Tilly's, Inc. (TLYS) Q1 2018 Earnings Report, Transcript and Summary

Greetings and welcome to Tilly's Incorporated First Quarter 2018 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 like to turn the call over to your host.

Thank you, operator. Good afternoon everyone and welcome Tilly's fiscal 2018 first quarter 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 website at tillys.com. From the same section, shortly after the conclusion of the call, you'll also be able to find the 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 30, 2018, 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 2018 first quarter earnings release, which is 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 and will include a Q&A session after our prepared remarks. I'll now turn the call over to Ed.

Thanks Gar and good afternoon everyone. Thank you for joining our fiscal 2018 first quarter earnings call today. Total comp sales for the first quarter increased 0.1%. Our sixth consecutive quarter of year-over-year store traffic growth drove a 1.2% comp sales increase in stores. As expected, e-com sales were down in the first quarter because of various technical issues associated with our new order management and website systems that we discussed during our fourth quarter earnings call in March. However, e-com sales have incrementally improved each month as we have addressed many of these issues. E-com sales progressed from a decline of 10.2% in February to a decline of 6.5% in March, to a decline of 5.5% in April. Although our e-com sales have been inconsistent from week-to-week, the overall trend has continued to improve and e-com sales are now up low single digits thus far in May. We believe this improvement is particularly encouraging because we have not yet fully reactivated our omnichannel initiatives. Our direct-to-consumer program is currently active in only about 20% of our stores. We have been methodically reintroducing this program district-by-district, week-by-week in order to carefully monitor its performance. Pickup in store is not yet active in any markets, but we currently expect to reintroduce it during the second quarter. We expect the trend of e-com sales to continue to improve during the second quarter as we address remaining lower level issues in omnichannel execution. Earnings per share of $0.04 for the first quarter beat the top end of our earnings outlook range by $0.01 due to disciplined expense management and better-than-expected product margins, which Mike will discuss later. Regarding merchandising, positive comps in girls, footwear, men's, and boys were offset by low-single-digit negative comps in women's and accessories. Our girls business was particularly good except for dresses. The strength of our branded assortments drove positive results in footwear, men's and boys. Our women's tops business improved for both branded and private label with the introduction of our spring assortments, but it was -- this was offset by weakness in swim dresses and intimates. In the early stages of the second quarter, all departments are comping positively with the exception of accessories, which remains down low-singledigits. Turning to our real estate, we opened one store, closed one store, and opened three new RSQ-branded pop-up stores during the first quarter. For the remainder of fiscal 2018, we currently expect to open four new stores in each of quarter -- second quarter and third quarter and three new stores early in Q4, bringing the total new store openings, including our three RSQ pop-ups to 15 for fiscal 2018. We currently expect to close five stores during Q3. We also continue to make progress on the roughly 120 lease decisions we have to make over the course of fiscal 2018 and 2019. Our efforts have generated five consecutive quarters of occupancy cost improvement relative to sales, and we currently expect this trend to continue throughout fiscal 2018. Turning to marketing, we continue to drive store traffic with store events, contests, and improved customer engagement. For example, in the first quarter, we collaborated with Warner Bros. and their movie, Rampage, to deliver an in-store augmented reality experience for customers in which they could take pictures with creatures from the movie and potentially win VIP experiences related to the movie. We also conducted several other chain-wide events that included a variety of food, fun, and giveaways. We appreciate the support and creativity shared by our brand partners to help drive excitement and interest in Tilly's in the brands that we carry. We have also engaged a branding firm to assist us in enhancing Tilly's branding -- brand awareness and engagement across the country, which has been very thought-provoking and has provided us with a number of ideas to consider. In closing, we are off to a decent start to fiscal 2018 with continued positive store traffic and improving e-com trends as we work through and pass our remaining technical issues. We look forward to sharing our progress with you throughout the year. Now, I will turn the call over to Mike to provide more details on our first quarter operating performance and introduce our second quarter earnings outlook. Mike?

Thanks Ed and good afternoon everyone. Our first quarter operating results compared to last year's first quarter were as follows; net sales of $123.6 million increased $2.7 million or 2.2% from $120.9 million due to the calendar shift impact of last year's 53rd week in the retail calendar. Stores represented 88% of our total sales for the quarter and were up 1.2% on a comparable basis, driven by our sixth consecutive quarter of year-over-year store traffic growth. E-com comps were down 7.2%, but with an improving trend line, as Ed noted earlier, including positive comps thus far in May. The combination of positive store comps and negative e-com comps resulted in total comps that were up 0.1% for the first quarter. We ended the quarter with 222 stores, including three RSQ-branded pop-up stores, compared to 222 full-sized stores at this time last year. Gross profit of $35.0 million was an improvement of $2.1 million or 6.3% compared to last year's $32.9 million. Our gross margin rate of 28.3% improved 110 basis points compared to last year's 27.2%. Buying, distribution, and occupancy costs improved by 120 basis points as a result of distribution savings and occupancy reductions. Product margins were better than expected, just 10 basis points below last year, as a result of lower initial mark-ups. SG&A expenses were $33.6 million or 27.2% of net sales, an improvement of 30 basis points compared to $33.2 million or 27.5% of net sales last year. The combination of corporate payroll savings and disciplined management of payroll by our store teams drove this improvement despite minimum wage increases in certain markets. The $0.4 million increase in SG&A was primarily due to costs associated with our new order management, POS, and website systems. Operating income was $1.3 million or 1.1% of net sales, an improvement of 140 basis points compared to an operating loss of $0.3 million or 0.3% of net sales last year. Income tax expense was $0.5 million or 28.6% of pretax income compared to $0.1 million last year. Income tax expense includes certain discrete charges related to employee stock-based award activity in both periods. Net income was $1.2 million or $0.04 per diluted share compared to a net loss of $0.2 million or $0.01 per share last year. Weighted average diluted shares for the quarter were 29.4 million versus 28.7 million non-diluted shares last year. Turning to our balance sheet, which remained strong, we ended the quarter with cash and marketable securities totaling $105.0 million and no debt compared to $105.6 million and no debt at this time last year. In February, the company paid a special cash dividend to stockholders of $1 per share or approximately $29 million in the aggregate, as previously announced. This followed the first-ever special cash dividend of $0.70 per share or approximately $20 million in the aggregate in February last year. We finished the quarter with inventory per square foot down 2.3% to last year, marking our 10th consecutive quarter with sales comps stronger than inventory comps. Total capital expenditures were $2.9 million compared to $3.0 million last year. Total capital expenditures for fiscal 2018 as a whole are not expected to exceed $20 million. Now, turning to our outlook for the second quarter. As a result of the calendar shift impact of last year's 53rd week, we expect total sales for the second quarter to range from $153 million to $157 million based on a 1% to 4% increase in comparable store sales. This calendar shift resulted in an increase of approximately $12.3 million in last year's comparable sales base and approximately $0.10 of EPS for Q2 comparability. This is due to the first several days of August, which are in the back-to-school season, now falling into Q2 this year versus Q3 last year. We expect that the same calendar shift will have an opposite impact on Q3 with a net reduction of approximately $13.9 million in last year's comparable sales base and approximately $0.12 of EPS out of Q3 for comparability purposes. We expect Q2 operating income to range from $9.5 million to $11.0 million and earnings per diluted share to range from $0.24 to $0.28. We expect our tax rate to be approximately 27% and weighted average shares to be approximately 29.5 million. We expect inventories per square foot to remain at or below last year's levels. We expect to end the quarter with 226 total stores comprised of 223 full-sized stores and three RSQ-branded pop-up stores after opening four new full-size locations in the latter half of the second quarter. Operator, we'll now take questions.

At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jeff Van Sinderen from B.Riley FBR. Please proceed with your question.

First, let me say congratulations on beating on the bottom-line and progress with e-commerce. I know you said that e-com trend is improving sequentially and can you give us a little bit more on what you're seeing in the test of your omnichannel system and what other steps you need to take to how that fully turned back on? And do you expect that to be fully operational for back-to-school?

Sure. Thanks Jeff. Most of the major functionality problems that we had in the fourth quarter, almost all of them have been fixed. So, now it's really fine-tuning the actual website itself, which substantial progress has been made. And then as far as the omnichannel, we just want to make sure we were extra -- we did some extra testing on the omnichannel integration with inventory systems with the stores. And so far, the tests have gone extremely well and I would expect both the website itself and the omnichannel capabilities will be ready for back-to-school. So, I don't anticipate any problems. I can't see anything at this point.

Okay, great. And then you've been able to keep inventory trending lower on a per square foot basis. Just wondering, how much more room you think you have to go in that process or kind of what inning we're in?

Well, I don't -- I think we're in the later innings, but it's something that we constantly are reviewing and managing and looking for opportunities. And the only -- sometimes, you run into a problem. When you have a bestseller, you never have enough inventory. But overall, the inventory levels, we're pretty comfortable with. I wouldn't expect continued declines going forward. We'll have some, but they're not going to be as material as what they have been run for the past several quarters.

Okay, that's helpful. And then one more follow-up, if I could squeeze it in. Just wondering on the women's business. I think you said the girls business was strong, but women's not fully positive yet. Can you give us a little more color on that? I guess what you're seeing there and what your outlook is for the women's segment?

Sure. We're seeing definite improvement in the women's category -- pretty much across all categories within women's. Certainly, I would expect that it will continue to improve through back-to-school. I mean the soft categories that Mike called out like swim, that's -- that was kind of -- that was softer than what we had planned; for sure, intimates. But categories like fashion tops and dresses, I mean -- and skirts comped pretty positively in the quarter. So, we're expecting that to continue. There's -- we're still seeing some newness out there in color, which I had mentioned on previous calls, which we think will be positive to our business.

Okay. Great to hear. Thanks for taking my questions and best of luck for the rest of the quarter.

Thanks Jeff.

Our next question comes from the line of Dave King from ROTH Capital. Please proceed with your question.

Thanks. Afternoon guys and forgive the background noise. I guess first up on the e-com system integration, can you help us better understand the weekly inconsistency there? Did you turn on some of the omnichannel initiatives at some point during the quarter and then the hiccups returned or was that just -- was the inconsistency apart from the integration issues and you just were conservative in turning that stuff on as you went?

Hey Dave its Mike. So, nothing has been turned on and then turned back off. The inconsistency so far, as you'll recall, back up to our last call, we had said we were starting to see some positive days that we haven't -- hadn't quite gotten into a cadence of having a full week positive. Now fast-forward, we'll see a week that's positive and then the next week will be down a little bit and then the following week will be back up. So, we've had four of the last seven weeks have been positive with some in-between weeks that were down there. We obviously just came out of Memorial Day weekend that was heavily influenced by Memorial Day sales. So, it's pretty promotional. We found that when we're more promotional, our e-com business tends to respond quite well, and it's nice to see that, especially with Memorial Day weekend sales that we just completed, the website functioned fine. We didn't have any major customer service issues to report. So, we handled that kind of higher level of promotional activity quite well, which generated some positive sales, but again, that was promotionally-driven.

Okay. Okay, that helps. That helps. And then maybe switching gears. So, the Q2 guide, obviously it assumes a fair amount of operating margin improvement. Now some of that's due to 53rd week timing. Can you help us better understand the geography of that improvement between product margin and occupancy leverage, SG&A leverage? And then if you can, kind of tell us how much of that's sustainable improvement versus the 53rd week timing?

Sure. So, there's going to be some opposing impacts between Q2 and Q3 that kind of balance out with each other, to put it as simply as I can. For Q2, because of that big volume shift that I mentioned about the first several days of August now being in Q2, that volume shift is going to bring with it quite a bit of leverage impact on both distribution and occupancy as well as SG&A. We're expecting somewhere in the neighborhood of 150 to 200 basis points of leverage on occupancy, about 50 or so in distribution, maybe about 100 or so in SG&A. And then those are going to reverse themselves in Q3 because of the net impact of the reduction in comparable base. So, rough order magnitude, that's kind of how to think about each line item, what it's going to do in Q2 and then on the opposite side in Q3 just due to the revenue shift of those peak weeks.

Okay. Okay, that helps. And then I guess lastly for me. On the RSQ pop-up shops, anything early to share there? Any successes or early learning with that?

Well, we're pretty pleased with the results so far because especially we opened all three during a nonpeak period. So we're really excited to get -- have these stores operated through back-to-school. And two of the stores are in newer markets for us -- not completely new and then one store is actually right in our backyard here, and it's across the street from our power center store that we have in a mall and we're pretty encouraged by the results so far. So, it's early in the game, but so far, so good. And again, we have tremendous flexibility in terms of how long these stores could keep open. The economics of this -- of the model with rents and stuff are very attractive. So, more to come on that after we get to the back-to-school season, okay?

Okay. So, I mean, understanding it's early, but do you think there's potential to maybe expand this to -- more broadly specifically for RSQ? So, either full stores or more of them?

Well, I definitely think there's an opportunity to do more going forward, but it's too early to make that determination. We know that -- from the recent real -- ICSC Real Estate Convention that there is a lot of interest with major landlords and us doing more, but right now, we're going to just stick with the three that we have, learn more about what works and what doesn't work, and then we'll make a decision on further expansion in the future months.

Perfect. Thanks for taking the questions.

Thank you.

Our next question comes from the line of Oliver Chen from Cowen and Company. Please proceed with your question.

Hi Ed and Mike, solid results. Our question is about traffic. The momentum there has been very encouraging. What are your thoughts for the back half in terms of how you're thinking about traffic-driving initiatives? And on a long-term basis, what are some of the priorities you have around traffic? The other comment that was very interesting, Ed, is awareness and the awareness opportunity that you see. Could you speak to your hypothesis there and also what you think are the levers for driving new customer acquisition through awareness? And what kind of strategies and timing are you considering as that seems like a big opportunity as well?

Sure. Okay so, on the first question related to traffic, I mean, we've been able -- as you know, we've been able to demonstrate that we can drive positive traffic even going back to last several months where the environment was very difficult and industry traffic numbers were down, and we continue to outpace that. We believe a lot of it has to do with a lot of the localized marketing that we're doing. The events in the stores that we've run have been really successful in bringing awareness. And most importantly, keeping our customers engaged with Tilly's. So, we're really excited about that. We've complemented the events with some local social media marketing. And I don't anticipate -- I anticipate that traffic will continue to be decent through the balance of this year for sure. So, we don't see anything that's going to stand in our way of traffic generation. On your second question related to awareness, being -- our heritage markets being Arizona, California, Nevada where the name is really well-known and where our challenge has been as we grew across the country in areas where we didn't cause the stores, there's not a lot of -- there hasn't been a lot of brand awareness out there. So, a lot of what we're doing is to drive better -- create better brand awareness in the newer markets for us, and it appears to be working in quite a few stores, including those stores that are isolated and where it may be a single-store market for us. We've seen improvement in those stores' results consistently for the last several months since we did some stuff to create more brand awareness and adjusted inventory mixes to that particular geographic area. So, I don't know if that completely answers your question, but that's kind of my thoughts.

Yes. Very helpful. And Mike, regarding merchandise margins, how should we think about markdown levels versus last year and promotional levels versus [Indiscernible] and what you expect in that line item? And then you also have a very attractive fundamental position in terms of your balance sheet. Could you just remind us of your priorities in terms of return of capital to shareholders and [Indiscernible] you're thinking about that?

Sorry. Remind me of the first part of the question, sorry.

The first part was on merch margins and--

That's right. So, our merch margins are going to be really consistent. They don't tend to change a great deal whether we're up a little bit or down a document from quarter to quarter. They don't tend to span much more than 100 basis points or less from quarter-to-quarter. In the first quarter in particular, it was IMU that was lower than last year. Our markdown rate was actually below last year. So, assuming we're on trend and what have you, we have a long history of demonstrating some pretty consistent product margins. So, we're really not expecting that to change. And then in terms of the cash question, this is the first year in the last three years where we're opening a meaningful number of stores. So, that's where -- part of the reinvestment back in the business. And then you've seen each of the last two Februarys, we have given cash directly back to shareholders in the form of cash dividends. We did $1 per share this most recent February, and we did $0.70 per share the year prior to that. So, we remain very cognizant of at the end of the day, our job is to return value to shareholders through performance of the business. And where we believe we have excess cash, we've been giving that back to shareholders for each of the last two years, and that remains a topic of conversation with our Board.

Okay. Just a final question. It's a little more broad, Ed, and your thoughts on customer relationship management and the opportunity to be everything what you want to do with the business in terms of the omnichannel vis-a-vis a loyalty perspective and ensuring that you're customer-centric and thinking about data in the right way, so understand how to move with personalization that makes sense for your business model.

Okay. So, you may not be aware of this, but we've had a catalog for, I think, 12 years now that we still issue. And surprisingly, over the years, even with the catalog, we really didn't have a CRM system. We just put in a CRM system recently and we're just in the beginning stages. We have a lot of data that we can analyze and use it for localization of merchandising, personalization on the website and in stores. And we -- I see that as a very big deal for us going forward and we'll continue to invest in that. And then the other thing that we did was we revamped our loyalty program several months ago and we're continuing to refine that. The loyalty program for us is our best customer. So, more direct marketing to the loyalty members will be really important. The thing that I think is a little bit unique about us is we haven't driven all this engagement and customer traffic by being promotional all the time. We historically have not been a promotional business, we -- and I don't anticipate that for us to be changing. And some of the other stuff that we're doing as far as local marketing and personalization is really working and I think we're at the early innings, early stages of development of all that and CRM will really help us improve our ability to improve our business in that respect.

It's all very helpful. Best regards. Solid quarter and good luck for the back-to-school season.

Thank you.

Thank you.

Our next question comes from the line of Sharon Zackfia from William Blair. Please proceed.

Hi, good afternoon. I guess on the e-commerce dynamic that's occurred in the fourth quarter and the first quarter, can you remind us if there were any onetime costs that you're incurring, whether it's consulting or anything like that that we should think about as not happening next year?

There certainly have been some as we've worked through these issues. I actually don't have that quantified in front of me. I'll have to get back to you on that one, but there certainly has been some additional ongoing third-party spend to remedy these issues as we've worked through fourth quarter and first quarter that on a normal run rate type of basis would not be there. So, there should be some favorability for us on a cost basis when you start anniversarying those two quarters.

Okay. And is there any mechanism to look for recovery of those costs from any of the vendors or no?

Well, let's put it this way. We're not being silent about it. So--

Okay. I guess--

There is. It's -- I don't want to get into specifics really because it's a pretty sensitive subject. But anyway, we -- the major third-party vendors have worked with us to remedy these issues, which has been, obviously, the top priority, and we've made great progress in the last quarter with still more to do.

Okay. And then on accessories, I don't remember if you've talked about kind of what's been dragging on that category. I know it's a very diverse category. Just your thoughts on it and if there's the opportunity for that to inflect in the positive territory as well as you go throughout this year.

Yes, I think some of the softness in the quarter was in women's jewelry and women's hats, whereas other categories like beauty was up -- comped very positively. So, there is a lot of different categories within the category, and some has been good and some has not been good. But we see -- we're confident in us being able to improve that across the Board.

Okay. Thank you.

Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. Now, I'd like to turn the call back to management for closing remarks.

Thank you for joining us today and we look forward to our next conference call to update everybody on our second quarter results. Thank you.

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