Tilly's, Inc. (TLYS) Q4 2016 Earnings Report, Transcript and Summary

Welcome to Tilly's Fourth Quarter FY '16 Earnings Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now turn the conference over to Mr. Gar Jackson, Investor Relations for Tilly's. Thank you Mr. Jackson. You may now begin.

Thank you, Operator. Good afternoon everyone and welcome to Tilly's fourth quarter FY '16 earnings call. Ed Thomas, President and CEO; and Michael Henry, CFO, will discuss the Company's results and then host a Q&A session. For a copy of Tilly's earnings press release, please visit the investor relations section of the Company's website at Tillys.com From the same section shortly after the conclusion of the call you will also be able to find a recorded replay of the call for the next 30 days. Certain forward-looking statements will be made during this call that reflect Tilly's judgment and analysis only as of today March 13, 2017 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 any forward-looking statements, please see the disclaimer regarding forward-looking statements that is included in our fourth quarter FY '16 earnings release that was furnished to the SEC today on form 8-K, as well as our other filings with the SEC referenced in that disclaimer. Today's call will be limited to one hour. [Operator Instructions]. With that, I now turn the call over to Ed Thomas, Tilly's President and Chief Executive Officer.

Thanks, Gar. Good afternoon everyone and thank you for joining us today. I will provide an overview of our FY '16 full-year and fourth quarter results before discussing some of our key initiatives for FY '17. Mike will then review our fourth quarter results in detail and introduce our FY '17 first quarter outlook. FY '16 was my first full fiscal year back at Tilly's. I believe we made good progress in certain areas. We achieved comp sales results that were better than our inventory comps all year long through improved merchandising efforts. We improved sales results in our underperforming stores through more localized merchandising which resulted in these stores outperforming the rest of the chain for the year. We tightened spending discipline to hold the line on total SG&A dollars for the year, despite absorbing minimum wage increases and other increasing costs. All of this resulted in a 6.8% improvement in operating income which was the first annual improvement in operating income of the last five years. We made progress but need to keep finding ways to drive sales and improve profitability in the absence of significant store growth. I will share more about that in just a few moments. Turning specifically to our 2016 fourth quarter results, our operating income and EPS exceeded our original outlook ranges. Comp sales including e-commerce increased just slightly by 0.1%. Sales results were consistent with store traffic patterns throughout the quarter, with a strong Thanksgiving week and final six weeks of the quarter offsetting negative results in the remainder of the quarter. On a total Company basis strength in our men's and boys' departments offset single-digit negatives in all other departments. Tighter expense management allowed us to deliver our third consecutive quarter of improved operating income relative to the prior-year period. Our balance sheet remains strong. We ended the fiscal year with inventory down 6.9% per square foot, cash and marketable securities totaling $134 million and no debt. We also renewed our credit facility and, in late January -- in late January and paid a $20 million special dividend to shareholders during February. Now I'll discuss certain key initiatives for FY '17, starting with real estate. As I noted a bit earlier, store growth is likely to remain very limited during FY '17. As of today we have 49 lease decisions to make during FY '17 representing over 20% of our fleet. These lease decisions span all markets and include lease extension options, lease kick-out opportunities and lease expirations that require negotiated renewals. Our goal with every decision is to improve the profitability of our Company in what is currently a volatile and unpredictable retail environment marked by mass retail closures and, at best, inconsistent mall traffic patterns. As I noted earlier, our focus on improving in our underperforming stores is working and we believe we can further improve the profit margins in our existing store base. As of today we have zero new stores signed for FY '17, although we're in active discussions on several opportunities. We will remain highly selective on any new store decisions and will only open stores where we feel convinced that sufficient sales can be counted on with appropriate economics to drive healthy profitability over a multi-year period. Depending on the outcome of the 49 lease decisions I noted earlier, we may growth store count modestly or we may be a net closer of stores during FY '17. Our primary focus is on improving the long term profitability of our business and our decision-making will reflect that objective. Given that new store growth is likely to be limited for the near term, our merchandise assortment must deliver results. Our team has built an assortment that we believe will lead to a successful spring and summer season despite what has been a slow start thus far. Without getting into specifics, we're introducing several new brands and expanding offering from certain others. We have some fresh new looks emerging within both the men's and women's department, including a new color palette for men's tees and new silhouettes for women's tops. We will also have an expanding offering is shorts, swim, intimates, beauty, grooming and home products. We're hopeful that these new product offerings will generate renewed excitement from a fashion perspective and deliver a solid spring/summer season. Beyond merchandising, we will continue to invest in technology and experiences that drive customer engagement and improve the overall customer shopping experience. The next few items I'll discuss are all aimed at this goal. First, as announced in mid-December, we have partnered with Aptos to improve our point-of-sale order management and customer relationship management capabilities through an end-to-end cloud-based suite of technology additions that will improve the customer's experience wherever, whenever and however our customers engage with us. Expected benefits include improved real-time inventory visibility and order management seamless omnichannel execution integrated across mobile devices and stores and true CRM capabilities that we do not have today. We're planning to have this new technology suite in place during the fall season and we're excited about its potential to improve customer engagement and thereby increase sales opportunities. Next, we will also replatform our website to a cloud-based, more cost effective solution from Demandware that we anticipate will be in place for the fourth quarter and further our upgrade our mobile app in advance of the holiday season. The replatforming of our website is designed to improve functionality and reporting capabilities, reduce internal operating cost and effort for updates and improve redundancy to better guard against system downtime. Both the new website platform and enhanced mobile app will be designed to function seamlessly with our new Aptos solution to provide a richer user experience to drive better customer engagement. We will fully implement our omnichannel initiatives for buy-online/pick-up-in-store and ship to store in FY '17. In fact, we just recently launched our pick-up-in-store program after a successful pilot period. And we're excited about the opportunities this program will have to generate additional store traffic and add-on purchases. We expect our ship-to-store program will be enabled with integrated audit management that will be developed in connection with our Aptos launch in the back half of the year. Beyond technology we will continue to proactively engage with our customers to drive traffic to the stores by marketing differently than this Company has traditionally done. Over the past year we have reduced aggregate marketing spend and redirected our marketing team around customer engagement. This will continue throughout FY '17 in a variety of ways. We have and will continue to create compelling in-store events and contests. We will launch co-branded promotions, both within and outside the branded apparel space. And we will further leverage our new loyalty program to ensure our best customers are truly rewarded for their membership. Finally, will continue to invest across social media platforms to generate interest and excitement about Tilly's with the overarching goal to drive traffic and sales. We're excited about the opportunities that both technology and our repurposed marketing efforts have to drive additional traffic to stores and increase customer engagement and excitement around the Tilly's brand. In closing, we made some good progress on a number of initiatives during FY '16. Our goals for FY '17 are focused on improving sales productivity and profitability, driving traffic to stores and improving customer engagement. We look forward to sharing our progress with you throughout the year. Now I'll turn the call over to Mike to provide more details on our FY '16 fourth quarter operating performance and to introduce our FY '17 first quarter earnings outlook. Mike?

Thanks Ed and good afternoon everyone. Our fourth quarter operating results for FY '16 compared to FY '15 were as follows. Net sales of $160.2 million increased 0.7% compared to last year's $159.1 million. Total comparable store sales including e-commerce increased slightly at plus 0.1%. By Department, strengthened men's and boys' offset single digit declines in all other departments. Store comps decreased 1% with inconsistent traffic. Store traffic was negative for five of the first seven weeks of the quarter, but then turned positive for the final six weeks. We ended the fiscal year with 223 stores, a decrease of 1 from a year ago. E-commerce sales increased 6.6% and represented 16.5% of our fourth quarter sales this year versus 15.6% last year. For FY '16 as a whole, e-commerce sales represented 13.4% of total sales versus 12.5% in FY '15. Gross profit of $49.1 million decreased $0.9 million or 1.8%, from just shy of $50 million last year. Gross margin was 30.6%, a decrease of 80 basis points from 31.4% last year. This 80 basis point decline was attributable to a 60 basis point decrease in product margins and 20 basis points of deleverage from buying distribution and occupancy costs. Product margins declined modestly due to increased markdowns, as has been the case all year, due to acting faster on slower sellers, but product margins remained very healthy overall and did not decrease as much as we had originally anticipated considering our slow start to the fourth quarter. Buying, distribution and occupancy costs increased $0.5 million compared to last year, largely driven by common area lease expenses and increased e-comm shipping costs. SG&A expenses were $38.7 million compared to $40.5 million last year, a decrease of $1.8 million. As a percentage of net sales, total SG&A was 24.1% compared to 25.4% last year, an improvement of 130 basis points. The primary reductions were from more efficient marketing spend, lower non-cash impairment charges and corporate payroll savings. Operating income of $10.4 million improve by nearly $1 million compared to last year. Income tax expense was $4.2 million or 40.2% of pretax income, compared to $6.6 million or 69.6% of pretax income last year. Last year's abnormally high tax rate was due to the differed tax impact of stock option expirations. Net income of $6.3 million or $0.22 diluted share, more than doubled compared to $2.9 million or $0.10 per diluted share last year. Weighted average diluted shares for the quarter were 28.9 million. Turning to the balance sheet, we ended the quarter with cash and marketable securities totalling $134 million, a 33% increase compared to $101 million at this time last year. As previously announced, we paid a $20 million special dividend to shareholders during February from cash on hand. We have no debt under our recently renewed credit facility. Inventory decreased 6.9% on a per-square-foot basis compared to our comp sales increase of 0.1% and our inventory aging was improved versus last year. Capital expenditures for the year were $17 million compared to $23.1 million last year. Capital expenditures have primarily been for remodeled stores, three new stores and IT investments. Turning now to our outlook for the first quarter of FY '17. Consistent with what we've seen from several other apparel retailers, we've had a week start to the quarter due to the combination of a late Easter shift and significant weather issues in our heritage markets of California, Arizona and Nevada where over half of our now 222 stores reside. Quarter-to-date comps are down high single digits, with heritage markets down in the mid-teens. Weeks two and three of February were particularly hard hit, with double-digit traffic declines. The trend of our business has improved since then driven by positive comps outside of our heritage markets, but our heritage markets have yet to deliver consistent results. We remain cautiously optimistic that sales will improve as we get deeper into the quarter with better weather and with the late Easter shift. However given our slow start, we expect first quarter comparable store sales to decrease in the low- to mid-single-digit range, operating loss to be in the range of $3 million to $7 million and loss per share to be in the range of $0.07 to $0.15 compared to last year's loss of $0.10. We expect our first quarter tax rate to be approximately 40% and weighted average shares to be approximately 29 million. We expect inventories per square foot to remain below LY levels and to end the quarter with 222 total stores which is a decline of 2 from the prior year. Capital expenditures for FY '17 are currently expected to be approximately $20 million for the combination of the IT investments Ed noted earlier, continuing store remodels and to assume new store openings late in the year. Operator, we will now take questions.

[Operator Instructions]. Our first question is from Jeff Van Sinderen of B. Riley. Please go ahead.

A couple things, I know that you said that your business had picked up a little bit in the last few weeks or last couple of weeks and I'm just wondering if you saw that in the Western markets where it was sort of quantifiably different? And then I know you said in the other markets it was positive, but is there a way to read what you're seeing in the Western markets? And maybe if you could just talk a little bit more about how you're planning promotions and discounting in Q1 this year versus Q1 of last year? And also, does it make sense for you to hold your ground on price and maintain merchandise margin while maybe just giving up some comp, is that what we're looking at for Q1? And then finally, if you could speak more about gross margin and SG&A expectations?

Okay. I'll start by answering, Jeff. We have seen a marked improvement in our heritage markets in the last few days, as the weather turns. So we suspected that the issue that we were dealing with in terms of underperforming was really related to the weather, particularly in California and Arizona, where it has been unseasonably cold and rainy and so on and so forth. It's only a few days, but certainly we're encouraged by what we're seeing the last few days. In terms of pricing, for competitive reasons I'm not going to tell what we're going to do, but certainly we have some things planned that is not really as much a reaction to the highly promotional environment that we're in right now, but certainly you'll see some things that we're going to do in the next few weeks, for sure. And then I probably lost you on your third question.

Yes. I was just wondering if you could talk a little bit more about how we should think about gross margin and SG&A in the near term, for as far out as you can see here?

Merchandise margins have been consistent in this company for many years, as you know and I don't expect that to materially change. We're taking markdowns on a more timely basis and have been doing that since I came back. And that's reflected slightly in the gross margin slight deterioration that we've seen quarter to quarter, but I don't expect anything material to change as far as gross margin goes. And SG&A, I think we've done a pretty good job. The team has done a really good job of addressing those areas where we felt we had an opportunity to reduce our operating costs. But at the same time, we've had some offsetting headwinds with the rise in the minimum wage that probably won't give us as much full credit for what we've done, but certainly we'll continue to look for opportunities as we move through 2017.

Our next question is from Janet Kloppenburg of JJK Research. Please go ahead.

It sounds like your assortments for spring are probably in pretty good shape, given what's going on with comps outside of heritage market. Do you think that beyond the weather that there could be some other factors impacting the heritage markets or can you see, through the analytics, that it primarily goes with the weather trends?

Janet, we can see through the analytics that it's not a merchandise product issue. We've got enough good leads in terms of our spring/summer merchandise where we feel very confident in the assortment that we have out there. There's always opportunity to improve on what we do, but certainly there's nothing that sticks out. And again, as we've seen weather turn, we've seen a lot of the categories that may have been running down all of a sudden pop up. So we're encouraged by that.

Okay. How is the footwear business, Ed? How's that running?

It's pretty normal.

It's been down a little bit.

Yes, slightly down, but nothing material.

Okay. I just thought with some of the brands that you have there that that may have been a -- maybe a positive influence this year, I mean in 2017, so that's why I bring that up. But can you talk at all about some of the trends that you see in men's and women's apparel that you think bode well for the year?

Yes. We're seeing, in men's in particular, we're seeing a little bit more color. We haven't seen that for quite a while and we're pretty encouraged by what we've seen there in early results on that. And really, women's is, there's some new silhouettes that we're seeing that are starting to take off, but we haven't seen enough yet for me to say, okay, this is going to be the next big trend.

Okay. And any comments on the denim business and the outlook there?

I think for us, denim's a decent part of our business and continues to do okay. So I'm not anticipating that to change.

And merchandise margins, looking out for this year, can you talk about some of the opportunities that exist there? Are you getting more opportunity as you localize more of the stores that the assortment's in stores or are there other factors going on there?

Well, I think that certainly the overall management inventory that the team has really executed really well on improving our management of inventory will really help not only drive sales in the localized markets, but should, over time, improve our merchandise margins which again have been very consistent in this business for the last several years. We've had these newer disciplines in place for over a year now and the execution overall has been good. So I'm not expecting any material changes.

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

Thanks, good afternoon. I don't know if you can talk a little bit about the Q1 guidance, I'm sure, negative low single to negative mid-singles. Is that assuming that the heritage market could see some slight improvement and somewhat reflecting what you've seen in the last few days? And then in terms of just trends, Ed, is there any way, without giving away your competitive advantage here, that the secret sauce, how you feel about the new trends in 2017 versus 2016, just in the sense of do you see greater trends, do you think they might be some stronger trends versus a year ago, to help us think about the opportunity? And then lastly, my question's regarding e-commerce continues to grow very nicely for you. Just curious on how that margin compares against the store brick-and-mortar margins. And where do you think e-commerce could be as a percent of total sales longer term? Thanks.

Okay, Betty, I'll start on the guidance. So as we noted in the prepared remarks, comps are down high single digits as we sit here now. The comp cadence range for the quarter being low to mid certainly assumes some level of improvement and it's just a matter of how much. So given that we were really hit pretty hard during February, if you assume relatively little of that comes back to us, you'd be more towards the lower end of our guidance range. If you assume most of that comes back to us, you'd get to the better end of our guidance range and that's kind of how it's phrased out. We've got a later Easter, so spring breaks are shifting around. We did lose a lot of ground in February, so in this environment, it's difficult to count on all of that coming back to us. So that's why the range is pitched the way that it is.

But Mike, to be clear, you did say that it is positive comps outside of the heritage markets?

It has been in recent weeks.

Okay, great.

What happened for us, I'll give you a little more color there. Really for the entire quarter, our heritage markets have lagged well behind our non-heritage markets. Even in weeks where both were negative, the heritage markets have lagged significantly behind the newer markets. And I don't know how much you've been paying attention, but we have had about the wettest winter we've had out here in the last six, seven years. So we're convinced that that has had a meaningful impact on us. If we just look at the last several days, including this most recent weekend, when we had our first spring-ish nice weather weekend, things turn around nicely positive. So that's why we feel pretty confident that it isn't an assortment issue and as we have better consistent weather, especially out here, we will see better results. Because remember, a little over 50% of our stores are out here in California, Arizona, Nevada. That's a dynamic that doesn't exist with a lot of the other publicly traded retailers. We have a larger percentage out here. So when it's good out here or bad out here, it impacts us more significant.

Okay, great. That's very helpful.

Okay. Regarding trends, as you know, Betty, we carry, I don't know, probably about 500 brands in the store and it's a very diverse assortment. So we're never dependent on any one single brand or trend. And we've put a big push for newness more frequently and during the past year and I think the team is doing a decent job of executing it. And it doesn't mean that 80% or 90% of the merchandise in the store is going to turn over, turn faster, it's just that we're always bringing newness into the store, including new brands and of which we have several that we've introduced recently and will continue to introduce throughout 2017. I don't see any one particular category that's emerging as a dominant trend. So that's pretty much all I can say on that at this point. Okay? And then in terms of e-commerce, e-commerce for us is a profitable business. So it's a good business, it's something that we know we can continue to build upon and I think with the changes that we talked about that we're making, we'll improve our ability to serve the customer, but also improve our efficiency overall.

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

Just a couple of questions, maybe more on capital allocation. First, on the $20 million for the CapEx, do you think there is an opportunity to come in below that? I know you were thinking materially below your initial CapEx guidance for 2016. And then walking through that, it seems like you'll still be generating healthy free cash flow in 2017. I know you're doing or did, the special dividend, but has the Board had any conversations about ongoing share repurchases or other ways to redeploy that cash?

Well, as you just noted, we just did in February a stock dividend, so we just took a meaningful action. The Board constantly considers this and will continue to consider this as we look at our business. That $20 million is our best estimate as we sit here right now. It could be less or it could be more, again, going back to our prepared remarks of whether we open a meaningful amount of stores or not or if we're a net closer of stores. So $20 million is our best guesstimate right now, being that we don't have any new stores signed, but we're pretty close on a couple of deals. If those happen, we'll be closer to that $20 million. If they don't, we might be a little bit under it. But we will be making some meaningful investments on the IT side, as we noted in the prepared remarks.

Okay. And then separately, on those 49 lease decisions that you need to make, were those all and I must have missed this, were those all leases that are coming up in 2017?

Well, they're a combination. So some are lease expirations that will need negotiated renewals, some are lease kick-outs that are at the midpoint, the 5-year mark of a 10-year lease, others are pushes of kick-outs that we might have negotiated last year or the year before that were pushed out a year or two and then others are lease renewal options where we might have a 5-year extension decision to make. All are going to be looked at in a very disciplined manner, with the goal of improving profitability of the business.

And it's a good position to be in, considering the fact that we don't have the 800-store problem and we only have a couple hundred stores, as you know. So this gives us a lot of flexibility on actions that we can take to try to reduce our overall occupancy cost on a smaller store base than what some of our competition is faced with.

Secondarily on that, is there the opportunity within those 49 locations to maybe relocate to another spot in the mall that might be a better visibility, given some of the other issues that are going on with some of the other players in retail?

Every time we have a lease that is coming up for some kind of lease action, we're always looking for better location if we think the location we're in is inferior. As you know, there's a lot of moving parts right now within the malls, in particular, with so many bankruptcies and store closures. It's right now, it's hard to figure out who's going to end up where and that's why we're taking our time and being very diligent about what we do with every lease and every location. So I feel pretty good, again, about where we're at and our ability to take advantage of a market that's pretty soft to our advantage, but certainly we still don't know -- I don't think we've seen the end of the story in terms of other retailers' store closures. And so we're going to be very careful in terms of the moves we make.

Thank you. We have no further questions at this time. I would like to turn the conference back over to management for closing remarks.

Thank you for attending our conference call today and we look forward to talking to you in the near future and updating you as we progress through 2017.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.