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The Children’s Place, Inc. (NASDAQ:PLCE) Q4 2022 Earnings Call Transcript

The Children's Place, Inc. (NASDAQ:PLCE) Q4 2022 Earnings Call Transcript March 17, 2023

Operator: Good morning. And welcome to The Children's Place Fourth Quarter and Fiscal Full Year 2022 Earnings Conference Call. On the call today are Jane Elfers, President and Chief Executive Officer; Sheamus Toal, Chief Financial Officer; Maegan Markee, Senior Vice President, Digital Marketing; and Josh Truppo, Vice President, Financial Planning and Analysis. After the prepared remarks, we will open the call up to your questions. The Children's Place issued its fourth quarter and full year fiscal 2022 earnings press release earlier this morning, and a copy of the release and presentation materials have been posted to the Investor Relations section of the company's website. Before we begin, let me remind you that statements made on this conference call and in the company's earnings release and presentation materials about the company's outlook, plans and future performance are forward-looking statements.

Actual results may differ materially from those projected. For a discussion of factors that could cause actual results to vary from those contained in the forward-looking statements, please refer to the company's most recent annual and quarterly reports filed with the Securities and Exchange Commission and the presentation materials posted on the company's website. On this call, the company will reference various non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the GAAP financial measurements is provided in the company's earnings release and presentation materials. Also, today's call is being recorded. It is now my pleasure to turn the call over to Jane Elfers.

Jane Elfers: Thank you, and good morning, everyone. After my opening remarks, I'll turn it over to Maegan who leads our marketing and Amazon teams to review our significant progress in 2022 and highlight our 2023 plans for these 2 key growth areas. Maegan will turn it over to Sheamus to review our Q4 and full year 2022 results and provide our Q1 and full year 2023 outlook. Sheamus will turn it back to me for closing comments. As we announced in early February, our 2022 operating results were negatively impacted by unprecedented input costs, the spike in cotton prices, air freight and container costs. While we are working through higher cost inventory in the front half of 2023, input cost reductions, our focus on expense and inventory management and our strategic growth initiatives are planned to drive double-digit operating margins in the back half of 2023.

Over the last several years, we have successfully executed a strategic transformation of The Children's Place focused on 4 key pillars: superior product; digital transformation; wholesale and international expansion; and fleet optimization. When we embarked upon this initiative, we analyzed the highly competitive environment, rapidly changing consumer shopping trends and birth rates, which, as of 2017 have been falling for a decade. We determined that in order to successfully compete, we needed to capture market share, while positioning ourselves to meet the needs of our increasingly digitally-savvy core millennial customer along every step of her purchase journey. We made several key strategic decisions during the course of our transformation, some of which led to short-term volatility in our results, but all of which have positioned the company for sustained long-term growth on both the top and bottom lines.

With our multiyear transformation now complete, we are focused on our next phase, top and bottom line growth. Our growth will be underpinned by the same 4 strategic pillars: superior product; digital dominance; wholesale and international expansion; and an optimized fleet. Today, we thought it would be helpful to review how our strategic initiatives have positioned us for long-term growth with our digitally-savvy core millennial customers and the Gen Z customers right behind them. So let's start with our successful digital transformation. Prior to the onset of the pandemic, we accelerated our digital transformation with a $50 million investment to upgrade our platform systems and omnichannel capabilities. This was a necessary and timely initiative that enabled us to keep pace with our core millennial customer, a younger consumer who is rapidly evolving into a digital-first consumer.

We know our customer well, and we recognized long before the pandemic that our millennial mom shift to digital was happening. And now as we are about to enter our fourth year since the pandemic hit, her preference for online shopping has only continued to increase. Without that investment, we would not have been able to service our customers when all of our stores were shut down for several months at the start of the pandemic. And we would not have the significant competitive advantage of our industry-leading digital penetration that we have today. Importantly, in order to take full advantage of our customers' strong preference for online shopping, we focused on rapidly shifting our primary acquisition channel from digital to digital from stores, and we have achieved our desired results in a remarkably short period of time.

With digital now our primary acquisition channel. We then made the strategic decision to aggressively promote our product in order to capture market share in the then over-stored kids retail space. One year later, we saw the benefits from the strategy as we captured pricing power for our core TCP brand when there were approximately 2,000 fewer mall-based kid stores. Concurrently, our design team began rejuvenating the iconic Gymboree brand, an acquisition that has strategically positioned us to be a more powerful competitor in what has been for us, an underpenetrated toddler demographic. And during the pandemic, we recognized the opportunity to further accelerate our transformation. We launched 3 new brands, each one targeting an untapped or underdeveloped market share opportunity and a higher-income demographic than our core TCP customer.

Our brand expansion strategy is a key element of our market share growth strategy as these new brands give us the opportunity to significantly expand our customers' lifetime value. Maegan will cover this in more detail in her prepared remarks. Looking ahead to what we believed was going to be a significantly larger and higher-margin digital business, post-pandemic, we further invested in our industry-leading digital channel with a focus on expanding our digital fulfillment capabilities. We partnered more closely with Amazon, and we invested in the Amazon business and achieved significant growth with this important wholesale partner and are now positioned for sustained growth with Amazon in 2023 and beyond. Based on our millennial customers' rapidly evolving preference for shopping online, we accelerated our fleet optimization initiative by closing almost 1/3 of our stores within 20 months without additional cost to us, given a lease flexibility we have built into our model.

Our store closing initiative enabled the structural change to our digital-first business model and significantly lowered occupancy expense on our remaining fleet. By the end of 2023, our fleet optimization strategy will be substantially complete, positioning us in the optimum brick-and-mortar locations to service our Millennial and Gen Z consumers omni-channel shopping preferences. And lastly, to support our strategic reset, we invested in and transformed our marketing function, positioning us to optimize every touch point along our younger, digitally-savvy core customers purchase journey. Our data-driven marketing strategy is designed to support topline growth by increasing new customer acquisition, increasing customer retention and loyalty and importantly, significantly increasing customer lifetime value by supporting a synergistic shopping experience across our expanded family of brands.

We made strategic investments across every area of the marketing organization, our teams, both internal and external, our research and processes and new state-of-the-art marketing tools and systems. As we have discussed several times, we have historically underfunded marketing. Our marketing strategies produced strong returns in the back half of 2022, particularly in the areas of brand awareness and acquisition. Now that we've seen strong returns from our marketing transformation, we believe we can unlock significant topline growth opportunity through increased marketing investments in 2023 and beyond, more closely aligning our marketing spend with industry norms. Despite major challenges for our team, our business and our customers, our work during the pandemic accelerated our digital transformation by approximately 5 years, allowing us to successfully complete our multiyear strategic reset at the end of 2022.

As we move into our next phase, sustained growth, our strategic pillars remain consistent. So let's take this opportunity to review the current status of each of them. Starting with our first strategic pillar, product. Our core TCP brand continued to strongly resonate with our customers in 2022. The strength of our core TCP product is due in large part to our long-tenured best-in-class design team's deep understanding of our customers' wants and needs. The consistent strength of our core TCP product gave us the confidence to explore new brand opportunities. To that end, we launched 3 new brands, Gymboree, Sugar & Jade and PJ Place. With respect to market share, birth rates peaked in 2007 and have not returned to those levels in the 15 years since, and future projections do not have birth rates approaching 2007 levels.

Counting on an uptick in birth rates to solve for declining sector market share is not a winning strategy. Each of our new brands is strategically positioned to target an underdeveloped or untapped market share opportunity, is rooted in our core competencies and targets a higher-income demographic than our core TCP brand. With the addition of these three brands, we can realize a significantly higher customer lifetime value than would be possible with just a single brand, making this complementary multi-brand approach, an important part of our future growth strategy. In addition to expanding our market share and increasing customer LTV, our family of brands provides us with additional opportunities to partner with our wholesale and international franchisees to further grow brand awareness, market share and increase our top and bottom line.

Starting with Gymboree. The Gymboree customer is a higher income customer and is less price sensitive than our core TCP customer. Gymboree targets the key toddler demographic, ages 2 to 6, which is an underpenetrated demographic for TCP. With the Gymboree brand, we are acquiring customers whose children are very young. And as the child grows, we introduce those customers to our wider stable of brands. For example, a Gymboree toddler girl can grow up wearing the iconic Gymboree bow-to-toe looks and then move on to TCP big girl product and then on to our Sugar & Jade tween line, and eventually into our Gen Z PJ Place offerings before she eventually starts a family of her own and the whole cycle repeats. Our launch of Gymboree on Amazon last fall was a very important step in Gymboree's growth trajectory as it provided us with a significant acquisition vehicle from a higher-income consumer.

Looking ahead to 2023 and beyond, we are planning to increase Gymboree's marketing investments to further drive brand awareness and acquisition. We now anticipate that the Gymboree brand will reach our initial revenue goal of $140 million in sales in full year 2025. Moving on to Sugar & Jade. The tween market is a fragmented market that is estimated at approximately $8 billion. Our largest TCP business is our big girl division. And due to our leadership position in big girl apparel and accessories, Sugar & Jade is a natural extension of that core competency. The strategy behind Sugar & Jade keeps our highest spending customer, our big girl customer, and our brands longer and further expands their lifetime value. We are entering our second year with Sugar & Jade.

And from a product point of view, we have a clear understanding of what categories resonate with the tween customer. With our refined product strategy, our next step in Sugar & Jade's evolution is to build brand awareness to reach a wider audience. This increased marketing investment is planned to begin for holiday 2023. And lastly, PJ Place. PJ Place is a one-stop shop for all of our sleepwear and loungewear. We have a leadership position in kids sleepwear and matching adult sleepwear. In fact, within our sleepwear business, adult is our fastest-growing category. This new sleep and lounge product also gives us an opportunity to be relevant to an older Gen Z customer and younger Millennials before they start families of their own. PJ Place houses all of our sleep and loungewear products and brands, TCP, Gymboree, Sugar & Jade and our new PJ Place sleep and lounge product in one easy-to-shop tab on our website.

Looking ahead to 2023 and beyond, we are focused on continuing to expand our total sleep and loungewear market share across all of our brands and partners in this fast-growing category. Moving on to our second pillar, digital transformation. For full year 2022, digital represented 48% of our retail sales versus 33% in 2019. We continued to deliver industry-leading digital penetration in our highest operating margin channel in 2022, supported by marketing initiatives, focused on optimizing our channel results. Approximately 60% of our acquisitions came through our digital channel in Q4. Our Millennial moms clear preference for the ease and convenience of shopping for her kids online is here to stay. And we believe our rapid and successful shift to digital as our primary acquisition channel gives us an important competitive advantage as we work to acquire and retain Millennial mom and begin to market to the oldest of the Gen Z cohort who are now starting to become our next generation of customers.

We are excited about our digital growth opportunities and our highest operating margin channel, and based on the success of our digital transformation, the strength of our digital business and our increased investments in this channel. Digital is projected to represent over $1 billion in sales by full year 2025 or over 60% of our total retail sales versus 33% of our retail sales in 2019, doubling our digital penetration in 6 years and further cementing our successful transition to a digital-first retailer. As a point of reference, our $1 billion digital revenue forecast does not include digital revenue from our wholesale or international businesses. Moving on to our third strategic pillar, alternate channels of distribution. Our Amazon business continued to outperform our projections in 2022.

Amazon is a key growth focus in our wholesale distribution strategy. And in 2022, we strengthened our Amazon partnership. Amazon is our second highest operating margin channel, a significant contributor to our top and bottom line and a very important consumer acquisition vehicle with many of these customers having higher income levels. Amazon represents a major growth opportunity in 2023 and beyond, and Maegan will further discuss Amazon in her remarks. And with respect to our fourth and final pillar, fleet optimization. We have made outstanding progress on our fleet optimization initiative over the last few years. We have closed 315 stores since 2019, representing 34% of our fleet. If we had stayed locked into our over-stored model with onerous fixed costs and multiyear double-digit traffic decline even before the pandemic, I believe we would have followed the path of dozens of other retailers who permanently closed their doors before and during the pandemic.

Instead, we have transformed into a dynamic, variable-based transactional cost structure with our industry-leading digital business, thereby reducing risk and paving the path towards sustained top and bottom line growth. Looking ahead, we are now anticipating that we will close approximately 100 more stores, with the bulk of those store closures occurring in 2023. This will leave us with an optimized fleet of approximately 500 stores as we enter 2024. Our fleet optimization strategy has been a critical part of our company's structural reset and aligns with our current and future customers' digital shopping preferences. The data is clear. Millennials have a strong preference for online shopping, and this is only projected to continue to increase with Gen Z parents.

I think it's important to note that we have a very small newborn and baby business. So our customers are overwhelmingly younger self-purchasers versus other retailers who still have a much larger share of older customers, including grandparents and gifters, many of whom, for example, still prefer an in-store experience as they drive to the store to pick up the perfect baby gift. We are confident that our projected fleet size of approximately 500 stores allows us to maximize our omnichannel capabilities and grow our industry-leading digital penetration and service our young, digitally-savvy customers through our highest operating margin channel. Thank you. And now I'll turn it over to Maegan to discuss our marketing transformation and our Amazon channel.

Maegan Markee: Thank you, Jane, and good morning, everyone. As Jane mentioned, our marketing transformation over the past few years enables us to capitalize on maximizing our interactions with our younger, digitally-savvy Millennial and Gen Z customers and to support the growth of a significantly larger and stronger digital business coming out of the pandemic. Starting in the back half of 2022, we felt confident in our ability to concept, build, deploy and optimize fully integrated creative marketing strategies paired with a robust media mix aimed to reach, inspire and convert our shoppers at every stage of their purchase journey with The Children's Place family of brands. Our data-driven marketing transformation was designed to support the significant future topline opportunity we've been discussing for several quarters by increasing new customer acquisition, customer retention and loyalty, and importantly, significantly increasing customer lifetime value through our marketing efforts and our new brand launches.

As Jane discussed earlier, the recent launch of our Gymboree, Sugar & Jade and PJ Place brands have not only aided in our success in driving overall brand awareness and our ability to seize untapped market share opportunities, but has also lifted customer lifetime value. Through our family of brands, we've been able to provide market differentiation through our unique and trend-right product assortments and provide value defined beyond just price that is delivered through quality, fit, versatility and durability, solidifying The Children's Place leadership position in the children's apparel industry. In the short time since launching these brands, we've seen strong results as it relates to customer lifetime value, spend and frequency. To date, our analysis shows that, on average, our multi-brand shoppers, customers who shop The Children's Place and one or more other of our brands spend 2.5x more than single brand shoppers.

These multi-brand shoppers have a frequency of more than 2x a single brand shopper and have a higher spend per purchase of 15% more than a single brand shopper. Said another way, customers that shop 2 or more of our family of brands are far more valuable than our single brand shoppers. Now let's move to recap. Our very encouraging full funnel strategy results from the back half of 2022, starting with top of funnel. With top-of-funnel brand awareness being a key area of focus for us in Q3 and Q4, The Children's Place, Gymboree, Sugar & Jade and our new brand launch, PJ Place, cut through the noise experienced by other retailers during this timeframe. It was a curtains-up moment for our brand, and we're incredibly proud of the results. We partnered with some of the largest celebrity names in mainstream media, including Kevin Hart, Kris Jenner, Khloé Kardashian, Mandy Moore and Tyler Cameron.

Across our back-to-school and holiday campaigns for The Children's Place, Gymboree and PJ Place, we garnered over 143 billion impressions across our earned and paid media efforts. To put this in perspective, our 2021 back half campaigns represented just 0.6% of the reach that we achieved in the back half of 2022. These incredibly disruptive brand campaigns also translated to positive topline results. For every dollar we invested, we made close to 7x back in topline revenue. And our blended return on ad spend of $6.75 is well above the industry benchmark for top-of-funnel performance. Moving on to our social dominance. While our followers continue to steadily increase, the true measure of success across social media is the quality of our followers and the level of engagement.

Our Q3 and Q4 brand campaigns have proven that The Children's Place brands continue to hold the #1 position on social media, driving industry-leading results, representing 70% of total social impressions and representing 59% of total social interactions amongst our children's apparel retailers' competitive set. The Children's Place family of brands dominated social media to take the #1 rank across impressions and interactions for Q3 and Q4 of 2022. All of these successful top-of-funnel brand activations fueled our growth and acquisition. In fact, U.S. acquisition during the fourth quarter of 2022 was up 3% versus last year despite being up against a record-setting Q4 in 2021. Even more impressive, when compared to Q4 of 2019, acquisition is up 11% despite having significantly less stores, which further validates our successful digital acquisition strategy.

When looking at full year 2022, acquisition was up 3% versus 2021, a banner year for the industry and up 7% versus 2019 despite having 34% less stores. Looking ahead to 2023 and based on the successes of our recent strategies, we're planning for growth in our customer file, driven by digital acquisition. Now let's move further down the funnel and discuss retention and loyalty. Consolidated U.S. retention was up 4% in Q4 of 2022 versus Q4 of 2021. As a customer-centric organization, we think mobile first. Our Millennial and Gen Z shoppers are connected to their mobile devices, and mobile is the cornerstone of our digital strategy. In Q4, 77% of our U.S. digital transactions occurred on a mobile device. Our targeted mobile app strategies have driven a significant increase in mobile app transactions and mobile app users.

In Q4, our mobile app accounted for 18% of our U.S. digital transactions versus 14% in Q4 of 2021, fueled by an impressive 15% increase in mobile app customers versus last year. Our mobile app customers spend and shop 2x more than our non-app customers. Our loyalty and private label credit programs also continue to be strong retention vehicles for our brand. Our consolidated loyalty penetration was 78% of U.S. sales in Q4 of 2022 versus 74% in 2021, showing meaningful growth across our largest customer base. And our private label credit penetration was 22% of U.S. sales in Q4 of 2022. While we saw strong acquisition and retention results in 2022, we also experienced challenges with respect to customer spend due to the unprecedented inflationary environment which disproportionately impacted our core customer.

While we were able to maintain our customer frequency in the U.S. versus 2021, we had a decrease in customer spend of 7% versus 2021. Now let's move on to our historical marketing investments, our future investment plans and their respective returns. As we've discussed before, The Children's Place has historically been underfunded with respect to marketing versus our specialty peers. Our marketing spend, measured by our ad spend to sales ratio was less than 2% in 2022, well below the industry benchmark of over 3%. Despite our relative underfunding in 2022, we delivered a blended return on ad spend of $10.52, which is significantly above the industry benchmark of $6 to $7. This clearly signals opportunity to further drive incremental sales through increased marketing investment, while still delivering a healthy return.

Now let's move on to Amazon. Along with our decision to accelerate our digital transformation, our store closure plans and our marketing transformation, we also accelerated our Amazon initiative. The significant time and resources, including inventory and marketing investment that we've dedicated towards building our Amazon marketplace over the past 2 years has resulted in significant growth, with Amazon delivering another strong performance in Q4. As we shared on our last call, we achieved record-high Amazon sales during the Prime Day period in Q2. And sales continued to build throughout the back half of the year. We participated in the Turkey Five Thanksgiving promotion in Q4, which resulted in the largest day of Amazon sales in our history, exceeding our Q2 Prime Day record.

Our Q4 Amazon site sales were up 120% versus Q4 of 2021, fueled by a 200% increase in traffic year-over-year. Our Q4 performance capped a strong end to the year with site sales up 118% in full year 2022 versus full year 2021, fueled by a 197% increase in traffic, serving as a strong indicator of the potential we have with this partner in 2023 and beyond. Marketing is a key component to driving the Amazon business and our successful marketing strategies are driving the significant year-over-year increases in traffic. Ad attributed sales with Amazon were 49% of total Amazon channel sales for 2022, up 308% versus 2021, with a strong double-digit return on ad spend. Last fall, we launched our iconic Gymboree brand on Amazon. And the Amazon Gymboree business has consistently built since our launch and exceeded our expectations for 2022.

Children, playing, games
Children, playing, games

Photo by Artem Kniaz on Unsplash

This momentum was partially fueled by an enhanced advertising strategy built around maximizing the brand's visibility in high-impact placements. Our Gymboree ad performance has been recognized by Amazon as a case study for successful cold start brands. Based on the strong performance with over 50% of total Amazon channel sales coming through at attributed sales in 2022 at a very healthy return on ad spend, which signals the significant opportunity ahead to drive incremental sales through increased marketing investment. We anticipate that our partnership with Amazon will continue to strengthen. We'll talk more about the future opportunities as the year progresses, but we see opportunity to pursue both expanding our family of brands through the Amazon channel as well as international growth opportunities.

Looking ahead to 2023 and beyond, we have significant growth potential from our marketing transformation, our realigned marketing spend and our strong Amazon partnership. I am proud to be leading these important initiatives. Now I will turn it over to Sheamus.

Sheamus Toal: Thank you, Maegan, and good morning, everyone. I would like to begin by providing some context to the full year 2022 and more specifics on our fourth quarter results. I will then provide some remarks with respect to our outlook for 2023 and our strategic vision for the future. First, as a relatively newcomer to the company, I was able to analyze the results of our comprehensive multiyear transformation with fresh eyes, and I am confident that our strategic reset to a digital-first company, provides a strong foundation for consistent and profitable growth in the future, which will drive shareholder value creation. Let me say a little bit more about the remarkable transition the company has made to a digital-first retailer with a productive, optimized store base.

Make no mistake about it. This was a change, which our younger Millennial customer required us to make. I know from my past experience that the journey from a company with over 1,100 stores and a single-digit e-commerce penetration to one having approximately 600 stores and 50% of its revenues online is not easy, but The Children's Place did it. Ignore for a moment the impact of the macro issues which we and all retailers faced in the last 12 months, including the unprecedented cost of cotton, shipping containers and airfreight as well as the impact of record inflationary pressures which our customers confronted. To successfully transform, we needed to practically reinvent the company, and that transition did not come without some ups and downs, both operationally and financially.

But it is my belief that the past volatility in our performance is now largely mitigated as we now have the key building blocks of our strategy in place, as Jane described. We will now begin to fine-tune and capitalize on our new model, and I am highly confident that beginning in the back half of 2023, our results will prove that our transformation strategy was the right one. In terms of a brief overview of our Q4, as we previously disclosed, our fourth quarter results came in significantly below our original expectations, but were slightly better than our revised guidance in early February. We reported adjusted loss per share of $3.87 per share for Q4. This loss was primarily due to the combination of high product input cost, most notably cotton and freight and the effects of the macroeconomic environment that proved to be far more challenging for our core customers than we originally expected.

In the face of these unforeseen challenges, the company made several strategic decisions with respect to the level and composition of inventory and expenses, which resulted in additional operating margin pressure as we disclosed in our February 6 press release. In terms of the detailed results, net sales for the fourth quarter decreased $52 million or 10% to $456 million, primarily driven by the macroeconomic challenges. Our U.S. net sales decreased by $72 million or 16% to $372 million, and our Canadian net sales decreased by $4 million or 9% to $43 million. Comparable store sales decreased 12.8% for the quarter. This result was negatively impacted by the challenging macro environment, resulting in the continued slowdown in consumer demand due to unprecedented levels of inflation and the absence of government stimulus.

Our comparable store traffic was up approximately 2%, and our e-commerce traffic was down approximately 3%, driven by lapping the COVID surge last year, which significantly decreased store traffic and increased e-commerce traffic last year in December and January. Our overall average dollar sale declined by approximately 10%, driven by a mid-single-digit decline in both AUR and UPT. Importantly, AURs remain significantly higher than pre-pandemic levels, validating the success of our updated pricing strategies, which we believe will pay significant dividends as input and transactional costs come down as we move into the back half of 2023. Adjusted gross profit margin for the quarter decreased to 17.5% of net sales as compared to 38.2% of net sales in the prior year, driven by the combination of an unprecedented increase in input costs, including cotton and supply chain costs, the impact of a highly promotional retail environment, temporarily elevated transaction costs due to an increase in the number of packages shipped, combined with various strategic initiatives that the company took to reduce inventory and ensure that we entered the spring season with clean, fresh inventories.

Adjusted SG&A was $129 million for the fourth quarter as compared to $119 million last year. This increase was primarily a result of the investment and marketing initiatives, as Maegan described, an increase in various sales tax reserves and inflationary pressures on various general and administrative expenses. Our net interest expense was $5 million for the quarter versus adjusted net interest of $2 million in the prior year's fourth quarter. The increase in interest expense was driven by higher borrowings and higher average interest rates associated with the revolving credit facility and term loan. For the fourth quarter, we reflected an adjusted net loss of $48 million or $3.87 per share as compared to an adjusted net profit of $44 million or $3.02 per diluted share in the comparable period last year.

Moving to our balance sheet. We ended the year with cash and short-term investments of $17 million, $287 million of outstanding borrowings on our revolving credit facility and a modest amount of long-term debt, which remains unchanged at $50 million. During the quarter, we made significant progress in our inventory reduction efforts. As we previously discussed, our inventory still includes certain higher average unit cost inventory that was purchased in 2022 when input costs were at their peak. Nonetheless, we are pleased that we were able to liquidate a significant portion of this inventory in Q4 and importantly, ended the year with lower inventory levels of seasonal fall and holiday inventory. Inventory levels, which had been up 24% as we entered the quarter, were only up approximately 4% as we ended the quarter, enabling us to end in a healthy unit position despite the higher carrying costs.

As previously disclosed, the increase in inventory as of year-end is entirely due to higher input costs, including cotton and supply chain costs as unit inventories are down double digits versus the prior year. Our basic inventory, which includes several key high-volume categories with limited to no markdown risk, accounted for approximately 50% of our on-hand inventory at the end of Q4. This is a larger portion of inventory dedicated to basics than in past years, which helps mitigate inventory risk in a low AUR category. Moving on to cash flow and liquidity. We generated $9 million of cash from operations in Q4 versus $66 million last year. As we will discuss in our outlook, our digital-first model positions us well to generate free cash flow, which will ramp up in the second half of the year.

Capital expenditures in Q4 were $14 million. During the fourth quarter, we repurchased 372,000 shares for $14 million, leaving $164 million outstanding on our current authorization. Year-to-date, we have purchased 2 million shares. During the fourth quarter, we closed 45 locations, and for the full year 2022, closed 59 locations, ending the year with 613 stores. We continue to carefully evaluate our store fleet and close low-volume, unprofitable stores. With over 75% of our fleet coming up for lease action in the next 24 months, we are maintaining meaningful financial flexibility in our lease portfolio. In a moment, I will provide further commentary about our real estate rationalization program as part of my discussion of our future outlook.

Before I get into our specific guidance, let me provide you with my thoughts on how we are approaching 2023 and beyond. With the support of Jane and the Board, I am making some necessary changes to install more financial and operating discipline to improve our results, provide more consistent and more profitable growth and drive shareholder returns. Let's start with our approach to inventory. Fiscal 2022 was clearly a challenging period for the company and the entire retail sector due to the impacts of record-high inflation and also from an inventory management perspective. These challenges included the impact of decade-high cotton prices, record-high container costs, an unprecedented reliance on airfreight due to supply chain delays, cost challenges that unlike most other retailers, the company was able to largely avoid in 2021, but they did impact us in 2022.

As we previously disclosed, our 2022 operating results were negatively impacted by approximately $125 million versus 2021 due to 3 input costs. First, a $65 million impact due to the spike in cotton prices, our largest product input cost; second, approximately $30 million of airfreight, amidst the worldwide supply chain delays caused by the COVID-19 pandemic; and third, approximately a $30 million increase in container costs also due to the COVID-19 pandemic. While these costs certainly impacted 2022, it will be a different story in 2023. As we enter 2023, cotton prices are down approximately 40% from their 2022 highs and are expected to continue to decline in 2023. Container costs are now approaching pre-pandemic levels. And we have effectively eliminated the use of airfreight in 2023 as the worldwide supply chain moves back in line with historical norms.

While we still need to work through inventory in the front half of 2023, that has these higher input costs embedded in it, beginning in the back half of 2023, the reduction in these costs is expected to result in an annualized benefit of more than $100 million. While the effects of these high input costs have impacted all cotton-based apparel retailers, the timing or quarterly periods impacted may be different from company to company, due to the length of each company's production cycle and their use of pack and hold from previous seasons. For us, given our supply chain process, these higher costs significantly impacted the latter part of 2022 and will continue through the first half of 2023. But we clearly see the light at the end of the tunnel as these costs have subsided.

We fully expect that these headwinds will turn to tailwinds in the second half of 2023 and will position us on a path of consistent, sustainable, profitable growth. As we moved into 2023, we remained cautious with our inventory investments as we believe the challenging environment will persist, and our customers will continue to face pressures due to high inflation and lower disposable income. This started with ensuring that we ended 2022 with lower levels of holiday fashion and non-go-forward inventory, which we accomplished in Q4. We also took a cautious view of spring and summer inventory and reduced unit inventory purchase for the first half of 2023, given the high input costs. Finally, we ensured that we appropriately invested in inventory in the back half of 2023 to maximize the margin opportunity that we see as average unit costs decline and we successfully hold the average unit price increases that we realized over the past 2 years.

We believe these actions together will enable us to deliver consistent margin performance and sustainable improvement in profitability as we move into the back half of 2023 and beyond, as we further enhance our already strong digital presence. Now let's shift to the digital transformation we've undergone. As Jane described, several years ago, the company developed a strategic plan to transform from a traditional brick-and-mortar business with a website into a dynamic multi-branded omnichannel business with an industry-leading digital penetration. This strategic decision not only saved the company during the pandemic, but I firmly believe that had the company not put this plan in place when it did, and had the team not remained laser-focused on achieving it despite the short-term volatility it may have caused, we would not be here today talking about how well positioned we now are for long-term sustainable growth on the top and bottom lines.

The main goal of this strategy was to increase the shareholder value by shifting away from deteriorating mall-based retail locations with multiyear declining traffic trends and high fixed cost structures to a multi-brand digital experience that increases the lifetime value of our core Millennial customers by extending the life of the relationship with them despite the negative demographic trends of 15 years of declining birth since their peak in 2007. This transformation also required a major shift in our DC strategy and capabilities as we had to rapidly transition from our then existing predominantly store-based distribution center operations to a digital-first fulfillment model. While this transformation strategy required significant investments and created short-term volatility, it has clearly positioned us for long-term success.

Without these investments, we would not have been able to optimize our relationship with our core Millennial customer, who clearly prefers a digital-first experience. The benefits of this transformation are clear, as we have not only doubled our e-commerce business, which now represents approximately 50% of our revenue, but we've done this during a time period when we've closed approximately half of our retail locations. This digital transformation has enabled us to show dramatic growth in this important component of our business, which has our highest operating margins with room for additional margin expansion and drives the best return on investment for our shareholders. First, in terms of brick-and-mortar, we previously had more than 1,100 retail stores, with very high fixed operating costs due to minimum guaranteed occupancy deals, high support costs and increasing payroll expenses due to rising minimum wage rates, which have led to a more than 30% increase in our store-level wage rates over the past 5 years.

Importantly, our transformation has allowed us to migrate customers away from underperforming low-volume stores to our higher operating margin digital channel, which is not burdened with high fixed costs and consistent negative traffic trends like mall-based retail locations. These real estate rationalization efforts have led to us ending 2022 with 613 stores with an industry-leading 50% digital penetration. In terms of our future store footprint, we have spent a considerable amount of time analyzing our portfolio. And depending upon the outcome of various landlord negotiations, we expect to optimize our fleet with approximately 500 retail stores in the best trade areas to service our core customers' omnichannel needs. On the digital side, as Maegan described, we continue to invest in marketing as this channel represents approximately 60% of our new customer acquisition as our Millennial customer clearly prefers to shop online, positioning us in very short order to have $1 billion digital business.

In order to support this consistent and profitable growth, we continue to invest in our distribution capabilities to further improve margins and increase profitability. We are expanding our Alabama distribution center to add further e-commerce fulfillment capabilities with a planned capital investment of up to $40 million over the next 18 months. This owned DC already operates at significantly lower cost than our third-party fulfillment centers, and once our expansion is complete, we will move more of our fulfillment from third parties to our lower cost owned DC, which is expected to further expand margins. In summary, our successful digital transformation has enabled us to profitably shift away from underperforming stores with high fixed cost to our variable-based digital model where every transaction is accretive to earnings.

We believe we will see the benefits of this success reflected in our financial results in the second half of 2023. We believe this strategy has successfully positioned us ahead of our peers for long-term sustainable growth in topline and expansion of bottom line profitability, driving incremental shareholder value. Moving to capital allocation. This is a topic on which we regularly discuss with our Board, and I have extensive experience. We have completed our operating plans for 2023, and we will maintain a strong focus on inventory management, reducing the level of inventory investment throughout the year. As we progress through the year and particularly in the back half of the year when free cash flow is expected to significantly expand due to our planned double-digit operating margins, we expect to reduce leverage and decrease borrowings by more than $100 million by the end of the year, further positioning us for long-term sustainable growth.

Now let me take you through our outlook for Q1 and fiscal year 2023. As the company has previously indicated and has been widely reported across the retail apparel sector, the first 6 months of 2023 are expected to be impacted by several temporary macro headwinds, primarily resulting from higher input costs, most notably, cotton. These high input costs which are embedded in inventory that will be liquidated in the first half of 2023 will negatively impact margin rates during the first 6 months of 2023. However, importantly, these input costs have already decreased and goods purchased for the back half of 2023 are at much more favorable costs, which is planned to result in more consistent and profitable growth through significant margin expansion, resulting in double-digit operating margins in the back half of 2023.

Our first quarter guidance also reflects a cautious consumer outlook with significant headwinds, including the macro environment, the continuation of record inflation, unfavorable weather trends across the country in March and lower tax refunds. These are significant factors affecting our lower-income customer. In light of these pressures, for Q1, the company expects the following: net sales are expected to be in the range of $335 million to $345 million, representing a decrease in the mid-single-digit percentage range as compared to the prior year first quarter; adjusted operating loss is expected to be in the range of 6.5% to 8% of net sales; adjusted net loss per share is expected to be in the range of $1.60 per share to $1.90 per share.

We anticipate that the first quarter gross margin rate will decline approximately 1,000 basis points, reflecting the impact of higher input costs on goods expected to be sold in the first half of 2023 as well as anticipated higher shrink costs given the current retail environment. Selling, general and administrative expenses are expected to be up slightly, reflecting inflationary pressures and planned increases in marketing, partially offset by reductions in store payroll due to lower store count and our expense rationalization initiatives. However, on a rate basis, these expenses are expected to deleverage due to the impact of lower revenue. At the end of the first quarter, inventory is expected to be down in the high single-digit percentage range versus the prior year first quarter and unit inventories are expected to be down double digits versus the prior year.

We are planning for capital expenditures of approximately $5 million for the quarter. The large majority being allocated to support digital initiatives and the expansion of our fulfillment capabilities. Moving on to Q2 and the full year outlook. As we move into the second quarter, we are expecting gross margin pressures to begin to subside. And while we're still expecting an operating loss for the quarter, this loss is expected to moderate versus our Q1 results. The cost headwind that is expected in the front half of 2023 are anticipated to turn to tailwinds in the back half of the year, largely due to inventory purchased for our critically important back-to-school and holiday seasons being at much lower input costs. This will enable us to significantly improve margins in the back half of the year as we plan to return to double-digit operating margins for the 6-month period and will drive significant free cash flow.

For the full year, the company expects the following: net sales are expected to be in the range of $1.62 billion to $1.66 billion, representing a decrease in the low to mid-single-digit percentage range as compared to the prior fiscal year; adjusted operating profit is expected to be in the range of 3.5% to 4.0% of net sales; adjusted net earnings per diluted share is expected to be in the range of $2.50 to $3 per share. These results include the impact of the 53rd week in 2023 based upon our retail calendar. This week occurs during a low-volume non-peak clearance period and as a result, is expected to have a very modest impact on revenue and an insignificant impact on operating results. We are planning capital expenditures for the full year to be in the range of $40 million to $50 million, primarily to support our DC expansion, digital initiatives and the enhancement of our fulfillment capabilities.

We anticipate closing 100 stores as part of our ongoing fleet optimization initiative with the bulk of the closures happening in 2023, leaving us with an optimized fleet of approximately 500 stores. We are planning for full year tax rate of approximately 25%. Thank you. And I will now turn it back over to Jane.

Jane Elfers: Thank you, Sheamus. I want to thank Sheamus for his strong partnership and the significant contributions he has made since he joined our team in November. He has made a very positive impact in a short time. And on behalf of the SLT, we are thankful for his experience and his contributions as we partner with him to drive shareholder value in 2023 and beyond. In closing, we are a very different company today than we were in 2019. We have architected and executed a sweeping structural reset of our company in the midst of one of the most turbulent times in retail history. I am so proud of our team for accomplishing this task. And I believe a large part of the reason we were able to deliver these accomplishments successfully and with conviction is our unique profile.

We are a women-led company. Our senior team is over 50% women and approximately 90% of our associates and our customers are women. And further, the majority of our associates are from the Millennial and Gen Z generations. We are our customer. We learn from each other every day, and we push each other to stay relevant through our laser focus on our digital-first model and our accelerated store optimization plan. We have product that resonates with our digitally-savvy Millennial mom, marketing that converts, and we now have an infrastructure that is optimized for the way they shop today and will shop tomorrow. I am grateful to lead such a dynamic team, and I want to thank all of them for their hard work along this exciting journey. With our successful multiyear strategic transformation now complete, we are focused on our next phase, top and bottom line growth.

Our growth will be underpinned by our four strategic pillars: superior product; digital dominance; wholesale and international expansion; and an optimized fleet. Topline growth will be fueled by our strong stable of brands, a business model focused on digital, our highest operating margin and most important channel for our young, digitally-savvy core Millennial customer and the Gen Z customer right behind her, our strong wholesale business and our successful marketing and branding efforts. Bottom line growth will be fueled by the return of normalized supply chain and cotton costs. The benefits of our significant AUR increases since the start of the pandemic, and the tailwinds from the strong financial and operational discipline initiatives that Sheamus is leading.

Our team is resolutely focused on execution and we believe we are on track to return to double-digit operating margins in the back half of 2023 and are well positioned to deliver long-term consistent growth for our shareholders. Thank you. And now we'll open the call to your questions.

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