Tilly's, Inc. (TLYS) Q2 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the Tilly's Second Quarter Fiscal 2016 Earnings Results Conference Call. At this time all participants are in a listen-only mode. And interactive question-and-answer session will follow the 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. Gar Jackson of Investor Relations. Thank you. You may begin.

Thank you, Operator. Good afternoon everyone, and welcome to Tilly's second quarter fiscal 2016 earnings call. Ed Thomas, President and CEO, and Michael Henry, CFO, will discuss the company's results and then host the Q&A session. For a copy of Tilly's earnings press release please visit the Investor Relations section of the company's Web site at tillys.com, where you will also be able to find a recorded replay of this call for the next 30 days shortly after conclusion of the call. Certain forward-looking statements will be made during this call that reflect Tilly's judgment and analysis only as of today, August 24, 2016, 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 please see the disclaimer regarding forward-looking statements that is included in our second quarter fiscal 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. Today's call will be limited to one hour. When we get to the Q&A session please limit yourself to one question at a time to give others the opportunity to ask questions. I now turn the call over to Ed Thomas, Tilly's President and Chief Executive Officer.

Thanks, Gar. Good afternoon everyone, and thanks for joining us today. I will provide an overview of our fiscal 2016 second quarter results before updating you on our fiscal 2016 initiatives. Mike will then review our second quarter results in greater detail and introduce our third quarter outlook. Our fiscal 2016 second quarter comp sales, operating income, and EPS all exceeded our outlook ranges. Comp sales, including e-commerce increased 0.9% for the quarter. Our online business continues to grow at double-digit rate while store comps was slightly negative. On a total company basis, all departments comped positive with the exception of women's. We generated SG&A leverage of 50 basis points due largely to tighter expense management. Second quarter operating income of $2.2 million and earnings per share of $0.05 more than doubled compared to last year's second quarter results. We ended the quarter with inventory down 7% on a per square foot basis, cash and marketable securities totaling $96 million and no debt. Our management team is focused on continuing these directional improvements in order to meaningfully grow company profitability over time. This leads me to an update of our fiscal 2016 initiatives; for the back-to-school season we are expecting a combination of some newness within both the men's and women's, including strengthening of product trends, denims, jackets to drive our business. We continue to bring in new brands with limited distribution and work with our existing branded partners to emphasize uniqueness to Tilly's, which we know our customers expect from us. We continue to evaluate micro merchandising and product allocation practices in certain underperforming stores with the goal of improving our operating performance in these locations. As a group, we continue to experience improved comp results that have outperformed the chain from our assortment adjustments to these stores. We will continue evaluating our results in these stores through the back-to-school period to determine next steps. Regarding our digital online efforts, we announced last week that Jon Kubo has joined us in the newly-created role of Chief Digital Officer. I am excited about the future of our digital efforts under Jon's leadership, and I am confident his extensive experience would generate many benefits to Tilly's over time. During the second quarter, we launched an improved and rebranded customer loyalty program. This program will offer more frequent and compelling benefits to our most loyal customers, and the response from customers and store employees alike has been very positive. We look forward to utilizing this new program to create greater connections with our customers in a variety of ways. On omni-channel initiatives, we continue to test and refine our buy online, pick-up in store, and ship-to-store programming, which we now anticipate will launch during the third quarter. These programs will complement our already successful ship-to-store -- ship-from-store program, and we remain excited about the potential of these new initiatives to drive sales by improving customer engagement and satisfaction. Regarding inventory management, we have been reacting faster to move through slow-selling styles to allow for better flow of new merchandise. Although our product margins declined modestly in the second quarter, the rate of decline was significantly less than in the first quarter, and product margins remained very healthy overall. We continue to manage inventories tighter as evidenced by our inventory per square foot decrease of 7% relative to our comp store sales growth of nearly 1%. Regarding real estate, for the time being we remain focused on improving the performance of our existing stores rather than opening a significant number of new stores. We believe that remaining cautious about new store growth is prudent in the current retail environment. We are carefully evaluating each store opportunity with the objective of improving company profitability. We continue to work with our landlords to restructure existing store leases in a number of locations to improve our profitability, and we are encouraged by some positive movement we have seen from these efforts thus far. We know the productivity of the existing fleet must continue to improve in order to drive increased profitability, which is a key objective of our management team. Tilly's has a strong balance sheet and ample opportunities for further store growth when the time, location, and economics are aligned, but we will continue to be very selective and opportunistic in our management of the business. Now, I'll turn the call over to Mike to provide more details on our second quarter operating performance and to introduce our third quarter earnings outlook. Mike?

Thanks, Ed, and good afternoon everyone. Our second quarter operating results for fiscal 2016 compared to fiscal 2015 were as follows. Net sales of $136.4 million were up 5% compared to last year. Total comparable store sales, including e-commerce increased 0.9%, which was above our outlook range. Double-digit e-commerce growth was partially offset by a slightly negative store comp. Our comps were driven by improved conversion and higher average dollar sales, partially offset by lower traffic. We ended the quarter with 225 stores, a 4% increase from 216 stores a year ago. Gross profit of $38.8 million increased $2.2 million or 6.1% from $36.6 million last year. Gross margin improved 40 basis points to 28.5% from 28.1% due primarily to a 70 basis point improvement in buying distribution and occupancy costs, partially offset by a 30 basis point decline in product margins as a result of increased markdowns. Occupancy costs in particular were better than anticipated due to a lease assignment and certain other lease negotiations. Product margins remain very healthy overall, and the rate of decline was considerably lower than the 90 basis point decline we experienced in the first quarter. SG&A expenses were $36.6 million compared to $35.5 million last year. The $1.1 million increase was primarily due to store payroll associated with nine net new stores, coupled with minimum wage increases. As a percentage of net sales, total SG&A improved 50 basis points to 26.8% from 27.3% last year. This rate improvement was primarily driven by the combination of more efficient marketing spend and reductions in corporate office payroll, stock compensation, and various other smaller expenses as a percentage of sales. Income tax expense was $0.9 million or 38.3% of pre-tax income compared to $0.6 million or 49.7% of pre-tax income last year, primarily due to the tax impact of discrete items related to restricted stock and stock option expirations. Net income improved to $1.4 million or $0.05 per diluted shares compared to $0.6 million or $0.02 per diluted share last year. Weighted average shares for the quarter were 28.5 million. Turning to the balance sheet, we ended the quarter with cash and marketable securities totaling $96 million, a 25% increase compared to $77 million at this time last year. We have no debt under our credit facility. Inventory decreased 7.2% on a per square foot basis, compared to our comp sales increase of 0.9%, and our inventory ageing was slightly improved versus last year. Capital expenditures for the first half of the year were approximately $10.4 million this year compared to $11.5 million last year. Total CapEx for fiscal 2016 is now not expected to exceed $20 million for the fiscal year. Capital expenditures have primarily been for remodeled stores, three new stores, and IT investments. Turning to our outlook for the third quarter of fiscal 2016, based on current trends we expect comparable store sale to be in the range of flat to minus 4% compared to a plus 3.9% comp increase in the third quarter last year. We expect operating income to be in the range of $3.5 million to $6.5 million, and earnings per share to be in the range of $0.07 to $0.13 compared to last year's $0.10. We expect our third quarter tax rate to be approximately 40% and diluted shares to be approximately 28.5 million. We expect inventories per square foot to remain below LY levels. We currently expect to have one new store opening and one closure during the third quarter followed by an additional store closure in the fourth quarter to end the fiscal year with 224 total stores. Operator, we will now take questions.

Thank you. [Operator Instructions] Our first question comes from Jeff Van Sinderen from B. Riley. Please go ahead.

First, let me say congratulations on the positive comp. I guess, one place to start that would be helpful, if you could speak a little bit more about women's, what's going on there. And then I think in your press release you said back-to-school had started mixed. Maybe you can frame that for us a little bit? Give us a little more color in terms of the puts and takes there? And then also maybe your outlook on kind of the progression in back-to-school and the timing of the peak, and your thoughts on how it extends if it's getting later?

Okay. Hi, Jeff. First of all, in the women's category I think overall it was down slightly, it wasn't down by a lot, and the encouraging part is our e-com women's comps were up pretty double digits. So overall, I think that there are a couple of things, like always, that we could've probably done better. We're a little late on a few trends, but nothing major. So I can't really add any more color than that. I think we're pretty much on trend in both men's and women's. Retro obviously has been really big. And so I'm pretty comfortable in terms of where we're at with that with the whole category. In terms of back-to-school timing, it's probably more complex now than I've ever seen it with the shifts in school dates and tax-free dates and everything else, we still have about 20-some-odd stores -- 21 stores I think that in our heritage market, which are big volume, that where they have not gone back-to-school. So we'll have more visibility on that in the next couple of weeks. Certainly tax-free days, like they always do, generated pretty big volume and pretty big traffic. But consistent traffic continues to be a challenge for us, and I think most retailers in seeing consistency in the traffic in between the big events. But our online business has been very solid and very consistent across all categories. So we're very excited about that.

Okay, that's helpful. And then if I could sneak one more in quickly. Just on gross margin, just wondering what we should look for in terms of gross margin, I think you had a rent reassignment. Maybe if you could just give us a little bit more on that?

Yes, Jeff. I'd say looking at the existing consensus that's out there on Q3; it's pretty consistent with what our view would be along each line item through the model in line with kind of the upper half of our outlook range that we gave. So I think within those parameters that looks pretty fair.

Okay, great. Thanks very much, and good luck for the rest of the quarter.

Thanks, Jeff.

Our next question comes from Betty Chen from Mizuho Securities. Please go ahead.

Thank you. Good afternoon. Thanks for taking our question, and congrats on the great improvement. I guess thanks for the color in terms of how we should think about the modeling. But just wanted to get more clarification on the B&O leverage, are those savings permanent so that we should be seeing that type of leverage every quarter going forward, or I guess to help us think about that, the lease assignment or the negotiations you were able to get?

Sure. So, no, there shouldn't be that kind of occupancy leverage every quarter going forward. The lease assignment was a discreet item to the second quarter. There was a store that was a money-losing store for us that we were able to assign to another third party and get out of the lease free and clear. And then as we do all the required accounting cleanup on the balance sheet relating to that store as we closed it during the quarter, it created about $300,000 of favorability to us in the occupancy line item that would not normally be there on a go-forward basis. So there was a little more favorability in the occupancy leverage than you would normally expect because of that particular item.

Okay. And so then when we think about gross margin complexion for the third quarter, is there any help you can give us in terms of if it's at the midpoint of the comp guide down to a percent, for example, what should we expect B&O leverage or not?

No. If we were in the middle of our range there would be a little bit of deleverage on the BDO as would more typically be expected. We wouldn't normally expect to have leverage on BDO costs on a negative comp. It just might not be as much as you might assume.

Okay, great. If I could also add one more question. When we think about the micro assortment stores, the stores in that [path] [ph], it sounds like they continue to outperform. Is there any color you can share on maybe that magnitude of their outperformance or improvement? And how that has changed or not since the prior quarters?

I can't get into specifics in terms of how much better or whatever, but we're clearly making progress in the majority of that control group, and we'll continue to work on that group. But as I've said on previous calls, anything that we see with this group that might apply to the balance of the team we would do in a minute. But these are very underperforming stores, and we're encouraged by very positive progress in most of them. And we're just going to continue with it. That's all I can say at this point.

Okay. And last thing, Mike, is there any regional color that you can share with us in the second quarter? Did you see any variances by market?

There are always some variances. I mean all markets we're either up single digits or down single digits, so nothing major. Generally we've talked in the past about our heritage markets and our new markets. Our heritage markets we're up slightly, and our new markets we're down low single digits, so not a wide disparity between markets.

Okay, great. Thank you so much. Best of luck.

Thank you.

Our next question comes from Pam Quintiliano from Robinson Humphrey. Please go ahead.

Great, thanks so much for taking my questions, guys. And congratulations on the quarter, it's really great progress.

Thank you.

I just wanted to follow up on Jeff's question that he had asked about that back-to-school commentary that you had in the release, where you'd said it was mixed. So do we think it's mixed by region, by classification? Just any more clarity on that would be much appreciated.

Yes, it's mixed in that with all the date shifts and everything, you would not believe the wide disparity of comp performance from week-to-week based on the shift. So significant double-digit declines when comparing against the LY dates, followed by very significant double-digit positives when they're in their peaks, and then some post-peak falloff as we're used to. So that's what we mean by mixed. And relative to our outlook, which is probably what you're getting at, we always route our guidance in where we are as we look at an earnings date. And then based on all historical data and relationships of what the rest of the quarter can be, we set it based on where we are, and then hopefully with a little downside protection. And that's how we think about it.

Okay. And then when we think about women's and that comment about, you know, e-com was up in the double digits although women's overall was down. Was it a different assortment online or what do you attribute that shift to? And have you been able to apply some of those online learnings specifically in those classifications and stores?

The mix online and in-store is pretty much the same. Some stores may not get the total assortment, but that's not what it is. We really haven't identified anything specific other than the fact that online traffic is more consistent on a day-to-day basis than what we've seen in stores. And I think it's probably more attributable to the traffic than it is to any kind of major merchandise mix differences or issues.

Okay. And then one last one for you, in terms of the inventory management and reacting faster, so does that mean you're taking markdowns quicker on products that's not doing as well as you had thought or are you taking deeper initial markdowns on the product, a combination of both, something else?

Pretty much all of the above. I think we've being more proactive identifying the slow sellers the things that we don't think are going to move. And in some cases we're just taking the markdowns faster than we historically have. And in very few cases we might be taking a deeper markdown. But I would say more reacting faster to items that we've identified that just aren't moving or moving too slowly.

And actually I lied. I do have one real last one now. So just based on your experience and knowing the consumer so far. Thus far this earnings season we've heard from others it hasn't been bad this earnings season, especially compared to what we have been seeing with specialty retail over the past several quarters, and back-to-school seems to start off a little bit better. What's your take on your consumer?

Well, I think that part of the reason why there's a little bit more optimism is there is a little bit more newness and what the fashion offerings are. So I felt that was an issue -- has been an issue for the last several months, where there hasn't been enough newness in product that really attract the customer to really shop as frequently as what he or she did, but I think it's probably -- my guess is it's probably applicable to that, but look, I don't want to you know, consistent traffic is still a challenge for all us and that's one thing that really we are -- we worry about consistency in traffic.

Our next question comes from Sharon Zackfia from William Blair. Please go ahead.

Hi, good afternoon. I guess a quick question; you mentioned earlier about your comp guidance, you obviously did nicely better than your comp guidance in the second quarter. I am just wondering if you had a much better June and July than May or it was pretty consistent.

Well, so I will take you a little bit through it, because it was actually quite an interesting quarter. At the time that we did last earnings call, we were in negative comp territory. We were negative entering Memorial Day weekend, and then we had a really surprisingly strong Memorial Day weekend and the entire following week leading into the weekend after that. Then we went through five out of the next six weeks were back in kind of modestly negative territory before finishing the quarter with two weeks that were slightly positive. So it was really up and down throughout the quarter, but really we had a very strong Memorial Day weekend and week after, and that's what put us in the positive territory and we are just able to hang on to it as we finish the quarter.

Okay, that's helpful. And then on micro merchandizing test that are you doing, are there any gating factors that we should be aware of, if you decide that's a go and you want to do that more broadly?

Well, I think in these stores I think that and certain stores because they were underperforming, we gave up on the stores a little bit earlier than what we should, and by that I mean we weren't giving them necessarily the full assortment or the right assortment and so on and so forth. And that's the principal that we now apply to all of our stores, where we look at merchandize mix and brand mix for every store and every category and we adjust accordingly, it's just in these particular stores, I do think, we gave up too early and we've adjusted -- we are adjusting accordingly and it's working, which is good. So that's pretty much where we are at, okay?

Thank you.

Our next question comes from Richard Jaffe from Stifel. Please go ahead.

Thanks very much, and congratulations, Ed. Given what's happened with the occupancy and knowing your familiarity with lot of these landlords, is there a possibility of more occupancy savings to realize in the foreseeable future or next two, three quarters?

Well, Richard I think that there is something that we work on a lot and all the time and we would do it regardless, but I think that there could be some opportunity here. There is a lot of unknowns as you will know, in terms of what's going to happen, we already know that Macy's is going to close several hundred's stores, and there is concerns over that about what's going to happen and traffic-wise, even though there might be the right stores to close. So I think it's a moving target and it's hard to really pin down exactly how much and how much more we can get, but certainly I think there might be an opportunity. My guess is that in some cases, rents are going to come down for us going forward. In light of the environment how difficult it is that when we start accelerating expansion again, we might see some opportunities on the rent side that we had not seen in the last few years.

And on the merchandizing side, surprising to hear the strength in men's and particularly footwear which has been a real challenge for a while, I am wondering if anything has changed for you guys or it's been steady as she goes and the customer come back, I'm wondering which one of those it might be.

I think that the assortment -- I mean lead times on shoes are extremely long, but I think that the assortment is constantly being evaluated and adjusted by our merchant team, and I think they do a really good job of this, in that category and every other category. So we didn't do really anything abnormal what we historically have not done and probably guessed it a little bit better this time and maybe the last time, but I think it's pretty normal.

And so, what's happened today with back-to-school or big portion of back-to-school still ahead of us, we should feel pretty encouraged what's in store today?

Yes, I am happy overall with the merchandize mix in the stores. So I think there is always room for -- there is always something we may have missed or room for improvement, but overall having seen the performance across all categories pretty much, I am pretty positive about the mix that's in the store.

Good to hear. Thanks a lot, Ed.

All right. Thanks, Richard. Bye.

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

Hello guys, this is Nick Meyers on for Dave King. How are you doing?

Good, how are you?

I am doing very good, thank you. Okay, first off, can you talk about the current level of profitability in your e-commerce biz and what do you think that will go in terms of gross margins or maybe even more importantly EBIDTA margins longer term?

Our e-comm business is -- it is profitable. We believe it can be more profitable than what it is. It's been a consistent profitable piece of our business. We do expect it to continue to grow and we expect to be able to do some things to improve its profitability over time, but not going to get into a whole lot of specific metrics on that.

Okay, I understand. Thank you. And then on store level productivity, I think it's currently running around $300. Where would you like that to go over the next few years, and what are you targeting for overall operating margins even if the current environment persists?

Well, if you look back several years, this business was in a high single-digit operating income territory, and we firmly believe we should be able to get back to that. Obviously, we do need cooperation in terms of mall traffic generally in the environment, but we do believe that we can get this business ultimately back into that single, high single-digit territory. That's what we are focused on trying to get done. Few years ago, our sales per square foot were in the 350 range as I recall, and we ended last year around 290. So we have lost some ground, and that's what we are challenging ourselves to do as make up that loss ground and that's what would get us back into that territory that we are talking about.

Okay, perfect. Thank you. Okay, just one more and then I will step back I know you mentioned some early Q3 churns such as back-to-school has been a little mix, can you share anything else maybe like conversion versus traffic strengthened various categories, just any other progression of the quarter so far?

I am not to going share any details of the sales metrics about Q3 yet. We are just four weeks in, got a long way to go. Those details will be forthcoming when we get to our next earnings call.

Fair enough. Congratulations on the quarter guys, and…

Thank you.

Thank you.

I would now like to turn the floor back over to the management team for any closing comments.

Thanks again for joining us. We look forward to discussing our third quarter results with you at the end of November. Have a good evening everyone.

Thank you.

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