Good morning, and welcome to the Children's Place Second Quarter 20 20 Earnings Conference Call. On the call today are Jane Alford, President and Chief Executive Officer and Rob Helm, Chief Financial Officer. The Children's Place issued its Q2 2021 earnings press release earlier this morning. A copy of the release and presentation materials for today's call have been posted to the Investor Relations section of the company's website. This call is being recorded.
If you object to our recording of this call, please disconnect at this time. All participants have been placed in a listen only mode and the floor will be open for your questions following the presentation. After the speakers' remarks, We will take questions as time allows. 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 the company's SEC filings, including the Risk Factors section and the company's Annual Report on Form 10 ks 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 Teresa, events or circumstances after the date hereof. After the prepared remarks, we will open the call up to your questions. We ask that each of you limit yourself to one question, so that everyone will have an opportunity. It is now my pleasure to turn the floor over to Jane Alpherds.
Thank you and good morning everyone. We delivered another outstanding quarter with gross margin, operating margin and EPS all at record level. The significant structural changes we made to our business in 2020, including an accelerated fleet optimization strategy to close 300 stores or a third of our fleet in less than 20 months, an occupancy cost reset on our gaming stores, optimization of our e commerce fulfillment costs, the introduction of Gymboree into our portfolio of brands and a restructuring of our P and L to support our digital first business model, Importantly, we're now able to add another significant structural change to our list. With the pandemic driven acceleration of competitor liquidations and store closures, the competitive landscape Well, the future is now and we anticipate that our pricing reset will continue to be a key driver of accelerated operating margin Our digital business has always been our highest operating margin contributor due to its high UPT, low return rates and lower overhead costs versus our stores channel. And with the pandemic driven acceleration of our digital business, we are now gaining additional leverage on fixed overhead costs and driving significantly higher digital margins.
As our digital business continues to grow on both the top and bottom line, We are making additional investments in marketing and technology to continue to support this growth. Our digital sales represented 43% of our Q2 sales versus 29% in 2019, and we are targeting an industry leading approximately 50% steady state annual digital penetration. We are focused on investing in brand awareness With respect to customer acquisition, we've leveraged our marketing tactics and focused our additional investments to achieve a fifty-fifty split between digital and stores acquisition, which is approximately in line with where our digital penetration We are benefiting from the improved channel mix. This mix change has resulted in significantly higher average spend per customer. We continue to see a shift towards mobile and our mobile app results continue to exceed our expectations.
Over 70% of our digital transactions come through a mobile device and our active mobile users are up double digits on top of the significant file increases we saw during the pandemic in the first half of twenty twenty. We launched Afterpay, a buy now, pay later option for our customers in conjunction with the launch of back to school selling. While it's only been a few weeks, we are impressed with Afterpay's performance to date, with AOV running 50% higher Then the average of our non buy now pay later tender options. Afterpay has over 20,000,000 users in the U. S.
And we are focused on leveraging Afterpay's ability to reach new millennial and Gen Z customers through this partnership. With respect to back to school marketing, we launched a $1,000,000 School is Back giveaway in early August in an effort to help families through these difficult times. In addition, we are donating $1,000,000 of back to school product to Baby 2 Baby, a non profit organization that provides children living in poverty with the basic necessities that every child deserves, We are well positioned with respect to lease flexibility with 85% of our remaining stores having a lease action within the next 18 months. With respect to Gymboree, we are extremely pleased to see the strong customer response to our August back to school offering. And we anticipate that as families are able to begin to resume more normal activities, We will continue to see increased momentum in this important business.
As we have discussed many times, Gymboree is a unique brand and you will not find similar product in scale anywhere else in the kids' market. This is a brand loyal customer and as you can read on our social media sites, mom loves what we are doing with this iconic brand. We're focused on our partnership with Amazon, and they are seeing very strong sell throughs on our back to school assortments. We recently launched a new storefront on Amazon and we are investing in brand marketing with strong results to date. We are now projecting accelerated growth with Amazon for the balance of 2021 and beyond.
With respect to current TCP business, the last 2 weeks of July were strong and Q3 is off to an explosive The combination of schools anticipated to return to 100% in person learning this fall, the enhanced child tax credit payments that started to deliver on July 15 and cover 88% of the kids in the United States, our strong in stock position on key back to school basics, our compelling back to school fashion assortment, record breaking results from our tax free events, our significantly enhanced and expanded digital marketing tactics, our strategic pricing reset and a less crowded competitive playing field all provide strong tailwinds for our key back to school selling period. Looking forward to September and beyond, we are carefully monitoring the daily changes and developments with respect to the Delta variant. Our seasoned team will continue to manage these unanticipated developments as they arise, as we have since the in his prepared remarks. In closing, 2020 was the most transformative year and our company's history. We've leveraged a very difficult period to significantly accelerate our strategic transformation and structurally reposition the company for accelerated operating margin expansion.
We continue to operate at a high level and we remain firmly on offense. We believe that we are uniquely positioned to continue to deliver accelerated returns for our shareholders in 2021 and beyond. Now, I'll turn it over to Rob.
Thank you, Jane, and good morning, everyone. I will review the Q2 results and then I will provide some thoughts on our Q3 and the balance of fiscal 2021. In the fiscal Q2, we delivered a record Q2 adjusted EPS of 1.71 Net sales increased by $45,000,000 or 12 percent to $414,000,000 versus last year's 369,000,000 Our U. S. Net sales increased by $39,000,000 or 12 percent to $372,000,000 versus last year's $333,000,000 While our Canadian net sales increased by $4,000,000 or 13 percent to $37,000,000 versus last year's $33,000,000 Comparable retail sales were a positive 14.1% in the quarter versus Q2 2020.
As an additional point of reference, comparable retail sales were a positive 12.4% versus Q2 2019. Our net sales were positively impacted by strong customer response to our product assortment, higher customer spending resulting in part from the unprecedented level of stimulus, including the enhanced child tax credit payments to our customers under the government pandemic relief legislation higher back to school sales driven by the announced return to in person learning. And lastly, the significant majority of our U. S. Stores were open For the entire quarter this year versus the temporary closures we experienced for more than 50% of the quarter last year as a result of government mandated shutdowns, ending the quarter with more than 99% of our retail stores open to the public for business this year.
Our Q2 net sales were negatively impacted by the impact of our 118 permanent store closures in the past 12 months, inclusive of 42 stores we closed this fiscal year to date and the 76 stores we closed during fiscal 2020. The impact of the government mandated temporary closures in Canada with approximately 50% of our fleet closed for May June and the impact of an approximately 10% reduction and mall operating hours as mandated by our mall landlords. Consolidated digital sales decreased 33% in Q2 versus 2020, representing 43% of our total sales. Digital sales decreased 36% in the U. S.
And increased 7% in Canada. As you may remember, our U. S. Digital penetration was approximately 70% in Q2 2020 due to the majority of our stores being closed for over half of the quarter. Store net sales were $219,000,000 for the quarter, which represents approximately 80% of our Q2 2019 store net sales, Despite having 265 or 28 percent fewer stores in Q2 2021 versus Q2 2019, 10% fewer operating hours is dictated by the mall landlords and half of our Canadian stores closed for 2 thirds of the quarter.
Similar to what we saw in Q1, U. S. Stores traffic remained under significant pressure for Q2, down 32% versus 2019 levels. Our store performance bolstered by our strong transfer rate Further reinforces our strategic fleet optimization strategy. Importantly, we were pleased to see existing customers return to our stores in significant numbers from the limited shopping options available to them last spring due to the government mandated closure of the vast majority of brick and mortar retailers.
Our Canada store business was under significant pressure due to the COVID-nineteen pandemic during Q2. Canada store sales increased 20% versus 2020, with 100% of the fleet closed for the 1st 6 weeks of the quarter in 2020. Versus 2019, Canada sales decreased approximately 39%, with traffic down approximately 59% Due to the continued impact of government mandated COVID-nineteen temporary closures, impacting approximately 50% of our Canadian fleet for 2 thirds of the 2nd quarter. Adjusted gross margin. Adjusted gross margin increased 2,168 basis points to 40.6 percent of net sales, a record Q2 gross margin compared to 18.9 percent of net sales last year.
The gross margin increase was the result of 1, significantly higher consolidated merchandise margins resulting from double digit AUR increases in both our digital and Stores channels due to strong customer product acceptance, leading to higher price realization and reduced promotions. It is also important to note that consolidated merchant margins expand versus 2019 despite an approximate 1400 basis point penetration increase our digital channel to 43% of our total consolidated net sales. 2nd, a reduction of $13,000,000 in occupancy expenses during the quarter, primarily due to favorable lease negotiations and reductions in occupancy expense for stores closed in the past 12 months, as well as rent and payments of $2,000,000 We anticipate meaningful occupancy savings for the balance of the year and beyond. And lastly, the leverage of fixed expenses resulting from the increase in net sales as a result of anniversarying the temporary closure of our entire fleet in Q2 2020. We also saw good expense leverage benefits in the quarter from the results of our work on e commerce fulfillment optimization, which virtually limited the amount of supplemental shipping store required to support our digital business in Q2.
These gross margin benefits were partially offset by higher inbound freight transportation costs, driven by ocean carrier equipment shortages, capacity constraints and higher container rates. Adjusted SG and A. Adjusted SG and A was approximately $114,000,000 versus $104,000,000 last year and leveraged 48 basis points to 27.6 percent of net sales compared to 28.1 percent of net sales last year. The 48 basis point leverage was a result of leverage on the higher net sales and cost savings resulting from the significant store closures in Canada, partially offset by higher incentive compensation accruals as well as higher marketing spend to support the increased e commerce penetration. Adjusted operating income.
Adjusted operating income for the quarter increased $89,000,000 to $40,000,000 or 9.7 percent of sales, a record result versus an adjusted operating loss of $49,000,000 last year and leveraged 2,302 basis points compared to a negative 13.3 percent of net sales last year. Interest expense. Interest expense for the quarter was 4 point $7,000,000 versus $2,600,000 last year. The increase in interest expense reflects a higher debt balance and the higher interest rate associated with our term loan. Tax rate.
Our adjusted tax rate was 27% in part due to higher incentive compensation accruals in the current year. Moving on to the balance sheet. Our cash and short term investments ended the quarter at $64,000,000 We ended the quarter with $200,000,000 outstanding on our revolving credit facility. We ended the quarter with total inventory up 21% versus last year. The increase in our inventory levels versus last year continues to be driven by the back to school we have been carrying since We anticipate our inventory levels will normalize post our back to school selling season ending Q3.
Moving on to cash flow and liquidity. We generated approximately $13,000,000 in cash from operations in the quarter, inclusive of the repayment of the majority of the balance of suspended 2020 rents, net of abatements, as well as other planned changes in working capital, which brought our vendor payables back in line with historical levels. Based on our liquidity position and our planned cash flows for the back half of fiscal twenty twenty one, we have resumed our share buyback program and purchased $11,000,000 during the quarter, leaving us with $80,000,000 outstanding on our current authorization. Capital expenditures in Q2 were approximately $7,000,000 Now I'll provide an update on our store activity in the quarter, along with planned actions we are taking to continue to accelerate our fleet optimization initiative. During the Q2, we finalized the balance of lease our 2020 occupancy.
We recognized a rent abatement of $2,000,000 in Q2, bringing our finalized total abatements for fiscal 2020 to $23,000,000 We also realized significant occupancy expense savings from favorable lease negotiations on our go forward store portfolio and from the 118 store closures in the past 12 months, inclusive of the 17 stores we permanently closed in Q2. We ended the quarter with 7 0 8 stores and total square footage of $3,400,000 a decrease of 13.7% compared to Q2 last year and 22.2 percent since the onset of the pandemic. We are planning to close an additional 81 stores by the end of fiscal 2021, which will bring our total store closures to our previously announced target of 300 stores. While we are not providing EPS guidance due to continued uncertainty, we want to provide you with some thoughts regarding Q3 and full year 2021. Starting with Q3, we are off to a very strong start for the quarter.
We expect to continue to be an outsized beneficiary of the enhanced child tax credit payments under the American Rescue Plan and expect to continue to see tailwinds for our business resulting from these payments throughout the back half of fiscal twenty twenty one. We also have seen benefits from the additional tax free days in the calendar this year in key markets like Florida among others and the new tax free market in West Virginia. We experienced historically low levels of back to school demand in both our digital and stores channels in August 2020 due to remote learning in response to the pandemic. Both digital and store sales will be significantly higher in August 2021 versus 2020 as parents stock up on key back to school basics for the first time in 2 years. With all of these tailwinds, we continue to experience some near term headwinds in our business.
1st and most significantly, the impact of the 2 65 permanent store closures since 2019, team, which contributed roughly $52,000,000 in net sales in Q3 2019. The impact of late deliveries and factory delays our business. We expect that Q3 gross margin will exceed our Q3 2020 gross margin as we continue to see merchandise margin in both channels driven by significant AUR increases as a result of reduced promotions and higher price realization. Occupancy savings from our favorable lease negotiations and permanent store closures and lower e commerce fulfillment costs due to a number of optimization efforts as well as our ability to virtually eliminate the supplemental amount of shift from store needed to support e commerce demand in the quarter. These items will be somewhat offset by higher inbound freight transportation costs driven by ocean carrier equipment shortages, capacity constraints and higher container rates.
SG and A is planned to be in the range of $115,000,000 increasing slightly from Q2 levels as a result of our expectation that our entire Canadian fleet will be open for the entire quarter in Q3 and inclusive of higher incentive compensation accruals and higher levels of digital marketing spend to support our e commerce business. Moving on to the balance of 2021. We are planning to close an additional 81 stores during the balance of fiscal 2021 to bring our total closures to our previously announced target of 300 stores and expect approximately 75% of our total revenues To be generated outside of traditional malls in fiscal 2022. We anticipate digital sales will represent approximately 50% of total sales, which puts our steady state annual digital penetration significantly ahead of our competition, supported by our digital investments, strong transfer rate and fleet optimization initiatives. We continue to experience late deliveries and factory delays resulting from the continued disruption in the global supply chain due to the pandemic, as well as increased costs for inbound ocean freight due to equipment and container shortages.
We are pulling up product receipts where possible and have been able to keep airfreight costs to date to a minimum. We anticipate that we will continue to see disruption in the environment at least until the end of 2021. Raw material input costs are also rising. We have been able to successfully mitigate these increased cost to date with our 2021 AUC projected to be down low single digits through our holiday 2021 placements. However, we are planning that starting with spring 2022, We will see AUC increases due to higher raw material costs and inputs such as cotton and polyester as well as general wage inflation in the countries in which we source our products.
We are planning to return to historical operating cash flow levels for fiscal year 2021 with significant positive cash flows planned for the back half. As a reminder, we are planning to receive a tax refund in the range $40,000,000 as part of the benefits provided under the CARES Act, and our term loan provides us with the opportunity to use up to $25,000,000 of this refund To pay down our term loan without penalty. We are now planning for capital expenditures in the range of $40,000,000 for fiscal year 2021, with the large majority allocated to digital and supply chain fulfillment initiatives. And lastly, as I mentioned earlier on the call, We resumed our capital return program during the Q2 and expect that our operating cash flows will provide us the opportunity to continue to return capital to our shareholders throughout the back half of fiscal twenty twenty one. At this point, we will open the call to your questions.
Alford. And we will take our first question from Dana Tsely. Your line is now from Tsely Advisory Group.
Good morning, everyone. Nice to see the progress. The margins are very impressive. There's a lot to chew on this quarter in terms of enhancements. Jane, you mentioned a couple of things, pricing and promotion reset that's going on.
How much of it would you say is due to Current state and how much of that is the game plan from the competitor closures that you've been planning all along? And what does this mean for the steady state of what merchandise margins in the future could be? Is there a permanent uptick that we could see that's there? And then you also mentioned on the top line enhanced Amazon business, anything in particular driving that? And then I have one follow-up.
Sure. Yes, on the Amazon business, we made a significant amount of progress since the pandemic started in 2020 on our relationship with Amazon. I mentioned on the call that we launched a new storefront and we're making some significant investments in marketing. They're seeing some outstanding business in back to And we anticipate that we're going to continue to grow that business accelerated through the balance of 2021 and then into 2022. So I think that that's going to be somewhat of a meaningful driver as we look towards 2022 and beyond.
I'll pass Rob The merch margin part of the question, but as far as the promotional reset, it really goes back to what we said in 2018 with competitors and what's happening with current inventory levels. It's a structural change that we had kind of promised and we're able to deliver on now. And from a merchandise margin point of view, like I said, I'll pass that to Rod.
So I think, Deana, we're living in a different competitive To gain share and gain competitive positioning, you have to continue to attack market share. Now with the reduced competitive playing field, we're able to realize higher prices and rethink our promotional strategy. And that's the differentiator for us in our competitive set where we're priced as a value player in our competitive set.
Got it. And then any follow-up on the AUC cost increases and your outlook for those in 2022? And then the progress on lower e commerce fulfillment costs. Where are you? How much did you lower by?
And is there more to go?
So we are experiencing rising across of our P and L, higher AUCs driven by lower raw material and labor inflation, Higher wages impacting our stores and DC associates. And those are just some of the key costs that impact our P and L. We've seen some of them in our supply chain already, while others have been we've been able to mitigate to date. We do expect that you see us to be higher Starting in the spring 2022, however, these costs are impacting really everyone in sales space and we've heard over and Again, the others intend to increase prices to maintain margins. Again, the differentiator, like I answered earlier was, We're playing in a reduced competitive playing field in our competitive set.
So we're able to realize higher prices And reduce markdowns and promotions to mitigate this impact.
And we will take our next question from Jim Cartier with Monness Preece and Harte.
Rob, I was wondering if you
could provide some more detail On the CapEx investments and supply chain and fulfillment capabilities you mentioned, what are the expected benefits from those investments? And then in terms of Timing, when do you expect to see start to see some of those benefits?
Sure. For a full year basis, we're expecting CapEx in the range Alford, dollars 40,000,000 which is significantly lower than our accelerated investments that we made for the past 3 years coming into the pandemic. From a composition perspective, our lower store count provides us with the opportunity to recast a significant portion of our CapEx On an annual basis into digital and supply chain fulfillment initiatives. And really the composition of those going forward Are to support the outsized growth that we've seen in the e commerce business to be able to increase our fulfillment capabilities.
And we will take our next question from Jay Sole with UBS.
Great. Thank you so much. Jane, I wanted to ask you about 2 quite interesting comments you made at the top of your remarks. One is that you said Q3 is off to an explosive start. And then you said The company is positioned for accelerated operating margin expansion.
I realize you're not giving quantitative guidance here today, but can you elaborate a little bit on what explosive means and sort of like where you
August 2019 was our highest revenue August in our history, and we're currently comping positive 41% against August 2019 and net sales are positive 25%.
In terms of operating margin targets, our current profitability is being driven by the structural changes mid-twenty 20 during the pandemic. Our sales were only a touch lower than 2019 Q2 and we made almost $35,000,000 more in operating profits during the quarter. Digital has always been our highest operating margin channel and we continue to improve those margins through our supply chain and fulfillment initiatives. With the steady state 50% digital penetration, our focus on driving that higher, we expect overall operating margins for the company to remain higher in the future. In terms of our pricing and promotional reset, back in we took the opportunity to take the pain in 2017 2018 as we strategically made the decision for short term margin pain for long term margin gain.
As we struggled As we competed for market share amongst a number of struggling retailers, the opportunity to reset on that is now. And in addition to those digital and pricing strategies, we have a number of other opportunities to improve profitability in 'twenty two and beyond. In terms of gross margin, we expect to see continued benefits from our accelerated store care program and fleet negotiations in both reduced occupancy expenses and the full year benefit from our 123 store closures in fiscal 2021. We've just scratched the surface with the Gymboree Bread, having launched this iconic brand at the pandemic. We're still targeting $140,000,000 sales opportunity there.
We're excited about our business with Amazon and we're focused on accelerating that growth. We expect that the shipping costs that we Incurred this year will start to moderate as we won't have to incur those higher costs next year as the world gets back to normal. And we have one cost one time cost in our P and L this year, including long term incentive compensation accruals that were restored this year based on strong performance.
And we will take our next question from Susan Anderson with B. Riley.
Hi, good morning. Nice job on the quarter. I'm curious, thanks for the details on the quarter today in August. I'm curious just in July when the Child tax credit did hit. Did you see a noticeable bump up from that?
And because it sounds like you're expecting to benefit from that going forward. And then also just on the price increases and the higher pricing, I'm curious just given the children's space obviously is very competitive. Are you seeing any pushback at from the consumer or are they just basically accepting those price increases?
I think with a 41% comp, I could Confidently say they're accepting the price increases. And your question on July, yes, we saw a bump in business with the child tax credit.
And we will take our next question from Paul Louise with Citi.
Hi, this is Kelly Crago on for Paul. Thanks for taking our question. Just a follow-up on an earlier question. I'm curious if you are expecting to build on your F 2021 EBIT margin in F22, just given some of the inflationary headwinds that you spoke about and some of the tougher comparisons related to some of the stimulus that's helping drive the top line currently. And then just another one quickly on gross margin in the Q3.
I think you said you expected that versus 2020. Curious if you're also expecting that versus 2019 in the Q3? Thank you.
From a 'twenty two perspective, just earlier I outlined a couple of the opportunities that we think there's more opportunities to improve margins in the future. Obviously, it's a rising cost environment with inflation and that's a headwind as well. But from a Competitive set and pricing perspective, we think that there's an opportunity to increase prices as many of us spoke about increasing prices there as well. From a Q3 Gross margin perspective, we haven't provided guidance obviously. There's an opportunity to have higher Margins are than what we've seen historically based on the opportunities that we talked about in terms of merchandise margin and pricing and promotion reset, as well as The lower occupancy costs and the fulfillment costs, but there are also obviously headwinds relative to freight transportation, higher inbound costs and
And we will take our final question from Marni Shapiro with Retail Tracker.
Hey, guys. Congratulations. The product has truly been outstanding. Jane, can you talk a little bit about or I guess either of you a little bit about 2 things. 1, The prices you said prices are going through higher.
Is this due to lower promotions or are you taking up like for like prices or a combination? And then just a follow-up, you dropped Halloween online in a little capsule in stores. I thought it looked very cute. Is it selling this early? I know we heard Home Depot already sold out of their Little Halloween Group.
So I'm curious if consumers are buying in advance this year.
Sure. Yes, Marni on the first 1, it's a combination of like for like and promotions. And I think we just keep going back to the same thing. It's been the strategy since 2018. We said we were going to pressure the margins in the short term.
If you look at the pricing right now on key items that we have online, you can See that they're priced considerably higher than they were in 2018, but in almost all instances, they're still lower than the competition. So the room is still there. And like I had said on previous calls, I'm not concerned that we're changing the DNA of Children's Place Pricing. It's been the strategic plan. And like I said in my prepared remarks, now is the time.
There really isn't anywhere near the competitive playing field, particularly in the malls that there was in 2018. And clearly, we don't expect That to come back and so we really have a lot of room to kind of set the prices where they should be versus where they were in 2018 as we were battling against, like Rob said, some struggling competitors. As far as Halloween is concerned, we delivered it last canceled last year. So we're very happy with what we're seeing so far. And you can also see on our website that we've also launched Christmas pajamas.
And I think people are already responding to those having hopefully some more confidence that people are going to be able to Be together during the holidays. So I think there's really kind of an emotional pull right now going on with that type of clothing. So we're pretty happy with what we're seeing. Thank
you. Thank you for joining us today. If you have further questions, please call Investor Relations at 201-558-2400extension14500. You may now disconnect your lines and have a wonderful day.