Tilly's, Inc. (TLYS) Q1 2017 Earnings Report, Transcript and Summary

Greetings and welcome to Tilly's First Quarter Fiscal 2017 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now turn the conference over to Mr. Gar Jackson, Investor Relations. Thank you, Mr. Jackson. You may now begin.

Thank you, operator. Good afternoon everyone and welcome to Tilly's Fiscal 2017 First Quarter 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 Web-site at tillys.com. From this 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, May 23, 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 fiscal 2017 first quarter earnings release, which 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. 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. With that, I now turn the call over to Ed Thomas, Tilly's President and Chief Executive Officer.

Good afternoon everyone and thank you for joining us today. I will provide a brief overview of our fiscal 2017 first quarter results and then provide a progress update on our key initiatives. Mike will then review our results in more detail and introduce our second quarter outlook. Our fiscal 2017 first quarter comp sales, operating results and earnings per share were all above our original outlook ranges. We achieved our fourth consecutive quarter of year-over-year operating income improvement. After starting the quarter with a negative double-digit February comp, we bounced back with a nearly flat March comp and a positive low-teens April comp, due to the Easter shift. Total comp sales, including e-commerce, were up 0.6% for the quarter and were up 5.3% for the combined March-April period. Over the past year, we have been working hard to better engage with our customers and improve the performance of the business. We believe our merchandising and traffic-driving initiatives have had a positive impact. Our spring assortment, which includes a variety of new styles and brands, is performing well overall based on our combined March-April comp, in the positive momentum we have seen carry into May. On a total Company basis, positive comps in our men's and boys departments offset low single-digit negative comps in other departments for the quarter. We believe that our assortment combined with our successful in-store events and contests drove a modest improvement in in-store traffic for the quarter despite what has been widely reported as continuing negative mall traffic environment. As just one example, we conducted a fun in-store virtual reality event for the movie Kong during the first quarter, which was very well received. We will continue creating what we hope are compelling in-store events and provide support to local schools and sports programs in order to engage more directly with our target customers and drive traffic to stores more frequently. While we are not ready to discuss details yet, we are in active discussions regarding potential new cobranded events that we believe will be exciting for our customers. We look forward to sharing details about these cobranded events at a more appropriate time. We continue to focus on improving sales productivity in our underperforming stores. As you may recall, we identified over 40 stores where we believe top line performance should have been stronger based on the quality of the real estate involved. We made various assortment adjustments in these stores based on individual store profiles over the past year or so. As a whole, they have generally continued to outperform the rest of the chain from week to week and we believe there is still additional room for improvement. We meet on this every week as a senior team and we will continue to refine our efforts with these stores to drive better sales productivity. Turning to our technology investments, as we noted previously we are upgrading and implementing a variety of in-store and online technologies to create and improve our omnichannel capabilities and customer engagement. We expect our upgraded Web-site platform, enterprise order management, new point of sale, and customer relationship management systems to launch during the second half of the year. A soft launch of our Buy Online, Pick Up in Store initiative went well and we just expanded this program to the whole chain. We plan to launch our Ship to Store program in conjuncture with a new integrated order management POS system ahead of the holiday season. We are excited about the potential these new capabilities have to improve customer engagement, drive store traffic and increase sales opportunities. Turning to real estate, as we noted during our last earnings call, we have lease decisions to make this year that impact over 20% of our store fleet. We have a similar number of lease decisions to make in each of the next two years. These lease decisions span all markets and store types and include lease extension options, lease kick-out opportunities and lease expirations that require negotiated renewals. It is uncertain what the net result of these decisions will be at this time, but we are working hard to realign lease cost structures wherever possible in light of the existing retail environment. In closing, despite thousands of store closures, several bankruptcies, continuing declines in mall traffic in the broader retail environment, we have delivered four consecutive quarters of improved year-over-year operating income, and we aim to continue this momentum. We are constantly looking for ways to drive traffic and sales, both in-store and online, and to be more cost-effective with our spending. Now, I'll turn the call over to Mike to provide more details on our fiscal 2017 first quarter operating performance and to introduce our second quarter earnings outlook. Mike?

Thanks Ed. Good afternoon, everyone. As Ed noted earlier, our fiscal 2017 first quarter comps, operating results and earnings per share exceeded our outlook ranges. Details of our first quarter operating results compared to last year's first quarter were as follows. Net sales of $120.9 million increased 0.6% from $120.2 million. Total comparable store sales, including e-commerce, were up 0.6%. Store comps were just shy of flat on store traffic that was up 1%. E-commerce sales increased 6% and represented 13.4% of our total sales versus 12.7% a year ago. Our store count dropped to 222 from 224 a year ago. Gross profit of $32.9 million was an improvement of $0.3 million or 1%. Gross margin was 27.2%, an improvement of 10 basis points. An 80 basis point improvement in buying, distribution and occupancy costs more than offset a 70 basis point decrease in product margins. Buying, distribution and occupancy costs decreased $0.8 million, primarily due to having two fewer stores. Product margins declined modestly due to increased markdowns but remained very healthy overall. SG&A expenses were $33.2 million compared to $36.6 million, a decrease of $3.3 million. As a percentage of net sales, total SG&A was 27.5% compared to 30.4%, an improvement of 290 basis points. As a reminder, last year's SG&A included $2.4 million for the combination of a legal provision and non-cash store asset impairment charges, representing 200 of the 290 basis point of SG&A improvement. After consideration of this non-comparable variance, total SG&A dollars were down another $0.9 million, primarily from reduced marketing expenses. Our operating loss was $0.3 million, or 0.3% of net sales, compared to an operating loss of $4 million last year or 3.3% of net sales. Despite our operating loss, we incurred income tax expense of $0.1 million due to certain discrete charges relating to employee stock grant activity and required estimated tax payments in certain states. Our net loss for the quarter was $0.2 million, or $0.01 per share, compared to a net loss of $2.7 million and $0.10 per share last year. Weighted average shares for the quarter were 28.7 million. Turning to our balance sheet, which remained strong, we ended the quarter with cash and marketable securities totaling $105.6 million, a 19.5% increase compared to $88.4 million at this time last year, despite having paid a first ever special cash dividend to stockholders of $20.1 million in the aggregate from cash on hand during February. We have no debt under our recently renewed credit facility. Inventory decreased 6.8% on a per-square-foot basis compared to our comp sales increase of 0.6% and our inventory aging was improved versus last year. This was on top of last year's 7.4% inventory decrease. Capital expenditures for the quarter were $3 million compared to $4.3 million last year and have primarily been for the IT investments noted earlier and remodeled stores. Turning to our outlook for the second quarter, based on current trends and with an expectation of continued choppiness in store traffic, we expect second quarter comparable store sales to be in the range of flat to up low single digits, operating income to be in the range of $1.2 million to $3.5 million, and earnings per share to be in the range of $0.03 to $0.07 compared to last year's $0.05. We expect our second quarter tax rate to be at a more normalized rate of approximately 40% and weighted average shares to be approximately 29 million. We expect inventories per square foot to remain below LY levels, and our store count to remain unchanged at 222 total stores, which is a decline of three from the end of the second quarter last year. Operator, we'll now take questions.

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

So first, I just want to say, great job getting SG&A down and getting flow-through from that. How should we think about SG&A going forward, are there other reductions we should be looking for as the year progresses versus last year?

During the second quarter, it should be down modestly, relative to LY again. We have made several structural changes in the marketing area in particular, but in every facet of the business we have been really looking at every single contract, we have had some favorability from open headcounts and the like that continue to be of benefit to us. So, we are going to continue to be very tight on SG&A going forward, and at least for the second quarter coming up based on the guidance range we have, it should still be a little bit below LY.

Okay, great. Ed, do you think the landlords have figured out yet that if they don't reduce rent, they're going to have a bunch of ghost towns on their hands?

Jeff, obviously it's a challenge for every retailer in the country with declining productivity and rents, and we have great relationships with our landlords and we continue to work closely with them to improve our own economics, but obviously I can't speak for them.

Okay, fair enough. Just one more, if I could squeeze it in, merchandise margins, how should we think about merch margin? I mean, obviously you guys are offsetting that with some other savings. I'm just wondering if we should think that at some point here your merch margin year-over-year will start to inflect.

Yes, it should stabilize at some point. As soon as Ed came onboard, we really took a hard push at getting inventory levels down as well as acting faster on things that we are not selling at an acceptable rate. We continue to do that, but we have been doing that for the entire past year. So at some point, we would expect that to moderate and hopefully start turning the other way at some stage.

Okay, fair enough. Thanks for taking my questions and best of luck.

The next question is from Dave King of ROTH Capital. Please go ahead.

I guess first off, maybe following up on Jeff's line of questioning a little bit, it seems that the operating income guidance, it assumes a little bit of margin degradation, even on a flattish comp if I look at the low end of the range. I guess if I compare that to the improvement you've had over the past few quarters, even on a flattish comp, I guess what are sort of the takes that might be driving that? You touched on it a little bit, Mike, but are there wage increases that we should be factoring in or is it more of a product margin this year?

There certainly have been legislated minimum wage increases that we have been absorbing and are a factor year-over-year. At the lower end of our guidance range, if we are closer to flat, we still would have some product margin erosion to try and keep inventories as clean as we can. We're going to continue to keep inventory very well controlled. So, that might be something you might factor in.

The merchandise margins in this Company have been consistent for many years, and now, again like Mike said earlier, we've been very disciplined since we both joined the Company in terms of making sure that markdowns are more timely and so on and so forth, and the merchant team has done an excellent job of executing that strategy and also keeping inventory comps in line with our sales comps.

Okay, fair enough. And then in terms of the Pick Up in Store launch, Ed, is there anything to point to there in terms of early learnings or has there been any quantifiable pickup in comp from add-ons, anything you can share there?

I don't think it's had any material impact on our overall results at this point. We're just happy with some of the activity that we're seeing. And it was a very, very limited soft launch that we went through for a few months, so more to come on that later. And as mentioned earlier, we just rolled it out to most of the inventory in all the stores, and so it's really the initial results, we are very encouraged with that. Obviously, it's another thing that we're doing to drive more traffic to the stores in a very challenging traffic environment.

Absolutely, but still encouraging to hear. And then I guess lastly for me, following on the special dividends and with the stock trading I think in the 4x range on EBITDA, what are the updated thoughts on buybacks, dividends, anything along those lines?

There is really no new news on that at all. We just did the special dividend. So, as we've said many times before, our cash position is something that our Board evaluates pretty regularly, but there is nothing new since the last dividend, okay.

No problem. Had to ask. All right, good luck with the rest of the year.

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

Congratulations on a nice quarter. I think you said, Ed or Mike, that it was men's and boys that drove the comp improvement. Maybe you could talk about, highlight the women's business and your footwear business, accessories, and what's going on there and what might be the outlook as we think about the rest of the year? And as far as the in-store events go, that seem to be helping traffic. Is that something that what percentage of stores was that done in and is there a plan to develop more of these kinds of events going forward?

So Janet, on the merchandising, the categories, you have men's and boys that really drove it, but the other categories, women's, footwear, they weren't materially – we didn't see big decreases in any of those major categories at all. And as a matter of fact, subsequent to quarter end, we have seen some improvement in some of those categories that may have been running a little softer than we would have liked. I think in the women's category, I think the biggest callout there is, there really was no dominant trend. So, I am encouraged by what I've been seeing, but still it's a little volatile out there as you know and we're going to walk before we run.

And is that where some of the gross margin pressure is coming, on the women's side?

Some, but not – yes, some.

Again, women's in particular was down less than 1%. So let's just be clear. It's not like there is a major problem or a major assortment issue within the women's assortment. It was down less than 1%.

Okay. Can you talk about any of the other categories or businesses?

There is really not much to say on any of the other categories. They were all – they were down, ones that were down were really small.

Kind of low single-digits.

So anyway, and again, we are seeing improvement in many of the areas that may have been a little softer. Part of the challenge we had early on was weather and some of the summer categories start out slow but they have bounced back nicely since the country has got warmer. So, there is not much I would read into what you are hearing.

Okay, got it, I understand.

Okay, then the second question was related to events. So, one of the things that we have been very proactive with as a company is, knowing that traffic is very challenging out there for everybody, we are trying to drive traffic to our stores, and one of the key elements that we have been really successful with is doing these events and a lot of them have been done chain-wide and we are going to continue to do those for the balance of the year. I think we learned a lot by some of the stuff that we have done and it's something that has worked for us and we're going to continue to do that. Some of the events, for example, we have done, one of the events we ran was cobranded with Adidas and we have done it with Vans. And so, we'll continue to do those because there is no question it's a tough environment out there, but we know that we can work harder and we are working harder at driving traffic to the stores.

Right, okay, good luck.

Thank you. I would now like to turn the conference back over to management for some closing remarks.

Okay. Thank you for joining us.

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.