Childrens Place, Inc.: Form 10-Q for the period ended Aug 3, 2024

This Quarterly Report on Form 10-Q contains or may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including but not limited to statements relating to the Company’s strategic initiatives and results of operations, including adjusted net income (loss) per diluted share. Forward-looking statements typically are identified by use of terms such as “may,” “will,” “should,” “plan,” “project,” “expect,” “anticipate,” “estimate,” and similar words, although some forward-looking statements are expressed differently. These forward-looking statements are based upon the Company’s current expectations and assumptions and are subject to various risks and uncertainties that could cause actual results and performance to differ materially. Some of these risks and uncertainties are described in the Company’s filings with the Securities and Exchange Commission, including in Part I, Item 1A. Risk Factors of its annual report on Form 10-K for the fiscal year ended February 3, 2024. Included among the risks and uncertainties that could cause actual results and performance to differ materially are the risk that the Company will be unable to achieve operating results at levels sufficient to fund and/or finance the Company’s current level of operations and repayment of indebtedness, the risk that the Company will be unsuccessful in gauging fashion trends and changing consumer preferences, the risks resulting from the highly competitive nature of the Company’s business and its dependence on consumer spending patterns, which may be affected by changes in economic conditions (including inflation), the risk that changes in the Company’s plans and strategies with respect to pricing, capital allocation, capital structure, investor communications and/or operations may have a negative effect on the Company’s business, the risk that the Company’s strategic initiatives to increase sales and margin, improve operational efficiencies, enhance operating controls, decentralize operational authority and reshape the Company’s culture are delayed or do not result in anticipated improvements, the risk of delays, interruptions, disruptions and higher costs in the Company’s global supply chain, including resulting from disease outbreaks, foreign sources of supply in less developed countries, more politically unstable countries, or countries where vendors fail to comply with industry standards or ethical business practices, including the use of forced, indentured or child labor, the risk that the cost of raw materials or energy prices will increase beyond current expectations or that the Company is unable to offset cost increases through value engineering or price increases, various types of litigation, including class action litigations brought under securities, consumer protection, employment, and privacy and information security laws and regulations, the imposition of regulations affecting the importation of foreign-produced merchandise, including duties and tariffs, risks related to the existence of a controlling shareholder, and the uncertainty of weather patterns. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date they were made. The Company undertakes no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

The following discussion should be read in conjunction with the Company’s unaudited financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the annual audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended February 3, 2024.

Terms that are commonly used in our Management’s Discussion and Analysis of Financial Condition and Results of Operations are defined as follows:

• Second Quarter 2024 — The thirteen weeks ended August 3, 2024
• Second Quarter 2023 — The thirteen weeks ended July 29, 2023
• First Quarter 2024 — The thirteen weeks ended May 4, 2024
• Year-To-Date 2024 — The twenty-six weeks ended August 3, 2024
• Year-To-Date 2023 — The twenty-six weeks ended July 29, 2023
• Fiscal 2024 — The fifty-two weeks ending February 1, 2025
• Fiscal 2023 — The fifty-three weeks ended February 3, 2024
• SEC — U.S. Securities and Exchange Commission
• U.S. GAAP — Generally Accepted Accounting Principles in the United States
• FASB — Financial Accounting Standards Board
• FASB ASC — FASB Accounting Standards Codification, which serves as the source for authoritative U.S. GAAP, except that rules and interpretive releases by the SEC are also sources of authoritative U.S. GAAP for SEC registrants
• AUR — Average unit retail price
• Comparable Retail Sales — Net sales, in constant currency, from stores that have been open for at least 14 consecutive months and from our e-commerce store, excluding postage and handling fees. Store closures in the current

fiscal year will be excluded from Comparable Retail Sales beginning in the fiscal quarter in which the store closes. A store that is closed for a substantial remodel, relocation, or material change in size will be excluded from Comparable Retail Sales for at least 14 months beginning in the fiscal quarter in which the closure occurred. However, stores that temporarily close will be excluded from Comparable Retail Sales until the store is reopened for a full fiscal month.

• Gross Margin — Gross profit expressed as a percentage of net sales
• SG&A — Selling, general, and administrative expenses

OVERVIEW

Our Business

We are an omni-channel children’s specialty portfolio of brands. We design, contract to manufacture, and sell fashionable, high quality apparel, accessories and footwear predominantly at value prices, primarily under our proprietary brands: “The Children’s Place”, “Gymboree”, “Sugar & Jade”, and “PJ Place”. As of August 3, 2024, we had 515 stores across North America, our e-commerce business at www.childrensplace.com (http://www.childrensplace.com) and www.gymboree.com (http://www.gymboree.com), social media channels on Instagram, Facebook, X, formerly known as Twitter, YouTube and Pinterest, and 202 international points of distribution with our five franchise partners in 15 countries.

Segment Reporting

In accordance with FASB ASC 280—Segment Reporting, we report segment data based on geography: The Children’s Place U.S. and The Children’s Place International. Each segment includes an e-commerce business located at www.childrensplace.com (http://www.childrensplace.com) and www.gymboree.com (http://www.gymboree.com). Included in The Children’s Place U.S. segment are our U.S. and Puerto Rico-based stores and revenue from our U.S.-based wholesale business. Included in The Children’s Place International segment are our Canadian-based stores, revenue from our Canadian-based wholesale business, as well as revenue from international franchisees. We measure our segment profitability based on operating income, defined as income before interest and taxes. Net sales and direct costs are recorded by each segment. Certain inventory procurement functions such as production and design, as well as corporate overhead, including executive management, finance, real estate, human resources, legal, and information technology services, are managed by The Children’s Place U.S. segment. Expenses related to these functions, including depreciation and amortization, are allocated to The Children’s Place International segment based primarily on net sales. The assets related to these functions are not allocated. We periodically review these allocations and adjust them based upon changes in business circumstances. Net sales to external customers are derived from merchandise sales, and we have one U.S. wholesale customer that individually accounted for more than 10% of our net sales for the Second Quarter 2024 and Year-To-Date 2024.

Recent Developments

Macroeconomic conditions, including inflationary pressures, higher interest rates, and other domestic and geo-political factors, continue to adversely affect our core customer, resulting in a decrease in discretionary apparel purchases during the Second Quarter 2024. These macroeconomic conditions are expected to continue to have an adverse impact during the remainder of Fiscal 2024.

On May 20, 2024, our Board of Directors (the “Board”) appointed Muhammad Umair, who is currently a Board member, as President and Interim Chief Executive Officer of the Company. Mr. Umair succeeded Jane Elfers, who departed as our President and Chief Executive Officer and as a member of the Board pursuant to a mutual agreement with the Company effective as of May 20, 2024.

On August 23, 2024, we appointed Claudia Lima-Guinehut as Brand President, effective as of September 9, 2024. Ms. Lima-Guinehut succeeded Maegan Markee, who departed pursuant to a mutual agreement with the Company effective as of June 14, 2024.

Operating Highlights

Net sales decreased $25.9 million, or 7.5%, to $319.7 million during the Second Quarter 2024 from $345.6 million during the Second Quarter 2023, primarily due to an anticipated decrease in e-commerce revenue, as we proactively rationalized our unprofitable promotional strategies, inflated marketing spend and “free shipping” offers to significantly improve profitability, which was successful during the Second Quarter 2024. These efforts not only improved the profitability of our e-commerce business, despite the lower revenue, but also benefited the brick-and-mortar channel as the stores business experienced a positive comparable store sales for the first time in ten fiscal quarters. The wholesale business also rebounded with double-digit growth after a decline in the First Quarter 2024. During the Second Quarter 2024, we closed three stores and did not open any new stores. Comparable retail sales decreased 7.2% for the Second Quarter 2024, largely driven by the planned decrease in e-commerce as this business decreased by a double-digit percentage, as we proactively sacrificed unprofitable sales to improve profitability. Stores experienced a positive comparable store sales result for the first time since the post COVID-19 period of 2021, driven by stronger units per transaction and conversion metrics, and improving traffic trends.

Gross profit increased $24.0 million to $111.8 million or 35.0% of net sales during the Second Quarter 2024 from $87.8 million or 25.4% of net sales during the Second Quarter 2023. The 960 basis point increase was caused by a combination of factors, including reductions in product input costs, including cotton and supply chain costs, which negatively impacted margins in the prior year. These improvements were combined with the success of our rationalization of profit-draining promotional strategies and shipping offers, which resulted in a significant improvement in the leverage of e-commerce freight costs due to our new shipping threshold for free shipping.

Operating loss decreased $15.1 million to $(21.8) million during the Second Quarter 2024 compared to a loss of $(36.9) million during the Second Quarter 2023. Operating loss was impacted by incremental expenses of $36.0 million, which included an impairment charge of $28.0 million on the Gymboree tradename, primarily due to reductions in Gymboree sales forecasts and a reduction in the royalty rate used to value the tradename, and restructuring costs of $6.1 million due to recent changes in our senior leadership team. Operating margin leveraged 390 basis points to (6.8)% of net sales.

Net loss decreased $3.3 million to $(32.1) million, or $(2.51) per diluted share, during the Second Quarter 2024 compared to $(35.4) million, or $(2.82) per diluted share, during the Second Quarter 2023, due to the factors discussed above.

While we continue to face a challenging macroeconomic environment, including inflationary pressures, higher interest rates, and other domestic and geo-political concerns, we continue to focus on our key strategic growth initiatives – superior product, digital transformation, alternative channels of distribution, and fleet optimization.

Digital remains our top priority and we continue to expand our digital capabilities. We have expanded our partnerships with our outside providers to help us monitor and reallocate our marketing budgets in a more efficient and timely manner to drive acquisition, retention and reactivation. We continue to position marketing as a key growth lever in Fiscal 2024 and beyond. As our digital business continues to expand, we continue to strengthen our partnership with our third party logistics providers in an effort to provide our customers with a best-in-class digital experience.

We have closed 684 stores since the announcement of our fleet optimization initiative in 2013, including three during the Second Quarter 2024. With over 75% of our store fleet coming up for lease action in the next 24 months, we continue to maintain meaningful financial flexibility in our lease portfolio. The average unexpired lease term for our stores is approximately 1.5 years in the United States, Puerto Rico, and Canada.

In November 2021, our Board authorized a $250.0 million share repurchase program (the “Share Repurchase Program”). Currently, given the terms of our credit agreement, dated as of May 9, 2019 (as amended from time to time, the “Credit Agreement”), by and among the Company and certain of its subsidiaries, and the lenders party thereto (collectively, the “Credit Agreement Lenders”), as amended by the seventh amendment to the Credit Agreement (the “Seventh Amendment”), we are not expecting to repurchase any shares in Fiscal 2024, except pursuant to our practice as a result of our insider trading policy. As of August 3, 2024, there was $156.7 million remaining availability under the Share Repurchase Program.

We have subsidiaries whose operating results are based in foreign currencies and are thus subject to the fluctuations of the corresponding translation rates into U.S. dollars. The table below summarizes the average translation rates that most significantly impact our operating results:

(1) The average translation rates are the average of the monthly translation rates used during each period to translate the respective statements of operations. Each rate represents the U.S. dollar equivalent of the respective foreign currency.

SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES

We describe our significant accounting policies in “Note 1. Basis of Preparation and Summary of Significant Accounting Policies” of the Consolidated Financial Statements included in our most recent Annual Report on Form 10-K for the fiscal year ended February 3, 2024. There have been no significant changes in our accounting policies from those described in our most recent Annual Report on Form 10-K.

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the amounts of revenues and expenses reported during the period. We continuously review the appropriateness of the estimates used in preparing our financial statements; however, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information. Consequently, actual results could differ materially from our estimates.

Our critical accounting estimates are described under the heading “Critical Accounting Estimates” in Item 7 of our most recent Annual Report on Form 10-K for the fiscal year ended February 3, 2024. Our critical accounting estimates include impairment of long-lived assets, impairment of indefinite-lived intangible assets, income taxes, stock-based compensation, and inventory valuation. There have been no material changes in these critical accounting estimates from those described in our most recent Annual Report on Form 10-K.

Recent Accounting Standards Updates

Refer to “Note 1. Basis of Presentation” of the accompanying consolidated financial statements for discussion regarding the impact of recently issued accounting standards on our consolidated financial statements.

RESULTS OF OPERATIONS

We believe that our e-commerce and brick-and-mortar retail store operations are highly interdependent, with both sharing common customers purchasing from a common pool of product inventory. Accordingly, we believe that consolidated omni-channel reporting presents the most meaningful and appropriate measure of our performance, including net sales.

The following table sets forth, for the periods indicated, selected data from our Statements of Operations expressed as a percentage of Net sales. We primarily evaluate the results of our operations as a percentage of Net sales rather than in terms of absolute dollar increases or decreases by analyzing the year over year change in our business expressed as a percentage of Net sales (i.e., “basis points”). For example, SG&A decreased 230 basis points to 30.1% of Net sales during the Second Quarter 2024 from 32.4% during the Second Quarter 2023. Accordingly, to the extent that our sales have increased at a faster rate than our costs (i.e., “leveraging”), the more efficiently we have utilized the investments we have made in our business. Conversely, if our sales decrease or if our costs grow at a faster pace than our sales (i.e., “deleveraging”), we have less efficiently utilized the investments we have made in our business.

The following table sets forth net sales by segment, for the periods indicated:

(in thousands)

Second Quarter 2024 Compared to Second Quarter 2023

Net sales decreased $25.9 million or 7.5%, to $319.7 million during the Second Quarter 2024 from $345.6 million during the Second Quarter 2023, primarily due to an anticipated decrease in e-commerce revenue, as we proactively rationalized our unprofitable promotional strategies, inflated marketing spend and “free shipping” offers to significantly improve profitability, which was successful during the Second Quarter 2024. These efforts not only improved the profitability of our e-commerce business, despite the lower revenue, but also benefited the brick-and-mortar channel as the stores business experienced a positive comparable store sales for the first time in ten fiscal quarters. The wholesale business also rebounded with double-digit growth after a decline in the First Quarter 2024. Comparable retail sales decreased 7.2% for the Second Quarter 2024, largely driven by the planned decrease in e-commerce as this business decreased by a double-digit percentage, as we proactively sacrificed unprofitable sales to improve profitability. Stores experienced a positive comparable store sales result for the first time since the post COVID-19 period of 2021, driven by stronger units per transaction and conversion metrics, and improving traffic trends.

The Children’s Place U.S. net sales decreased $20.8 million or 6.6%, to $292.4 million in the Second Quarter 2024, compared to $313.2 million in the Second Quarter 2023. This decrease was primarily due to an anticipated decrease in e-commerce revenue, as we proactively rationalized our unprofitable promotional strategies, inflated marketing spend and “free shipping” offers to significantly improve profitability. The wholesale business also rebounded with double-digit growth after a decline in the First Quarter 2024.

The Children’s Place International net sales decreased $5.1 million or 15.8%, to $27.3 million in the Second Quarter 2024, compared to $32.4 million in the Second Quarter 2023. This decrease was primarily due to an anticipated decrease in e-commerce revenue, as we proactively rationalized our unprofitable promotional strategies, inflated marketing spend and “free shipping” offers to significantly improve profitability.

Total e-commerce sales, which include postage and handling, were 49.3% of net retail sales and 41.7% of net sales during the Second Quarter 2024, compared to 50.8% and 44.3%, respectively, during the Second Quarter 2023.

Gross profit increased $24.0 million to $111.8 million in the Second Quarter 2024, compared to $87.8 million in the Second Quarter 2023. Gross margin increased 960 basis points to 35.0% of net sales in the Second Quarter 2024. The 960 basis point increase was caused by a combination of factors, including reductions in product input costs, including cotton and supply chain costs, which negatively impacted margins in the prior year. These improvements were combined with the success of our rationalization of profit-draining promotional strategies and shipping offers, which resulted in a significant improvement in the leverage of e-commerce freight costs due to our new shipping threshold for free shipping.

Gross profit as a percentage of net sales is dependent upon a variety of factors, including changes in the relative sales mix among distribution channels, changes in the mix of products sold, the timing and level of promotional activities, foreign currency exchange rates, and fluctuations in shipping and material costs. These factors, among others, may cause gross profit as a percentage of net sales to fluctuate from period to period.

Selling, general, and administrative expenses decreased $15.9 million to $96.1 million during the Second Quarter 2024 from $112.0 million during the Second Quarter 2023. SG&A leveraged 230 basis points to 30.1% of net sales in the Second Quarter 2024. The Second Quarter 2024 results included incremental operating expenses of $7.8 million, including restructuring costs of $6.1 million and credit agreement lender-required consulting costs of $1.1 million. The Second Quarter 2023 results included incremental operating expenses of $10.3 million, including restructuring costs of $9.7 million. Excluding the impact of these incremental charges, SG&A leveraged 180 basis points to 27.6% of net sales, primarily as a result of significant reductions in store payroll and home office payroll, and the elimination of inflated and unprofitable marketing costs. This represents the lowest level of Adjusted selling, general, and administrative expenses in over 15 years for the second quarter of a fiscal year.

Depreciation and amortization was $9.5 million during the Second Quarter 2024, compared to $12.0 million during the Second Quarter 2023. The decrease was primarily driven by reduced depreciation of capitalized software and the permanent closure of 81 stores during the past twelve months.

Asset impairment charges were $28.0 million during the Second Quarter 2024 due to the reduction in fair value of the Gymboree tradename, which was primarily due to reductions in Gymboree sales forecasts and a reduction in the royalty rate used to value the tradename. Asset impairment charges were $0.8 million during the Second Quarter 2023, inclusive of right-of-use (“ROU”) assets. These charges were related to underperforming stores identified in our ongoing store portfolio evaluation primarily as a result of decreased net sales and cash flow projections.

Operating loss decreased $15.1 million to $(21.8) million during the Second Quarter 2024, compared to $(36.9) million during the Second Quarter 2023. Operating loss was impacted by incremental expenses of $36.0 million, which included an impairment charge of $28.0 million on the Gymboree tradename, and restructuring costs of $6.1 million due to recent changes in our senior leadership team. These charges have been classified as non-GAAP adjustments, leading to a shift back to profitability with an adjusted operating income of $14.2 million in the Second Quarter 2024, or an improvement of $39.2 million compared to an adjusted operating loss of $(25.0) million in the Second Quarter 2023, and leveraged 1,170 basis points to 4.5% of net sales.

Net interest expense was $9.2 million during the Second Quarter 2024, compared to $7.6 million during the Second Quarter 2023. The increase in interest expense was primarily driven by higher average interest rates associated with our revolving credit facility due to the impact of refinancings and continued market-based rate increases, partially offset by continued benefits associated with certain non-interest bearing loans from our majority shareholder, Mithaq Capital SPC, a Cayman segregated portfolio company (“Mithaq”).

Provision (benefit) for income taxes was a provision of $1.1 million during the Second Quarter 2024, compared to a benefit of $(9.2) million during the Second Quarter 2023. Our effective tax rate was a provision of (3.6)% and a benefit of 20.7% in the Second Quarter 2024 and Second Quarter 2023, respectively. The change in our effective tax rate and income tax provision (benefit) for the Second Quarter 2024 compared to the Second Quarter 2023 was primarily driven by the establishment of a valuation allowance against our net deferred tax assets in Fiscal 2023.

Net loss, which included certain non-cash impairment charges and non-operating restructuring charges, decreased $3.3 million to $(32.1) million, or $(2.51) per diluted share during the Second Quarter 2024, compared to $(35.4) million, or $(2.82) per diluted share during the Second Quarter 2023, due to the factors discussed above. Adjusted net income shifted back to profitability after two years of losses during the Second Quarter 2024, improving by $30.4 million to $3.9 million, or $0.30 per diluted share, compared to an adjusted net loss of $(26.5) million, or $(2.12) per diluted share during the Second Quarter 2023.

Year-To-Date 2024 Compared to Year-To-Date 2023

Net sales decreased $79.7 million or 11.9%, to $587.5 million during Year-To-Date 2024 from $667.2 million during Year-To-Date 2023, primarily due to reductions in retail sales due to lower store count, and anticipated declines in e-commerce demand due to the rationalization of promotions, reductions in inflated and unprofitable marketing spend, and the strategic decision to change “free shipping” offers, as we proactively sacrificed unprofitable sales in an effort to improve profitability. Comparable retail sales decreased 9.4% during Year-To-Date 2024.

The Children’s Place U.S. net sales decreased $68.1 million or 11.2%, to $538.6 million during Year-To-Date 2024, compared to $606.7 million during Year-To-Date 2023. This decrease was primarily due to lower store count, and anticipated declines in e-commerce demand due to the rationalization of promotions, reductions in inflated and unprofitable marketing spend, and the strategic decision to change “free shipping” offers, as we proactively sacrificed unprofitable sales in an effort to improve profitability.

The Children’s Place International net sales decreased $11.5 million or 19.1%, to $49.0 million during Year-To-Date 2024, compared to $60.5 million during Year-To-Date 2023. This decrease was primarily due to lower store count, and anticipated declines in e-commerce demand due to the rationalization of promotions, reductions in inflated and unprofitable marketing spend, and the strategic decision to change “free shipping” offers, as we proactively sacrificed unprofitable sales in an effort to improve profitability.

Total e-commerce sales, which include postage and handling, were 51.2% of net retail sales and 45.1% of net sales during Year-To-Date 2024, compared to 48.0% and 42.9%, respectively, during Year-To-Date 2023.

Gross profit increased $20.3 million to $204.5 million during Year-To-Date 2024, compared to $184.2 million during Year-To-Date 2023. Gross margin leveraged 720 basis points to 34.8% of net sales during Year-To-Date 2024. The increase was primarily due to reductions in product input costs, including cotton and supply chain costs, which negatively impacted margins in the prior year. These improvements were combined with the success of our rationalization of profit-draining promotional strategies and shipping offers, which resulted in a significant improvement in the leverage of e-commerce freight costs due to our new shipping threshold for free shipping.

Gross profit as a percentage of net sales is dependent upon a variety of factors, including changes in the relative sales mix among distribution channels, changes in the mix of products sold, the timing and level of promotional activities, foreign currency exchange rates, and fluctuations in shipping and material costs. These factors, among others, may cause gross profit as a percentage of net sales to fluctuate from period to period.

Selling, general, and administrative expenses decreased $19.7 million to $205.2 million during Year-To-Date 2024 from $224.9 million during Year-To-Date 2023. SG&A deleveraged 120 basis points to 34.9% of net sales during Year-To-Date 2024. The Year-To-Date 2024 results included incremental operating expenses, including costs associated with our change of control of $13.7 million, financing related charges of $6.7 million, restructuring costs of $6.4 million, and credit agreement lender-required consulting costs of $1.9 million, partially offset by the reversal of a legal settlement accrual of $2.3 million. The Year-To-Date 2023 results included incremental operating expenses, including restructuring costs of $9.9 million, contract termination fees of $3.0 million, and fleet optimization costs of $1.2 million. Excluding the impact of these incremental charges, SG&A leveraged 150 basis points to 30.1% of net sales, primarily as a result of significant reductions in store payroll and home office payroll, and the elimination of inflated and unprofitable marketing costs. This represents the lowest level of Adjusted selling, general, and administrative expenses in over 15 years for the first two quarters of a fiscal year.

Depreciation and amortization was $21.1 million during Year-To-Date 2024, compared to $23.8 million during Year-To-Date 2023. The decrease was primarily driven by reduced depreciation of capitalized software and the permanent closure of 81 stores during the past twelve months, partially offset by the accelerated depreciation related to the voluntary early termination of the corporate office lease.

Asset impairment charges were $28.0 million during Year-To-Date 2024 due to the reduction in fair value of the Gymboree tradename, which was primarily due to reductions in Gymboree sales forecasts and a reduction in the royalty rate used to value the tradename. Asset impairment charges were $2.5 million during Year-To-Date 2023, inclusive of ROU assets. These charges were related to underperforming stores identified in our ongoing store portfolio evaluation primarily as a result of decreased net sales and cash flow projections.

Operating loss decreased $17.2 million to $(49.8) million during Year-To-Date 2024, compared to $(67.0) million during Year-To-Date 2023. Operating loss was impacted by incremental expenses of $58.9 million, which included an impairment charge of $28.0 million on the Gymboree tradename, primarily due to reductions in Gymboree sales forecasts and a reduction in the royalty rate used to value the tradename, restructuring costs of $6.4 million primarily due to recent changes in our senior leadership team, and several charges due to our recent change of control, due to the investment in us by Mithaq, and several new financing initiatives, which include $10.8 million of non-cash equity compensation charges and $3.8 million in other fees associated with the change of control, and $6.7 million of financing-related charges. These charges have been classified as non-GAAP adjustments, leading to a shift back to profitability with an adjusted operating income of $9.2 million during Year-To-Date 2024, or an improvement of $58.7 million compared to an adjusted operating loss of $(49.5) million during Year-To-Date 2023, and leveraged 900 basis points to 1.6% of net sales.

Net interest expense was $17.0 million during Year-To-Date 2024, compared to $13.5 million during Year-To-Date 2023. The increase was primarily driven by higher average interest rates associated with our revolving credit facility due to the impact of refinancings and continued market-based rate increases, partially offset by continued benefits associated with certain non-interest bearing loans from our majority shareholder, Mithaq.

Provision (benefit) for income taxes was a provision of $3.2 million during Year-To-Date 2024 compared to a benefit of $(16.4) million during Year-To-Date 2023. Our effective tax rate was a provision of (4.8)% and a benefit of 20.3% during Year-To-Date 2024 and Year-To-Date 2023, respectively. The change in our effective tax rate and income tax provision (benefit) for Year-To-Date 2024 compared to Year-To-Date 2023 was primarily driven by the establishment of a valuation allowance against our net deferred tax assets in Fiscal 2023.

Net loss, which included certain non-cash impairment charges and non-operating restructuring charges, increased $(5.7) million to $(69.9) million, or $(5.50) per diluted share during Year-To-Date 2024, compared to $(64.2) million, or $(5.16) per diluted share during Year-To-Date 2023, due to the factors discussed above. Adjusted net loss, which was driven by losses in the First Quarter 2024 and partially offset by profits in the Second Quarter 2024, was $(11.0) million, or $(0.87) per diluted share during Year-To-Date 2024, compared to $(51.2) million, or $(4.12) per diluted share during Year-To-Date 2023.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our working capital needs typically follow a seasonal pattern, peaking during the third fiscal quarter based on seasonal inventory purchases. Our primary uses of cash are for working capital requirements, which are principally inventory purchases, the payment of interest expense on our revolving credit facility and interest-equivalent expenses on our term loans, and the financing of capital projects.

Our working capital deficit decreased $74.9 million to $71.2 million at August 3, 2024, compared to $146.1 million at July 29, 2023, primarily reflecting a decrease in borrowings on our $433.0 million asset-based revolving credit facility (the “ABL Credit Facility”) under our Credit Agreement and in our accounts payable balances, partially offset by an increase in accounts receivable balances.

At August 3, 2024, we had $316.7 million of outstanding borrowings under our $433.0 million ABL Credit Facility and no borrowings under our $40.0 million senior unsecured credit facility with Mithaq (the “Mithaq Credit Facility”). We had total liquidity of $116.9 million, including $67.3 million of availability under our ABL Credit Facility, $40.0 million of availability under our Mithaq Credit Facility, and $9.6 million of cash on hand. At August 3, 2024, we had $12.2 million of outstanding letters of credit, with an additional $12.8 million available for issuing letters of credit under our ABL Credit Facility.

We expect to be able to meet our working capital, capital expenditure, and debt service requirements for at least the next twelve months from the date that our consolidated financial statements for the Second Quarter 2024 were issued, by using our cash on hand, cash flows from operations, and availability under our ABL Credit Facility and Mithaq Credit Facility. This liquidity may be further supplemented with proceeds from a future rights offering, if any, that we are currently contemplating.

ABL Credit Facility and 2021 Term Loan

We and certain of our subsidiaries maintain the $433.0 million ABL Credit Facility and, before it was fully repaid, maintained a $50.0 million term loan (the “2021 Term Loan”) under our Credit Agreement with Wells Fargo Bank, National Association (“Wells Fargo”), Truist Bank, Bank of America, N.A., HSBC Business Credit (USA) Inc., JPMorgan Chase Bank, N.A., and PNC Bank, National Association as the Credit Agreement Lenders and Wells Fargo, as Administrative Agent, Collateral Agent, Swing Line Lender and, before the 2021 Term Loan was fully repaid, Term Agent. The ABL Credit Facility will mature and, before it was fully repaid, the 2021 Term Loan would have matured, in November 2026.

As of April 18, 2024, which is the effective date of the Seventh Amendment, the ABL Credit Facility includes a $25.0 million Canadian sublimit and a $25.0 million sublimit for standby and documentary letters of credit.

Under the ABL Credit Facility, borrowings outstanding bear interest, at our option, at:

(i) the prime rate per annum, plus a margin of 2.000%; or

(ii) the Secured Overnight Financing Rate (“SOFR”) per annum, plus 0.100%, plus a margin of 3.000%.

Prior to April 18, 2024, we were charged a fee of 0.200% on the unused portion of the commitments. As of April 18, 2024, based on the size of the unused portion of the commitments, we are charged a fee ranging from 0.250% to 0.375%. Letter of credit fees are at 1.125% for commercial letters of credit and 1.750% for standby letters of credit. The amount available for loans and letters of credit under the ABL Credit Facility is determined by a borrowing base consisting of certain credit card receivables, certain trade receivables, certain inventory, and the fair market value of certain real estate, subject to certain reserves and an availability block.

From and after February 4, 2025 and on the first day of each fiscal quarter thereafter, based on the amount of our average daily excess availability under the facility, borrowings outstanding under the ABL Credit Facility will bear interest, at our option, at:

(i) the prime rate per annum, plus a margin of 1.750% or 2.000%; or

(ii) the SOFR per annum, plus 0.100%, plus a margin of 2.750% or 3.000%.

Letter of credit fees will range from 1.000% to 1.125% for commercial letters of credit and will range from 1.500% to 1.750% for standby letters of credit. Letter of credit fees will be determined based on the amount of our average daily excess availability under the facility.

For the Second Quarter 2024 and Year-To-Date 2024, we recognized $6.3 million and $12.0 million, respectively, in interest expense related to the ABL Credit Facility. For the Second Quarter 2023 and Year-To-Date 2023, we recognized $6.1 million and $10.8 million, respectively, in interest expense related to the ABL Credit Facility.

Prior to April 18, 2024, when the 2021 Term Loan was fully repaid, credit extended under the ABL Credit Facility was secured by a first priority security interest in substantially all of our U.S. and Canadian assets other than intellectual property, certain furniture, fixtures, equipment, and pledges of subsidiary capital stock, and a second priority security interest in our intellectual property, certain furniture, fixtures, equipment, and pledges of subsidiary capital stock. As of April 18, 2024, the ABL Credit Facility is secured on a first priority basis by all of the foregoing collateral.

The outstanding obligations under the ABL Credit Facility may be accelerated upon the occurrence of certain customary events of default, as further described below. We are not subject to any early termination fees.

The ABL Credit Facility contains covenants, which include conditions on stock buybacks and the payment of cash dividends or similar payments. These covenants also limit our ability to incur certain liens, to incur certain indebtedness, to make certain investments, acquisitions, or dispositions or to change the nature of our business. Pursuant to the Seventh Amendment, the requisite payment condition thresholds for some of these covenants have been heightened, resulting in certain actions such as the repurchase of shares and payment of cash dividends becoming more difficult to perform. Additionally, if we are unable to maintain a certain amount of excess availability for borrowings (the “excess availability threshold”), we may be subject to cash dominion.

The ABL Credit Facility contains customary events of default, which include (subject in certain cases to customary grace and cure periods) nonpayment of principal or interest, breach of covenants, failure to pay certain other indebtedness, and certain events of bankruptcy, insolvency or reorganization, such as a change of control.

In October 2023, we became aware of inadvertent calculation errors contained in the June, July and August 2023 borrowing base certificates provided to the Credit Agreement Lenders under our Credit Agreement, all of which have since been remedied. As the Credit Agreement Lenders determined that the calculation errors resulted in certain technical defaults under the Credit Agreement (including us not being in compliance with certain debt covenants), we and the Credit Agreement Lenders entered into a Waiver and Amendment Agreement (the “Waiver Agreement”) on October 24, 2023, pursuant to which the Credit Agreement Lenders waived all of the defaults and we agreed to certain temporary enhanced reporting requirements and temporary restrictions on certain payments. These enhanced reporting requirements and restrictions will cease once we achieve certain excess availability thresholds. At no time prior to or following entering into the Waiver Agreement were we prevented from borrowing under the Credit Agreement in the ordinary course in accordance with its terms.

During the First Quarter 2024, Mithaq became the controlling shareholder of the Company and this change of control triggered an event of default under the Credit Agreement, thus subjecting us to cash dominion by the Credit Agreement Lenders. Subsequently, the Credit Agreement Lenders agreed to forbear from enforcing certain other rights and remedies during a limited forbearance period. On April 16, 2024, we and certain of our subsidiaries entered into the Seventh Amendment to the Credit Agreement with the Credit Agreement Lenders that, among other things, provided a permanent waiver of the change of control event of default. As of April 18, 2024, the ABL Credit Facility was reduced from $445.0 million to $433.0 million, and until we achieved certain excess availability thresholds, the Seventh Amendment preserved the temporary enhanced reporting requirements under the Waiver Agreement and continued to impose cash dominion.

As of August 29, 2024, we are no longer under cash dominion and we have reverted to the standard reporting requirements under the Credit Agreement.

The table below presents the components of our ABL Credit Facility:

(in millions)

(in millions)

(1) In the Second Quarter 2024, given that we were under cash dominion, the excess availability threshold was not applicable to the total borrowing base availability. As of August 29, 2024, we are no longer under cash dominion. In Fiscal 2023, the total borrowing base availability was calculated net of the excess availability threshold under the Credit Agreement, as prior to the Seventh Amendment, crossing that threshold would have resulted in cash dominion, which would have triggered a fixed charge coverage ratio covenant test and would likely have led to a default under the Credit Agreement. As of the Seventh Amendment, the fixed charge coverage ratio covenant has been removed from the Credit Agreement.

(2) In the Second Quarter 2024, given that we were under cash dominion, the excess availability threshold was not applicable to the determination of the credit facility availability. As of August 29, 2024, we are no longer under cash dominion. In Fiscal 2023, the credit facility availability was calculated net of the excess availability threshold, as prior to the Seventh Amendment, crossing that threshold would have resulted in cash dominion, which would have triggered a fixed charge coverage ratio covenant test and would likely have led to a default under the Credit Agreement. As of the Seventh Amendment, the fixed charge coverage ratio covenant has been removed from the Credit Agreement.

(3) The lower of the credit facility availability and the total borrowing base availability.

(4) The sub-limit availability for letters of credit was $12.8 million at August 3, 2024, and $42.6 million at February 3, 2024 and July 29, 2023.

The 2021 Term Loan bore interest, payable monthly, at (a) the SOFR per annum plus 2.750% for any portion that was a SOFR loan, or (b) the base rate per annum plus 2.000% for any portion that was a base rate loan. The 2021 Term Loan was pre-payable at any time without penalty, and did not require amortization. We recognized $1.1 million in interest expense related to the 2021 Term Loan during Year-To-Date 2024. For the Second Quarter 2023 and Year-To-Date 2023, we recognized $1.0 million and $1.9 million, respectively, in interest expense related to the 2021 Term Loan.

As of April 18, 2024, the 2021 Term Loan was fully repaid.

As of August 3, 2024, unamortized deferred financing costs amounted to $2.4 million related to our ABL Credit Facility.

Mithaq Term Loans

We and certain of our subsidiaries maintain an interest-free, unsecured and subordinated promissory note with Mithaq for a $78.6 million term loan (the “Initial Mithaq Term Loan”), consisting of (a) a first tranche in an aggregate principal amount of $30.0 million (the “First Tranche”) and (b) a second tranche in an aggregate principal amount of $48.6 million (the “Second Tranche”). We received the First Tranche on February 29, 2024 and the Second Tranche on March 8, 2024.

The Initial Mithaq Term Loan matures on February 15, 2027. The Initial Mithaq Term Loan is guaranteed by each of our subsidiaries that guarantee our ABL Credit Facility.

We and certain of our subsidiaries also maintain an unsecured and subordinated $90.0 million term loan with Mithaq (the “New Mithaq Term Loan”; and together with the Initial Mithaq Term Loan, collectively, the “Mithaq Term Loans”).

The New Mithaq Term Loan matures on April 16, 2027, and requires monthly payments equivalent to interest charged at the SOFR plus 4.000% per annum, with such monthly payments to Mithaq deferred until April 30, 2025. The New Mithaq Term Loan is guaranteed by each of our subsidiaries that guarantee our ABL Credit Facility. For the Second Quarter 2024 and Year-To-Date 2024, we recognized $2.1 million and $2.5 million, respectively, in deferred interest-equivalent expense related to the New Mithaq Term Loan.

The Mithaq Term Loans are subject to an amended and restated subordination agreement (as amended from time to time, the “Subordination Agreement”), dated as of April 16, 2024, by and among us and certain of our subsidiaries, Wells Fargo and Mithaq, pursuant to which the Mithaq Term Loans are subordinated in payment priority to our obligations under the Credit Agreement. Subject to such subordination terms, the Mithaq Term Loans are prepayable at any time and from time to time without penalty and do not require any mandatory prepayments.

The Mithaq Term Loans contain customary affirmative and negative covenants substantially similar to a subset of the covenants set forth in the Credit Agreement, including limits on our ability to incur certain liens, to incur certain indebtedness, to make certain investments, acquisitions, dispositions or restricted payments, or to change the nature of our business. The Mithaq Term Loans, however, do not provide for any closing, prepayment or exit fees, or other fees typical for transactions of this nature, do not impose additional reserves on borrowings under the Credit Agreement, and do not contain certain other restrictive covenants.

The Mithaq Term Loans contain certain customary events of default, which include (subject in certain cases to customary grace periods), nonpayment of principal, breach of other covenants of the Mithaq Term Loans, inaccuracy in representations or warranties, acceleration of certain other indebtedness (including under the Credit Agreement), certain events of bankruptcy, insolvency or reorganization, such as a change of control, and invalidity of any part of the Mithaq Term Loans.

As of August 3, 2024 unamortized deferred financing costs amounted to $3.2 million related to the Mithaq Term Loans.

Maturities of our principal debt payments as of August 3, 2024 are as follows:

(in thousands)

Mithaq Commitment Letter

On May 2, 2024, we entered into a commitment letter (“the Commitment Letter”) with Mithaq for a $40.0 million Mithaq Credit Facility. Under the Mithaq Credit Facility, we had the ability to request for advances at any time prior to July 1, 2025. On September 10, 2024, we entered into an Amendment No. 1 to the Commitment Letter with Mithaq, that extended the deadline for requesting advances until July 1, 2026.

If any debt is incurred under the Mithaq Credit Facility, it shall require monthly payments equivalent to interest charged at the SOFR plus 5.000% per annum. Such debt shall be unsecured and shall be guaranteed by each of our subsidiaries that guarantee our ABL Credit Facility. Similar to the Mithaq Term Loans, such debt shall also be subject to the Subordination Agreement, contain customary affirmative and negative covenants substantially similar to a subset of the covenants set forth in the Credit Agreement, and contain certain customary events of default. Additionally, such debt shall require no mandatory prepayments and shall mature no earlier than July 1, 2026. As of August 3, 2024, no debt had been incurred under the Mithaq Credit Facility.

Cash Flows and Capital Expenditures

Cash used in operating activities was $194.7 million during Year-To-Date 2024, compared to $32.7 million during Year-To-Date 2023. Cash used in operating activities during Year-To-Date 2024 was primarily the result of higher inventory purchases and a lower accounts payable balance compared to Fiscal 2023.

Cash used in investing activities was $12.5 million during Year-To-Date 2024, compared to $18.3 million during the Year-To-Date 2023, driven by lower capital expenditures.

Cash provided by financing activities was $203.7 million during Year-To-Date 2024, compared to $53.0 million during Year-To-Date 2023. The increase primarily resulted from proceeds from higher net borrowings under our ABL Credit Facility and the Mithaq Term Loans, partially offset by the repayment of the 2021 Term Loan.

Our ability to continue to meet our capital requirements in Fiscal 2024 depends on our cash on hand, our ability to generate cash flows from operations, and available borrowings under our ABL Credit Facility and Mithaq Credit Facility. Cash flows generated from operations depends on our ability to achieve our financial plans. We believe that our cash on hand, cash generated from operations, and funds available to us through our ABL Credit Facility and Mithaq Credit Facility will be sufficient to fund our capital and other cash requirements for at least the next twelve months from the date that our consolidated financial statements for the Second Quarter 2024 were issued.

In the normal course of business, our financial position and results of operations are routinely subject to market risk associated with interest rate movements on borrowings and investments and currency rate movements on non-U.S. dollar denominated assets, liabilities, income, and expenses. We utilize cash from operations and short-term borrowings to fund our working capital and investment needs.

Cash and Cash Equivalents

Cash and cash equivalents are normally invested in short-term financial instruments that will be used in operations within 90 days of the balance sheet date. Because of the short-term nature of these instruments, changes in interest rates would not materially affect their fair values.

Interest Rates

Until February 4, 2025, our ABL Credit Facility bears interest at a floating rate equal to the prime rate plus 2.000% or SOFR, plus 0.100%, plus 3.000%. As of August 3, 2024, we had $316.7 million in borrowings under our ABL Credit Facility. A 10% change in the prime rate or SOFR would not have had a material impact on our interest expense.

Our 2021 Term Loan bore interest, payable monthly, at (a) the SOFR per annum plus 2.750% for any portion that was a SOFR loan, or (b) the base rate per annum plus 2.000% for any portion that was a base rate loan. As of April 18, 2024, our 2021 Term Loan was fully repaid.

The New Mithaq Term Loan requires monthly payments equivalent to interest charged at the SOFR per annum plus 4.000% per annum, with such monthly payments to Mithaq deferred until April 30, 2025. A 10% change in the prime rate or SOFR would not have had a material impact on our interest expense.

As of August 3, 2024, we had no borrowings under our Mithaq Credit Facility. If any debt is incurred under the Mithaq Credit Facility, it shall require monthly payments equivalent to interest charged at the SOFR plus 5.000% per annum. A 10% change in the prime rate or SOFR would not have had a material impact on our interest expense.

Assets and Liabilities of Foreign Subsidiaries

Assets and liabilities outside the United States are primarily located in Canada and Hong Kong, where our investments in our subsidiaries are considered long-term. As of August 3, 2024, net assets in Canada and Hong Kong amounted to $1.2 million. A 10% increase or decrease in the Canadian and Hong Kong foreign currency exchange rates would increase or decrease the corresponding net investment by $0.1 million. All changes in the net investments in our foreign subsidiaries are recorded in other comprehensive loss.

As of August 3, 2024, we had $4.2 million of our cash and cash equivalents held in foreign subsidiaries, of which $1.5 million was in India, $1.3 million was in China, $0.9 million was in Canada, $0.3 million was in Hong Kong, and $0.2 million was held in other foreign countries.

Foreign Operations

We have exchange rate exposure primarily with respect to certain revenues and expenses denominated in Canadian dollars. As a result, fluctuations in exchange rates impact the amount of our reported sales and expenses. Assuming a 10% change in foreign currency exchange rates, the Second Quarter 2024 net sales would have decreased or increased by approximately $4.5 million, and total costs and expenses would have decreased or increased by approximately $6.7 million. Additionally, we have foreign currency denominated receivables and payables that, when settled, result in transaction gains or losses. A 10% change in foreign currency exchange rates would not result in a significant transaction gain or loss in earnings.

We import a vast majority of our merchandise from foreign countries, primarily Vietnam, Bangladesh, Ethiopia, Cambodia, Kenya, India, and China. Consequently, any significant or sudden change in the political, foreign trade, financial, banking, or currency policies and practices, or the occurrence of significant labor unrest in these countries, could have a material adverse impact on our business, financial position, results of operations, and cash flows.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are designed only to provide “reasonable assurance” that the controls and procedures will meet their objectives. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected.

Management, including our President and Interim Chief Executive Officer, and our Chief Operating Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of August 3, 2024.

Based on that evaluation, our President and Interim Chief Executive Officer, and our Chief Operating Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level, as of August 3, 2024, to ensure that all information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including our principal executive, principal accounting, and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(f) and 15d-15(f) of the Exchange Act that occurred during the quarter ended August 3, 2024 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Except for the new risk factor described in our Quarterly Report on Form 10-Q for the quarter ended May 4, 2024, there were no material changes to the risk factors disclosed in Item 1A of Part I in our Annual Report on Form 10-K for the year ended February 3, 2024.