.4 million of shares in the first half and approximately $8.3 million after quarter-end through August 23.

Important facts for investors to verify

• Confirm the correct period: this filing is for Q2 2019, not Q2 2018.
• Track comparable sales, promotional intensity, e-commerce profitability and whether gross-margin pressure stabilizes.
• Assess liquidity and seasonal inventory funding, including revolving borrowings, facility availability and the working-capital deficit.
• Evaluate the actual cost and scope of China tariffs, and progress against store-closure, Gymboree relaunch and capital-spending plans.
• Review the assumptions behind inventory, store-impairment, insurance and tax estimates, and the outcome of the pending class-action settlement.