Tilly's, Inc. (TLYS) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, greetings and welcome to the Tilly’s Inc. Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Gar Jackson of Investor Relations. Thank you. You may begin.

Thank you, operator. Good afternoon, everyone and welcome to Tilly’s fiscal 2017 second 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, which includes reconciliations of GAAP based financial measures to certain non-GAAP financial measures that will be discussed during this call please visit the Investor Relations section of the company’s website 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, August 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 second quarter earnings release, which was furnished to the SEC today on Form 8-K, as well as other filings with the SEC referenced in that disclaimer. Today’s call will be limited to one hour and will include a Q&A session after our prepared remarks. 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 operating results for our recently completed second quarter and then provide a progress update on our key initiatives. Mike will then review our results in more detail and introduce our third quarter outlook. Our second quarter comp sales increased 2.1%, which was on the higher side of our outlook range. Store comps were aided by the strongest store traffic improvement we have seen in a long time and our e-comm business continued to grow. Absent said provision for a legal matter during the quarter, we achieved our fifth consecutive quarter of improved year-over-year operating results, including improved product margins for the first time since the third quarter of fiscal 2015. We believe our merchandising, marketing, and operating initiatives are gaining traction and driving these improved results despite a very difficult brick-and-mortar retail environment. Strength in our men’s business in particular, along with positive comps in women’s footwear and boys led to a positive comp for the quarter. Our early back-to-school results are encouraging and we believe that we are well-positioned to continue the operating momentum we have been building over recent quarters. Turning to marketing, we have worked hard to reduce aggregate spending and improve the efficiency of that spending over the past several quarters. In doing so, we continue to prioritize direct consumer interactions over broad-brushed marketing campaigns, which we believe improves customer engagement and the in-store experience. As a couple of examples, we launched an augmented reality program in our Ontario, California store that continues to generate a lot of enthusiasm, interest and traffic. We also recently launched an all-store augmented reality scavenger hunt in partnership with social media star, Shonduras. Looking forward, we are working towards the introduction of some interesting enhancements to our in-store experience that we believe will be compelling and exciting for our customers, but we are not ready to release details yet. We believe that these kinds of marketing efforts improve customer engagement and generate excitement about Tilly’s leading to improved store traffic. Turning to real estate, we continue to work on driving store occupancy costs down as best we can. It is a slow process with moderate results thus far. However, we remain in great position to make further progress over the next couple of years, with an aggregate of nearly 120 lease decisions to make from now through 2019 through a combination of lease kick-out opportunities, expirations and extension options. We will make each decision with the goal of improving our business for the long-term benefit of our shareholders. We also continue to consider new store opportunities, which we believe have the appropriate economics to produce successful results on the conservative sales assumptions. We have identified two such opportunities that will open prior to the holiday during the fourth quarter. Turning to technology, we are on track to launch several systems designed to improve our omnichannel and customer engagement capabilities. We just initiated a pilot of our new point-of-sale order management and customer relationship management systems. If all goes well with the pilot, we expect to upgrade the entire chain before 2017 holiday season. We also expect to launch an upgraded website platform and mobile app before the 2017 holiday season. We then plan to launch our new ship-to-store program in the post holiday period. We are excited about the potential of these new capabilities we have to improve customer engagement and drive store traffic and increase sales opportunities. In closing, despite the seemingly constant stream of negative news in the brick-and-mortar retail industry, we continue to deliver improved results. I am proud of our team’s efforts. We aim to continue the momentum we have been building through the back-to-school and holiday seasons. Now, I will turn the call over to Mike to provide more details on our second quarter operating performance and introduce our third quarter earnings outlook. Mike?

Thanks, Ed. Good afternoon, everyone. Details of our second quarter operating results compared to last year’s second quarter were as follows. Net sales of $138.8 million increased 1.8% from $136.4 million. Total comparable store sales including e-commerce increased 2.1%. Store comps were up 2% on the strongest traffic result we have seen in several years, e-com sales increased 3.9% and represented 12.1% of our total sales versus 11.9% a year ago. We ended the quarter with 221 total stores compared to 225 stores a year ago. Gross profit of $40.9 million was an improvement of $2.1 million or 5.4% compared to last year’s $38.8 million. Our gross margin rate of 29.5% improved 100 basis points to last year’s 28.5%. Product margins improved 60 basis points which was considerably better than expected due to reduced markdowns. We also leveraged buying, distribution and occupancy costs by 40 basis points on our positive sales comp. On a GAAP basis, SG&A expenses were $42.2 million or 30.4% of net sales compared to $36.6 million or 26.8% of net sales last year. This year’s SG&A includes an estimated $6.2 million legal provision as previously disclosed in our Form 8-K filed in mid-July. Excluding this non-comparable legal provision, total SG&A expenses decreased to $36.0 million or 25.9% of net sales on a non-GAAP basis. Primary expense reductions were from marketing and non-cash store asset impairment charges. These reductions more than offset increased expenses from ongoing system implementations and the minimum wage impacts on store payroll. On a GAAP basis our operating loss was $1.2 million or 0.9% of net sales compared to operating income of $2.2 million or 1.6% of net sales last year. This year’s results include the previously noted legal provision. Excluding the legal provision we generated operating income of $4.9 million or 3.5% of net sales on a non-GAAP basis due to the combination of comp sales growth, gross margin increase and SG&A reductions. On a GAAP basis income tax benefit was $0.4 million or 42.8% of pretax loss compared to income tax expense of $0.9 million or 38.3% of pretax income last year. On a non-GAAP basis excluding the impact of the noted legal provision from this year’s results income tax expense was $2.0 million or 39.1% of non-GAAP pretax income. On a GAAP basis net loss for the quarter was $0.6 million or $0.02 per share compared to net income of $1.4 million or $0.05 per diluted share last year. On a non-GAAP basis excluding the impact of the noted legal provision from this year’s results net income was $3.1 million or $0.11 per diluted share. Weighted average diluted shares for the quarter were 28.9 million versus 28.5 million last year. Turning to our balance sheet which remains strong we ended the quarter with cash and marketable securities totaling $109.6 million and no debt which is a 13.7% increase compared to $96.4 million and no debt at this time last year. This increase is despite having paid a first ever special cash dividend to stockholders of $20.1 million in February of this year. Inventory per square foot decreased 1% on top of last year’s 7.2% decrease and our inventory aging was better than at this time last year. Capital expenditures for the first half of fiscal 2017 were $7.0 million compared to $10.4 million for the same time period last year and were primarily for the IT investments noted earlier and remodeled stores. Turning to our third quarter outlook, based on current and historical trends, we expect third quarter comparable store sales to be in the range of flat to up low single-digits. This was on top of a 2-year comp stack of plus 8% in our two most recent third quarters. We currently expect operating income to be in the range of approximately $9 million to $11.5 million compared to last year’s $10.7 million and earnings per diluted share to be in the range of $0.19 to $0.24 compared to last year’s $0.22. We expect our tax rate to be approximately 40% and weighted average shares to be approximately $29 million. We expect inventories per square foot to remain below last year’s levels and we continue to expect full year capital expenditures to be approximately $20 million. Regarding store count, we currently anticipate ending both the third and fourth quarters with 220 total stores. We anticipate closing one store during the third quarter and then opening two and closing two during the fourth quarter. Operator, we will now take questions.

Thank you, ladies and gentlemen. [Operator Instructions] Our first question comes from the line of Dave King from ROTH Capital. Please go ahead. Mr. King, your line is live. Please go ahead.

Sorry, I was on mute. Good afternoon, guys. I guess it looks like you had a pretty strong quarter that, that continued into August. I guess at what sense or Mike, what sense you have in terms of the markets that have already gone back to school. Typically, there has been some sort of drop off after we move off of peaks. Have you not seen that this time around? I mean, I guess what do you think sort of driving that? And is it just improved overall health of your customer or do you guys think you are taking a fair amount of share even in some of that off-peak times if you are. Some color there would be helpful. Thanks.

Hi, Dave. I think what we have seen so far is as you know we have a significant amount of stores in California, which back-to-schools are late. And we have seen pretty good results in those stores and some of those stores still have customers that still are shopping, because we are still in the middle of going back this week. We haven’t seen anything abnormal in fact in terms of drop off in the earlier markets. And right now, we feel pretty good about what we have seen through the back-to-school season up to this minute now.

Okay, that helps. And then maybe switching gears a little bit in terms of the product margins, I guess, I was surprised to see that up, so congratulations there given kind of what’s been going on in recent quarters. And is that just a function of inventory levels now being in a way they need to be on a square footage basis? And then as we think about the guidance for next quarter on operating income, it looks like you are guiding the kind of flattish op margins or actually operating income despite the flat .com maybe product margins holding in. I guess, just some color and context would be helpful? Thanks.

Okay, I will talk about what’s happened is that as you know we have worked really hard in the past year in terms of managing our inventory and we have made pretty good progress on that. We are starting to reap the results of that. The thing that I am most proud of the team is that we have driven positive results without having to get into the promotional environment that most of our competitors have done very aggressively until this day. So, I think it’s really a combination of better discipline from our team and discipline both on the inventory management side and also on the promotional side and one of the things that we have worked on in the last year have come together. Mike, you want to talk about?

Sure. On the guidance side, on the lower end, you are correct in that, we saw a 60 basis point increase in product margins in Q2. Our guidance does not contemplate that kind of improvement in Q3, particularly if we are on the lower end of our comp guidance range, if we are flat, then we would probably expect product margins to be no worse than flat, because the improvements we have made over the past year and some improvement as we get to the higher end, but maybe not quite as far as we achieved in Q2. And then for several quarters in a row, we have actually had year-over-year raw dollar decreases in SG&A and in Q3 we are not expecting that to continue. SG&A will be modestly up on a raw dollar basis in Q3. So hopefully that can help you with calibration of the model.

Okay, that helps. Thanks and good luck.

Thank you.

Thank you. Our next question comes from the line of Jeff Van Sinderen from B. Riley & Company. Please go ahead.

Hi, everyone. Just let me add my congratulations on the strong Q2 metrics, great to see. Maybe you can give us a little bit of – little bit more color I guess on some of the key things that you think are driving traffic, to both your stores and your website, maybe touch a little bit more on some of the in-store experiential elements which I know you commented on a bit, maybe kind of I know you don’t want to give away too much there, so I respect that, but just any other color you can give us there in terms of what’s developing?

Sure. One of the things, for several months now, not every month, but in a lot of the months, past months we have run in-store events Saturday’s afternoons and with the intention of really bringing attention to the Tilly’s brand, particularly in newer markets and it’s really helped draw a more consistent traffic. And as Mike mentioned earlier, we have seen really consistent improvement in traffic across the board, despite the fact that obviously it’s a very difficult environment out there. So from that perspective I think Jeff we have really – we have done a lot of different things in those store events. But it’s worked and it certainly brought attention to the brand and to our merchandise assortment. And then in terms of the Ontario Mills is where we did the augmented reality, it’s still there now, it’s a fun window and it’s a traffic draw. And then lastly the last thing we did as we mentioned was through social media a combination of social media doing the scavenger hunt in the store. We made the shopping experience fun and that’s what we are going to continue to do that– those types of things going forward.

Okay, good. And then if we could focus maybe a little bit more on e-com and omnichannel, I know you guys have considerable talent in-house there, just wondering what trends you are seeing in e-com, omnichannel, what initiatives you are focused on for that part of the business over the next few quarters?

Sure. The customer pick up, as you know we introduced a few months ago and that’s – it’s worked pretty well. So we have been – it definitely has proven to drive more traffic to the stores. And our focus really right now is we are getting good traffic to the website both on mobile traffic and desktop. Mobile doesn’t always convert the same as desktop for anybody. But anyway we are seeing good traffic and what we are most excited about is when we go – move over to the new platform, it will make the shopping experience a lot better for our customers and we felt for months that that was really needed. And I think we will see even further improvement in our results going forward.

Okay, great to hear continued success. Thanks.

Thank you, Jeff.

Thank you. Our next question comes from the line of Sharon Zackfia from William Blair. Please go ahead.

Hi, good afternoon. I guess the question as you are seeing this improvement in trends, I mean I know you are opening a couple of stores later this year, but any thoughts on the pipeline of development beyond 2017 like what you are looking for to be more aggressive, if you are seeing any kind of more palatable offers from landlords at this point that makes the deals more compelling?

Sure. So yes, we have a lot of deals under negotiation in the pipeline. We haven’t yet decided to accelerate the growth, but certainly we are positioning to add a lot more stores than what we have added in the past. I don’t know – yet know what the timing is. One of the complications that every retailer is dealing with is the vacancies keep changing in the malls and we are seeing more and more vacancies, so seeing how it all plays out. Right now it’s more prudent to be, I am talking in malls, more prudent to walk before we run in terms of store growth. And then the good thing about our formula is we also are very successful off mall, which we have done for years. And we are really excited about the growth prospects we have for off mall in addition to mall. And there for the quarter there was really no material difference in what we saw in results between our mall results and our off mall results, so more to come on that, probably on the next call in terms of what we are thinking in terms of store growth in the immediate future.

Maybe a follow-up, I mean would your preference be to focus more on some of the emerging markets or the core or is it just wherever the deals land?

The immediate focus is to fill in newer markets where we have a small amount of stores and the expansion that took place over the last few years has left a lot of really good opportunities for us to expand within those markets. So that will be the primary concentration and the two deals that we have signed for or we haven’t signed them yet, but we have mentioned that we expect two stores to open before holiday. One is in existing market and one is in a newer market.

Thank you.

Okay.

Thank you. Our next question comes from the line of Janet Kloppenburg from JJK Research. Please go ahead.

Hi Ed. Hi Mike. Congrats on a good quarter.

Thanks Janet.

I got on a little bit late, I think you said it was comp was helped by men’s, boys and footwear, is that what you said?

Yes. Men’s actually for the quarter men’s was our strongest category, but women’s footwear and boys were also up.

Okay. So the women’s maybe is improving from where it had been prior is that right?

Yes, that’s correct.

Can you talk a little bit about that improvement and also did I hear that right at the e-com business was up may be 3.9%, maybe I would have expected something a little bit more robust than that, so maybe you could talk a little bit about just given the trends I am hearing about from others? Thanks.

Yes, okay. So answer to the first question in women’s, as you know we carry so many different brands and so many different works in our store. There is not one particular category that I can point to that drove that business, I just think we definitely improved across the board in the women’s category, so I will not – I can’t really tell you what...

Is denim better, Ed?

Denim was good for us, yes. But as you know denim is not a huge percentage of our – but it’s good, but it’s not a huge percentage of our business. Certainly denim was positive, yes.

Okay. The trends we are hearing about the denim and bottoms are good and dresses are softening up and I just wonder how that may be impacting your business?

Well, I think one of the advantages we have is we are not relying on any one particular category, because we carry so many different brands and so many different works in the store, that that helps us a lot. So certainly when there is no dominant trend, I am not going to really say much for competitive reasons right now but we are seeing a few trends in women’s for spring that are encouraging in tops. I felt like the tops category across the board was the offer of for – throughout the industry was not very compelling and I think we are seeing some stuff for spring that I am encouraged by.

Okay, great. Thanks.

And then your last question on e-com, so our e-com business could have been better for sure. We were in the middle of a platform change that we expect to go in before holiday. I think part of the challenge for us is has been the shopping experience has not been very good. We also did – we also focused on more regular price selling on e-com than what we historically have done, so our margins are up on e-com and a lot of our competition has been extremely promotional on – to drive business on e-com. We elected to do a combination of things. One is focus on profitability first. And then secondly with the new platform, I think the shopping experience will be a lot better and we will see volumes grow there.

And so this platform change for holiday will be secured before we enter like the Black Friday season and all that?

Sorry you are breaking up during that Janet.

The platform change for e-com that will be completed Michael before you go into the holiday season?

Yes, we are anticipating that being completed before we finish third quarter.

Okay. And when you look at current trends it sound like they are pretty good, do you feel like there could be any pull forward at because weather trends are cooler across the country or is there anything there that worries you about a slowdown later in the quarter?

There is nothing that sticks out that concerns me about a potential slowdown at this point.

Okay.

Obviously, I think what’s happened Janet is too, is that, it’s really hard to forecast people show up for the big events, but what happens in between is a great unknown, especially in the terms of traffic. But we have proven that we can drive traffic even in the worst of times and that we are going to continue to work on the things that we have been working on and hopefully improve our conversion as a result.

Okay, great. Good luck. I will talk to you guys later.

Alright. Thank you.

Thank you.

Thank you. Ladies and gentlemen, there are no further questions in queue at this time. I would like to turn the floor back over to management for closing comments.

Thank you for attending our call today. We look forward to speaking with you after our next quarterly call. Thank you. Have a good day.

Thank you. Ladies and gentlemen, this does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for participation and have a wonderful day.