Tilly's, Inc. (TLYS) Q1 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the Tilly's First Quarter 2016 Earnings Results Conference Call. At this time, all participants are on a listen-only mode. A question-and-answer session will follow a formal presentation. [Operator Instructions]. As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Mr. Chris Lal. Thank you. You may begin.

Thank you. Good afternoon everyone. Thank you for joining us today to review Tilly's first quarter fiscal 2016 earnings results. On today's call are Ed Thomas, President and CEO; and Mike Henry, CFO. A copy of today's earnings press release is available in the Investor Relations section of Tilly's website at tillys.com. Shortly after we end this call, a recorded replay will be available for 30 days in the Investor Relations section of the company's web site. I would like to remind you that certain statements that we will make in this presentation are forward-looking statements. These forward-looking statements reflect Tilly's judgment and analysis only as of today, and actual results may differ materially from current expectations based on a number of factors affecting Tilly's business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made on this conference call and web cast, we refer you to the disclaimer regarding forward-looking statements that is included in our first quarter 2016 earnings release, which was furnished to the SEC today on Form 8-K as well as our filings with the SEC referenced in that disclaimer. We also note that this call contains non-GAAP financial information. We are providing this information as a supplement to information prepared in accordance with accounting principles generally accepted in the United States, and you can find a reconciliation of these metrics to our reported GAAP results, and a reconciliation table provided in today's earnings release. Today's call will be limited to one hour. When we get to the Q&A portion of the call, we ask you please limit yourself to one question at a time to give others the opportunity to also have their questions addressed. With that, I'll turn the call over to Ed Thomas, Tilly's President and Chief Executive Officer.

Thanks Chris. Good afternoon everyone and thanks for joining us today. I will provide a brief overview of our fiscal 2016 first quarter performance, before updating you on our key initiatives for fiscal 2016. Mike will then review our first quarter results in greater detail, and introduce our fiscal 2016 second quarter outlook. Our fiscal 2016 first quarter comp sales declined 4% in line with our outlook range of down 3% to 6%. Our comp sales trend began to improve in the final two weeks of the quarter, and this improvement has continued into the second quarter. Our online business continued to perform well, with strong growth in the first quarter, but this was offset by negative comp in stores. All departments comped negative, single digits, with the exception of our boy's business, which comped positive. On a GAAP basis, our operating loss was $4 million and our loss per share was $0.10. On a non-GAAP basis, excluding a legal provision, our operating loss of $2.3 million and loss per share of $0.06 for the quarter, on the better end of our outlook ranges. We ended the quarter with inventory down 7.4% on a per square foot basis, and consistent with last year, in terms of aging. As we look few, we continue to bring in new brands, to create a sense of newness and uniqueness to Tilly's. We are constantly editing our broad and diverse assortment to provide our customers with the most exciting and compelling assortment that speaks to their lifestyle. Our fiscal 2016 initiatives are aimed at driving top line, offsetting declines in stores traffic, and improving profitability. We touched on these initiatives during our last call, and I will now update you on our progress. As discussed on our last call, we identified opportunities for us to improve upon micro merchandising and product allocation. We began testing some changes in a small number of stores, a few months ago, to improve sales performance. During the first quarter, we expanded the number of stores involved, and we continue to be encouraged by the results we have seen. This growth of stores has generally outperformed the chain in terms of comp sales in recent weeks and months. Turning to our digital online efforts, our customers want a seamless satisfying shopping experience, regardless of how they interact with us. We are on track to launch Buy Online/Pickup in the store and Ship to Store during the second quarter, to complement our already successful Ship From Store program. We are also on schedule to launch an improved and rebranded customer loyalty program during the second quarter. This new program offers more frequent and compelling benefits to our most loyal customers and will be integrated with our mobile app. We are excited about the potential these new initiatives have for improving customer engagement satisfaction in our overall sales results. Now, turning to inventory management; our customers want frequent, new and unique offerings. Consequently, we have been reacting faster to move through store sellers and allow for better flow of new products. Although our product margins declined in the first quarter compared to last year, they were still very strong. Our team did a good job of managing inventory to sales, with inventory per square foot coming down 7%, relative to our comp sales decline of 4%. We continue to work to improve our inventory flows and we are in active discussion on this topic with all sources. We continue to bring in new brands, and with our existing brand partner and work with our existing brand partners to emphasize uniqueness to Tilly's and there will be more to come in this area over time. Now turning to real estate; as we noted during our last call, we have slowed new store growth, due to a very challenging retail environment we all are living in. We currently have just three new store openings slated for fiscal 2016. However, it is important to note that we are also uniquely positioned to continue growth, when the time and economics are right. We currently have 226 stores in 32 states, much less than many of our competitors. Roughly half of these stores are in malls and half are off-mall. Our flexible real estate model and strong balance sheet, leaves us uniquely positioned to be very selective about opening new stores in great centers [ph] with the proper economics. We will fill within existing markets, only when the time, economics and location are right. Now I will turn the call over to Mike to provide a more detailed review of our first quarter operating results, and to introduce our second quarter outlook. Mike?

Thanks Ed and good afternoon everyone. Our first quarter operating results for fiscal 2016 compared to fiscal 2015 were as follows; net sales of $120.2 million were flat to last year. Total comparable store sales, including e-commerce, decreased 4.1% with strong e-commerce growth, offset by negative store comps. All departments comps negative single digits with the exception of boys, which comps up in the single digits. Our comps were driven by lower traffic, partially offset by stronger conversion. We ended the quarter with 224 stores, a 5% increase from 213 stores a year ago. Gross profit was $32.6 million, a 9.6% decrease from $36.1 million last year. Gross margin declined 290 basis points to 27.1% from 30%. There were three components to the gross margin decline; first, occupancy costs deleveraged 170 basis points, due to the negative comp, and having 11 net new stores year-over-year. Second, product margins remain strong, but declined 90 basis points due to increased markdowns. And third, distribution costs deleveraged 30 basis points on the negative comp, largely due to increased shipping costs associated with increased e-commerce sales. SG&A expenses were $36.6 million compared to $33.9 million last year. Of this $2.7 million increase, $2.4 million was due to the combination of legal provisions and non-cash store asset impairment charges. The remaining increase of less than $300,000 was primarily attributable to store payroll associated with 11 net new stores and minimum wage increases, offsetting other expense reductions. Although we were able to absorb minimum wage increases, without increasing our average payroll per store, we still delivered store payroll on the negative sales comp. Our income tax benefit was $1.1 million or 29.5% of our pre-tax loss, compared to income tax expense of $0.9 million or 40% of pre-tax income last year. This lower effective tax rate was due to a $0.4 million discrete charge related to restricted stock vesting during the quarter. On a GAAP basis, our net loss was $2.7 million or $0.10 per share this year, compared to net income of $1.3 million or $0.05 per diluted share last year. Weighted average shares for the quarter were $28.4 million. On a non-GAAP basis, excluding legal provisions, our net loss was $1.7 million or $0.06 per share, which was at the better end of our outlook range for the quarter, which did not contemplate the change in legal provisions. Turning to the balance sheet, we ended the quarter with cash and marketable securities totaling $88 million, an 11% increase compared to $79 million at this time last year. We have no debt under our credit facility. Inventory decreased 7.4% on a per square foot basis compared to our comp sale decline of 4.1% and our inventory aging was consistent with last year. Capital expenditures were $4.3 million this year, compared to $5.1 million last year, primarily for remodeling stores and for two new stores that opened just last week. Turning to our outlook for the second quarter of fiscal 2016; based on current trends, we expect comparable store sales to be in the range of flat to minus 4%. Operating results to range from breakeven to a loss of $3 million and per share results to range from breakeven to a loss of $0.06. We expect our second quarter tax rate to be approximately 40%. We expect diluted shares to be approximately $28.5 million. We expect inventories per square foot to continue to remain below LOI levels during fiscal 2016, and total CapEx for the year to be approximately $25 million. With that, I turn the call back over to Ed.

Thanks Mike. I am excited about the opportunities we have identified thus far, in my first seven months back at Tilly's. We have a number of things to work on, as we discussed, to improve our competitive positioning and I look forward to sharing our progress with you throughout the remainder of the year. With that, I'd like to open the call up for questions. Operator?

[Operator Instructions]. Our first question comes from Betty Chen from Mizuho Securities. Please go ahead.

Thank you. Good afternoon. Very nice execution in this tough environment. I was wondering if you can talk a little bit more, I think about the micro merchandising? It sounds like the control group continues to outperform. Is there any color you can give us or quantify the level of outperformance, and what are some of the adjustments that you have been making in those stores to see that improvement? My second question is, I guess, regarding some of the late quarter, Q1 trends and early Q2. Can you talk about the difference there? Is it more traffic driven or kind of what did you see in the business in late Q1 to kind of see that improvement? Thanks.

Okay. Well starting with micro merchandising, I am not going to really specify what the numbers are. But the numbers are pretty good. And what we have been doing is, some of these stores in the test group, I think were probably penalized, by not getting the full assortment or not getting enough merchandise. And we saw that early on and we have adjusted accordingly, and we are using our store profiles, which we did, a few months ago, to adjust every stores; merchandise mix to what we think the profile -- what we know the profile to be. So we continue to do that. We have -- some of these things are specific to the stores that we are doing, and others -- I would say, others we could roll out to the whole chain. But I would say, its more store specific for the -- what we call, an underperforming store than a chain-wide thing. So that's kind of it on micro-merchandising. Secondly, in terms of what we see in the last couple of weeks; I think we, like most retailers have been challenged with traffic, and certainly, our conversion rate actually was pretty good in the quarter. So we are actually seeing customers walk into the store. We are doing a better job of converting them. But certainly, I think that, we are starting to see some traction in some of the things we are doing, but also a lot of it is related to improvement in traffic in general.

Okay. That's great. If I could sneak one in for Mike; with inventory so clean coming into the second quarter, how should we think about merchandise margin opportunity or gross margin as well in Q2?

That will depend on exactly where we land in our earnings range, right. So coming out of Q1, our product margins were down 90 basis points. If we were to the better end of our range, we might not see that kind of product margin degradation, if we were at the lower end of the guidance range, you might see something similar -- there is a range there depending on exactly what you assume on the top line.

Okay. Okay, great. Thank you so much and best of luck.

Thank you.

Our next question comes from Dave King from ROTH Capital Partners. Please go ahead.

Thanks. Good afternoon guys. I guess a follow-up to a couple of Betty's questions, in terms of the improving comps as the quarter progressed and then in the May a little bit, it sounds like some of that was traffic. But are there any category standouts there? And then, as we think about the test groups in the micro merchandise stores, how many stores are in that sort of test group now, and am I understanding your comments correctly, Ed, in terms of how much opportunity is there still to roll out some of those things that you have learned in the underperforming stores to other stores, or is it more just specific to those stores? Thanks.

Okay. So as far as the micro merchandising goes, again, a lot of these are , what I'd call store specific things that we identified with store -- we weren't capitalizing on particular brands, we didn't have enough inventory on our brand, and we just weren't putting a brand at specific stores. It's more like that, so I'd say it's less -- if we see something that's a chain-wide opportunity, we are not going to wait for the test of the stores, we are going to do it right away. So I think from that perspective, we are learning more, as we go along, and we are just paying a little bit more attention, and I think just because of that and adjusting the merchandise mix and adjusting some of the marketing -- the marketing we are doing, I think that's overall, driving a lot of the results. In terms of our overall improvement in the last few weeks, I think, its across all categories. It's not specific any one particular category. So I have never felt that we had any major merchandise misses or weaknesses, I think it's more -- again, I think -- we have traffic counters in all our stores. So we can see it. I think it's more traffic related. And once we see the traffic, the customers' reception to our merchandise mix overall, its pretty good across the board.

Okay, that helps. Thanks for the color there. And in terms of the digital initiatives that you have been rolling out, and particularly with free shipping or more shipping initiatives, I guess is a better way of characterizing it; being part of the sort of e-comm part of it going forward; how do you think about the ROI in your e-comm business versus the bricks and mortar business? Is it similar? Are we in a new paradigm? This is sort of a high level question; are in a new paradigm in terms of how to think about return on investments, as a retailer, I guess, what are some of your high level thoughts there?

Okay. So we are sensitive to that business, the e-comm business, as a standalone business and its profitability. And it is profitable for us today. So it's not -- I know that we are seeing some comments, but some retailers have been challenged with that. Certainly, we can get better in improvement. And free shipping is part of everybody's formula to a certain extent. It's not new to our company, it has been done in the past, and we are selective when we do it. So we are very sensitive, in terms of how we manage that business, and making sure its profitable, and at the same time, giving our customers the multiple choices in which to shop our merchandise mix on our brands.

Our next question comes from Pam Quintiliano from SunTrust. Please go ahead.

Great. Thanks so much for taking my questions, guys, and congrats on the quarter, especially in this challenging environment. So I have a few for you, and I apologize I hopped on a little bit late; so I apologize in advance if you already answered. Can you just quickly talk about performance of guys versus girls and also any difference in the regional performance?

Yeah. So we commented in our scripted remarks that all departments comp down in the single digit, so it wasn't a lot of variability between the departments. Our boys business was what comped positive, and that was a low single digit positive. So it wasn't a lot of disparity between the different departments. And then, geographically here recently, as we headed towards the end of the quarter, it was really in our heritage markets, where we saw improved response. We have seen some of the same challenges, as we have seen comment from others about the northeast lately in recent weeks, and we have seen that impact as well. But really, our heritage markets is what picked up there, towards the end of Q1, leading into Q2.

Okay. Thank you. Can you also talk about -- there is a lot of talk out there about the health of the consumer, and there has been some positive trends macro-wise, but yet, there are several retailers who are kind of scratching their heads, that's not translating into sales volumes and when they are anticipated? So how do you think about -- just how your consumer is feeling right now, and their willingness to part with their precious cash?

I think it’s a challenge for sure, but in terms of -- there are a lot of things, particularly in the teen-young adult category, that there are a lot of other things that they can spend their money on. But I think, certainly, there is -- I think there is pent-up demand in some respects, and we have talked about this in the past is, I think, a little bit more newness in merchandise mix from across the board, whether it's men's, women's, it certainly will drive better results. So I don't think what we are seeing in terms of headwinds is so much economic. Clearly, the web has become a more significant weapon, and I think the traffic -- I think the biggest challenge in the industry is getting consistent traffic into the mall. There is probably a more bigger challenge for everybody than it is the consumer sentiment.

And, if I could follow-up on [indiscernible]], wanted to read right into your commentary on the mall traffic. How do I think about what you are doing to combat that; because there is -- what's in your control and what's not in your control; so when I think about touch points of the consumer and how you are communicating with them, and if you are thinking about doing anything differently going forward, being more aggressive, approaching the creative differently; and then when I think about online and all this talk about Amazonable versus un-Amazonable and given you guys have some product that's available at other retailers with all the third party component; how do you defend yourself against that?

Okay. So there are some of the things that we are doing for omni-channel, particularly Ship to Store and Buy Online and Pickup in Store. I know from prior experience and from other retailers, that that will definitely drive traffic to our stores. So we are excited about that, and a lot of times that results in an incremental purchase, when they come to pick up the merchandise. So that alone was not going to solve the problem, but certainly, it helps. And I think the other thing that we see today is, a customer does a lot of homework online, before they go shopping in the mall, and so; I think whatever marketing we do online, is really important, because it's -- the days of lingering around the mall, like they used to, I think they are gone. They are not completely gone, but I don't think they spend as much time in the malls, as they used to. So there is a number of things. And you know, our company, historically, has done a number of special events for specific stores throughout the mall that drives traffic. So there is a bunch of stuff like that, that I think we can -- we have done, we will do some new stuff and we will continue to do that in the future. In terms of the Amazon effect, a lot of our brands do not sell directly online, and it doesn't mean it wouldn't happen someday. We are hoping it doesn't, but certainly, even with Amazon, and a lot of our brands have their own web sites too. I think e-comm business is very healthy, and we see it continue to grow, despite the Amazon effect, and other competitive factors that we are dealing with, with online only retailers.

The other thing I think I'd point out is that we have such a broad and diverse assortment with -- we have sales from over 600 different brands last year, for example; some of those are tests, not all are store buys, and some of them are very limited distribution, so they are not ready to be in Amazon just yet. Those are some of the things that we have coming in and out of our assortment all the time, that helps make our assortment unique and diversified from what you might perceive from others.

Our next question comes from Neely Tamminga from Piper Jaffray. Please go ahead.

Great. Thank you. I want to follow-up a little bit on the comment you made around, the consumer does a lot of homework online. We agree. We think it's about 100% digital search, before they do any sort of physical purchases, and I guess, to that end, I mean, Buy Online, Pickup at Store, Ship To Store, Ship From Store, these are all important initiatives, but particularly, if you allow the consumer to know that that product is in their nearby store too. Are you guys -- I know it’s a super specific question, but are you putting location based inventory in that launch here in Q2?

It’s a great question. We are working on that. We don't have it in place now, to the extent that I'd like to see it. But certainly, it's in our short term plans to improve the whole inventory visibility for the consumer, so they can see it for sure. So yes. There is certain things that we do. Our customer service that supports e-commerce is excellent, in terms of re-routing customers to different areas or specific stores, where you may have merchandise. We know that's really important, and we will continue to improve upon that, over the next year or so.

Okay. That's helpful. And then we will look for that in our local market for sure. And then, while I have you on the phone here too Ed, as we look into the fall, there has been some elements of denim that seem to be working, doing their own separate work in across a handful of retailers and [indiscernible] much more of a Q3 sort of dynamic. How are you thinking about that category, and how important it is to your customer, and is there a reason to kind of upgrade her assortments and her own closet in denim? Or are there other categories that we are missing? And then before I lose the queue, Mike on D&A, what are you anticipating for D&A this year? Thank you.

Okay. So I will give you a quick answer on denim; I think denim -- its an important category for us, and certainly, not as important for us, as it is with other retailers. But certainly it's an important category. Our denim results have been decent, and I would expect that to continue. So I know that certainly tells there is challenge still with denim, but we are seeing enough and hearing enough, and seeing enough of our own results, that I am encouraged that denim will improve. I am not expecting any -- there is always some newness in our inventory mix going into fall, and back to school, it will be again this year, and I am happy with what I have seen go in. But there is no one dominant category that I would say sticks out.

Thank you.

And on D&A, I don't have a full year number here in front of me, I will have to bounce back to you with that one.

Sounds good. Thank you guys. Best of luck.

Thank you.

Our next question comes from Howard Tubin from Guggenheim. Please go ahead.

Thanks guys. You did a great job with expense management in the quarter, items growing very low single digits. Could we expect that growth rate to keep up over the next several quarters?

Can you help me understand that question a little bit better? You are saying that growth rate --

Just growth rate in SG&A dollars, sort of quarter-over-quarter, grew very low single digits. I expect it to grow a little bit more.

Part of how we plan the year, definitely, we tightened a number of things in a number of areas. So yes, I expect us to remain fairly tight to LY, on a percentage basis, assuming we don't have meaningfully negative comps over the remainder of the year. We have been pretty strict on headcount and open positions, and we looked at a variety of contracts and tightening marketing spend and things of that nature. So I think you can continue to expect that type of behavior from us, going forward.

That's great. Thanks.

[Operator Instructions]. And if there are no further questions, I'd like to turn the floor back over to management, for any closing remarks.

Thanks again for joining us. We look forward to discussing our second quarter results with you all in August. Have a good evening everybody.

This concludes today's teleconference. Thank you for participation. You may disconnect your lines at this time.