Tillys Inc (TLYS) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Tilly's, Inc. Third Quarter Fiscal 2017 Earnings Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Gar Jackson, Investor Relations.

Thank you, operator. Good afternoon, everyone, and welcome to Tilly's Fiscal 2017 Third 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 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, November 29, 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 third 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 1 hour and will include a Q&A session after our prepared remarks.

I now turn the call over to Ed.

Thanks, Gar. Good afternoon, everyone, and thank you for joining us today. I will summarize our fiscal 2017 third quarter operating results before providing an update on our key initiatives. Mike will then review our results in more detail and introduce our fourth quarter outlook.

In the third quarter, we delivered a 32% improvement in year-over-year operating income, driven by our sixth consecutive quarter of positive comp sales, fourth consecutive quarter of store traffic growth and continued strict inventory and expense management. Our comp sales increased 1.5%, which was the midpoint of our outlook range. Store comps increased low-single digits, e-com sales were just about flat due to certain transitionary issues associated with the launch of our new Demandware website platform, which was completed in early November.

We believe our broad and diverse merchandise assortment of over 400 brands over the course of the year continues to differentiate Tilly's from many other retailers.

During the third quarter, our branded men's and boy's assortment drove our third quarter comp sales results with high single-digit and mid-single-digit percentage increases, respectively. Accessories, women's and footwear were all flat to down 1%, and our growth business was down mid-single digits due to weakness in fashion tops and dresses.

Turning briefly to the early stages of the fourth quarter. Comp sales to date, including Black Friday weekend and Cyber Monday, are up low single digits. In early November, we rolled out a new accessory fixture package to all stores to enhance the presentation of our accessories assortment, and we are encouraged by the early results we have seen from this new package. We are cautiously optimistic that this bodes well for a solid fourth quarter.

Turning to technology. Our new integrated Aptos point-of-sale order management and customer relationship management systems as well as our new Demandware website platform are all now in place. As with any new systems, there are bugs to work out, but we have had no material negative impacts on our business from these implementations. We're excited about the capabilities of these new systems to improve customer engagement and drive increased sales opportunities going forward.

Our next technology deployments will be the launch of an enhanced mobile app and a ship-to-store program in the first half of fiscal 2018.

Turning to marketing. As we discussed on prior calls, we have reinvigorated our marketing efforts towards driving store traffic. We believe more direct consumer interactions improve customer engagement and generate additional excitement about Tilly's.

Early in the third quarter, we launched an all-star augmented reality scavenger hunt in partnership with a social media star, which was a big hit with our customers. We continue to work on new in-store collaborations, but I'm still not able to share details just yet.

Lastly, I want to thank our internal team for their efforts in delivering some much-needed clothing and supplies to the Houston area in the aftermath of Hurricane Harvey during the third quarter. Houston will be a new market for us upon the opening of our new store there during the fourth quarter, and we wanted to help our soon-to-be neighbors begin the recovery process.

The mention of Houston brings me to real estate. We will have 2 new store openings during the fourth quarter. The first of the 2 new stores opened in Providence, Rhode Island just in time for Black Friday weekend. The second new store in Houston is scheduled to open next week.

Now that we have turned the operating margin trend of our business around, we plan to get back into a moderate store growth mode by opening approximately 10 to 15 new stores in fiscal 2018. We also plan to open a limited number of rescue branded pop-up stores during the fiscal 2018. We will leverage existing markets where we believe Tilly's brand recognition and bottom line would be enhanced with additional stores.

One of these new stores in Alderwood, Washington will be the first to have our new smaller store format that we developed last year. As a reminder, the format is designed to present our full assortment in as little as 4,500 square feet. Alderwood will be approximately 5,100 square feet. We will also continue to work on driving store occupancy cost down on existing stores as lease actions allow for renegotiation. It is a slow process, but we have made some progress in fiscal 2017. We have an additional 120 lease decisions to make over the course of 2018 and 2019, and we intend to make further progress in optimizing our occupancy cost structure.

In closing, I remain proud of our team's efforts and dedication in driving improved results over the past 1.5 year, during which was arguably has been one of the most challenging and complicated retail environment ever. We are off to a decent start to the holiday season, and we believe we can continue our operating momentum through the fourth quarter and into fiscal 2018.

Now I will turn the call over to Mike to provide more details on our third quarter operating performance and introduce our fourth quarter earnings outlook. Mike?

Thanks, Ed. Good afternoon, everyone. Our third quarter operating results compared to last year's third quarter were as follows. Net sales of $152.8 million increased 0.5% from $152.1 million despite ending the quarter with 220 total stores compared to 225 stores a year ago. Total comparable store sales, including e-commerce, increased 1.5%. Store comps were up 1.7% with positive store traffic for the quarter.

E-com sales increased just 0.1% due to the website transitionary issues Ed noted earlier and represented 12.4% of our total sales versus 12.1% a year ago.

Although e-com growth was soft, our e-com business was meaningfully more profitable than this time last year due to improved inventory and expense management.

Gross profit of $50.1 million was an improvement of $2.1 million or 4.4% compared to last year's $48 million. Our gross margin rate of 32.8% improved 130 basis points to last year's 31.5%, with 100 basis points coming from reductions in buying, distribution and occupancy costs, and the remaining 30 basis points from improved product margins.

SG&A expenses were reduced to $36 million or 23.5% of sales compared to last year's $37.3 million or 24.5% of net sales. This 100 basis point improvement in SG&A was primarily attributable to decreased marketing and corporate payroll cost.

Operating income of $14.1 million or 9.2% of net sales was an improvement of $3.4 million and 220 basis points compared to $10.7 million or 7% of net sales last year. The combination of comp sales growth, improved gross margins and reduced SG&A expenses on higher sales generated this improvement. Income tax expense was $5.7 million or 39.6% of pretax income compared to $4.4 million or 40.4% of pretax income last year.

Net income of $8.8 million or $0.30 per diluted share improved $2.3 million or 36.5% compared to $6.4 million or $0.22 per diluted share last year. Weighted average diluted shares for the quarter were $29 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 $121.9 million and no debt, which is a 15.7% increase compared to $105.3 million and no debt at this time last year. This increase is despite having paid the first-ever special cash dividend to stockholders of $20.1 million in February of this year. Inventory per square foot decreased 2.3% on top of last year's 9% decrease, and our inventory aging was more current compared to last year.

Year-to-date capital expenditures for the first 3 quarters of fiscal 2017 were $9.7 million compared to $14.8 million last year and were primarily for the IT investments noted earlier and remodeled stores.

Turning to our outlook. Based on current and historical trends, we expect fourth quarter comparable store sales to increase by a low single-digit percentage, operating income to be in the range of approximately $10.5 million to $13 million compared to last year's $10.4 million, and earnings per diluted share to be in the range of $0.22 to $0.26 compared to last year's $0.22.

We expect our tax rate to be approximately 40% and weighted average shares to be approximately $29.2 million. We expect inventories per square foot to remain below last year's levels. Fiscal 2017 full year capital expenditures are now expected to be approximately $15 million.

We expect to end the fiscal year with 219 total stores compared to 223 last year, which includes the opening of 2 new stores and closing 3 existing stores during the fourth quarter.

Our preliminary expectation for fiscal 2018 CapEx is approximately $20 million to $25 million, which includes the 10 to 15 new stores Ed mentioned earlier.

Operator, we'll now take questions.

(Operator Instructions) Our first question is from Dave King, Roth Capital.

I guess, first off, maybe for Mike. In terms of the guidance, it looks like you're guiding to, I don't know, 80 basis points of operating margin improvement. If I use the midpoint, I guess, it looks like that's about 2 -- versus 200 basis points or more of improvement over the last few quarters. Can you talk about what that assumes between merch margins, BDO leverage? Looks like SG&A's been churning down now for a few quarters. Is there any reason to think that should now be up? I guess, just some color there would be helpful.

Sure. We are anticipating SG&A to be up modestly in the fourth quarter for a couple of different reasons. One, as we noted, with all the new systems we just implemented, there are the new system expenses associated with those systems, whether it be depreciation, maintenance contracts and the like for that. On bonus side, there would be some profit-based bonus in the fourth quarter that would not have been present last year, assuming we land within this range. So those are a couple of things that are present that wouldn't have been present LY and why we wouldn't expect necessarily for SG&A to continue to be down.

Okay. And then on the merch margins versus BDO?

Merch margin in the third quarter, we were up 30 basis points. So we're assuming similar to LY, may be up 30 basis points on product margin side and the net would fall out through the BDO.

Okay, that helps. And then in terms of -- it looks like the quarter's started off pretty well for you guys, low-single digits quarter-to-date. Is there anything you can share about how the Black Friday Cyber Weekend trended versus earlier in the quarter? Any regional callouts you can point to? And then in terms of the e-com business, the demand where hiccups -- it sounded like you had in the third. Sounds like those have now been resolved? Have you seen the e-com business reaccelerate?

Yes. So on e-com specifically, the issues we're having were more on our old platform. We were having some operating issues with that before we transitioned to the new system. So those issues have been resolved now that we're onto the new platform. So that's good. We have that behind us. You asked about Black Friday weekend and Cyber Monday. I would just say our quarter-to-date, up low-single digits that we referenced is basically how that weekend performed as well and then Ed has a couple of comments.

Yes. And also, unlike a lot of retailers that we saw, we didn't do anything abnormal in terms of promotional cadence and we really didn't buy it. We didn't buy our comps either on e-com or in-store, and we're probably a lot less promotional than most of the people out there.

Our next question is from Jeff Van Sinderen, B.Riley FBR.

Great to see the strong flowthrough in the P&L. A couple of things I wanted to delve into, if we could. I know you mentioned a number of things on real estate. Just wondering how you would characterize the negotiations with landlords. I know it is a process. Just wondering kind of what sort of terms you're seeing, maybe how many closures you're anticipating for next year or just for the foreseeable future. And then I guess, any color you can give us on how you're approaching the 10 to 15 new locations as far as clustering, et cetera, for next year?

Sure. Well, we've made some progress. It is a very slow process in terms of renegotiating a lease that's coming up for expiration and stuff. But we've made some progress on that, some better than others, but certainly, we are pleased with where -- what we've been able to achieve. It's not easy to deal with our balance sheet, obviously, but we've made some progress there. We're not anticipating closing any stores next year. We're not planning on it, but however, as we've said before, the economics on the renewal has to be right for us to renew a lease. So there's nothing that I'm anticipating that's unusual that will happen. But certainly, it's a slow process and there's a lot in process as we speak now. In terms of the 10 to 15 stores, we're sticking with our strategy of filling in an existing market. The only new market we're really going into is Houston, which we have planned for a long time, and that will be the one store that opens next week, but we certainly could follow that up with several stores after that. New England, Midwest, Chicago market, we've got a number of deals teed up for that and then Utah, which is an existing market for us, we have 1 or 2 stores that will open there. That's what we know so far, Jeff.

Okay. Good, that's helpful. And just in terms of categories for Q4, I know that girls was a little bit slower for you in Q3. Are you thinking that, that -- maybe it starts to turn around or is there something else going in the girls' business that we should be aware of?

Well, I think in terms of the girls' and the women's business, we see a lot of newness heading into spring. In terms of -- which we haven't really seen a lot of that for a while, and we're excited about some of the newness that we see coming up, both in the women's side and the girls' side. In both women's and girls', our branded business has been pretty decent. It was pretty decent in the quarter. It was more on our proprietary merchandise that we -- our performance was less than expected.

Okay. And is it -- do you feel like that's something where you need to maybe tweak some of the proprietary merchandise a little bit? Or how are you thinking about that?

So I think, I mean, it's something that we work on constantly like most retailers in apparel, but we've made changes where necessary and again, I think what will really drive the business is, there's a lot of newness both in color and silhouette that we see coming up that will help drive that business and bring to our customer a fresh look.

Okay, great. That's helpful. And then any thoughts -- I know you guys, you paid a special dividend this year. Any thoughts you could give us on potentially another special dividend? I'm just wondering how we should think about that cash on the balance sheet? I mean, it's great you have it, but any thoughts on that would be helpful.

There's nothing really new on that other than the fact that, as we said many times before, it's something that our board reviews quite regularly and will continue to do that through the balance of the year. So there's nothing more I could say at this point, Jeff, than that. Okay.

Our next question is from Janet Kloppenburg, JJK Research.

So Ed, did anything come of California? It was awfully hot during the quarter in those -- in that market. I know you have a lot of stores. So maybe you could talk a bit about that. And the brick-and-mortar traffic was impressive, and perhaps, you could talk about what you think is driving that and if we should expect that to continue. And then maybe some comments on the footwear category.

Okay. So I'll let Mike start out with the regional performance and then I'll talk a little bit more.

Sure. So we didn't have wide disparity regionally, but California was a little bit softer than outside of California, particularly during those weeks where we did see temps in the mid-90s around here. So nothing major, nothing of concern, but it was a little bit softer out here in California than in regions outside of California.

Okay. Can you say anything about quarter-to-date? Because it's off -- been awfully warm out there as well for November.

Well, as we said in our prepared remarks, quarter-to-date, we're up low single digits, and that's all the color that we're going to provide on the current quarter business.

Yes. And obviously, we have a substantial portion of our stores is in the state of California. So this skews our results quite a bit. I think that's all we can say at this point.

She asked about footwear.

Footwear? Our footwear business is okay. I mean, some brands are always hotter than others and certainly, we didn't see anything drastically different. Although some brands -- which I won't say for competitive reasons, but some brands outperformed the others, Janet.

And there was another part, the middle part there.

There was the middle part. What did we miss?

Just about the brick-and-mortar traffic. I thought that was pretty good.

Okay. So this is something that we've seen consistently for months. Our traffic has outpaced what we've seen as industry statistics, and we've really put a concerted effort into driving traffic, primarily starting with the in-store events, which have been very successful in bringing brand awareness and new markets for us and where we don't have major representation. And then also, just if the event is good, it just drives traffic to the store. So that's one thing, we're driving traffic through other means of marketing like social media and stuff like that, but we're very sensitive to the fact that it is very difficult for everybody in terms of driving traffic to the stores. We own the stores and you can sit back and do nothing about it or try to do something about it, and what we've done so far has worked. So we're pretty pleased about that and more to come.

And what about the pop-up stores that you're thinking about or you're planning for next year? Like, what's the theory around that?

It's really driven about marketing and bringing brand awareness to markets where we may have little representation. The RSQ brand is a very, very good brand for us. It's our own brand. The concept will be primarily denim. The availability of real estate to do pop-up stores is, obviously, it's very available. It's inexpensive to do one of this stores. The stores will be, my guess is, we're targeting about 2,500 square feet. So that will be small and it will be not only denim, but it will be definitely the RSQ brand, which also we have tops and other things other than denim. So we think it will -- using it as a marketing tool and eventually, could turn into something bigger. I mean, who knows?

I mean, you could -- some of these could become permanent stores, yes?

Yes, eventually. Or if we're looking for a proper location in a particular mall, it might be an entry for us before we get that proper location and the proper size. It's a good entry. And it will be -- the name of the concept will be RSQ by Tilly's, so we'll have the Tilly's brand out there.

So you could be -- may be developing a second tier concept as well?

Yes, but that's -- yes, potentially, that could happen. But that's not the primary intent right now. It's more of building the brand than it is a new concept.

And should we think that e-com should accelerate now that these transitory issues are behind you?

Yes. I think it's our biggest opportunity for next year, for sure. We've had -- we definitely had challenges transitioning, as Mike mentioned on the call, and we mentioned we had challenges with our older system in terms of transitioning off of it towards the end of the quarter. We know we missed some opportunity with that, and we think with the implementation of the new platform and a bunch of other things that we've had to hold off until the new platform is up, including our new mobile application -- app, which will go up in first quarter of next year. We think it's our biggest opportunity for us soon.

Our next question is from Sharon Zackfia, William Blair.

I apologize if these questions were asked. I actually inadvertently cut off from the call for a moment. I recognize the guidance you gave for the fourth quarter. I was wondering if you had any specific gross margin targets you were looking for in the quarter. I assume it's still going to be up year-over-year. And then as you reaccelerate growth, anything you can share about the new units, targets that you'll be looking for, whether in revenue or returns? And how should think about any inherent margin pressure that comes from a reacceleration in growth?

Sure. So relative to the fourth quarter, we noted that raw SG&A -- we've had a couple of quarters in a row where the raw dollar count of SG&A was down. Not anticipating to continue that into the fourth quarter for a couple of reasons. One, we noted was the new systems that we just launched. So whether it's maintenance contract system, support, depreciation and the like that go with new systems, those expenses obviously were not there last year. And then given the strong year we've had year-to-date, our operating income is up 40%. We would have some profit-based bonuses baked into the fourth quarter that were not there last year. So those are 2 larger pieces of expense that would not have been there LY and why SG&A would be up on a year-over-year basis. And then in terms of gross margin, on the product margin side, we were up 30 basis points for the third quarter. So our guidance contemplates being flat to up 30 basis points for the fourth quarter and then the rest just falls out through the BDO cost. On the new stores, we're not going to get too terribly specific on precise targets because each store is -- it's a new opportunity. We don't really think in terms of a static economic model that is applicable to each and every situation. What I would say is that we look at each individual location, our performance in that given market and develop a reasonable yet conservative sales assumption that we then use to negotiate rents so that we derive a store that we feel fairly confident is going to be a double-digit profit store out the gate and payback to us in relatively short order within the first couple of years.

And then on the margin side, that's just something you would prefer not to talk about at this point? Or is there a store ramp that you'll share with us at some point when you start to reopen or reaccelerate growth?

I'm not sure what exactly are -- is the question.

Well, just that, typically, new units open up at lower volumes and lower margins in more mature units. So particularly, they're outside of the whole market. So I just didn't know if -- it's been a while since the company was growing at the pace you're anticipating growing at in 2018. So I didn't know if there was the opportunity to re-share kind of what you think of the new store ramps will be going forward.

We've -- I'll start. I mean, we've modeled the stores, the deals around somewhat slower growth than what's historical because that's a reality in this environment so we've been very conservative in terms of what our approach was, including the rent we negotiated. So the breakeven on the stores is different than what historically it's been in this company, and we'll continue to be extremely conservative and careful knowing that environment is challenged but the stores will be accretive, day 1. So I don't anticipate any challenges, but until we get a few open, I'm not -- I don't think there's anything that's going to be drastically different from the way we operate today.

And then I think part of your question is just about the natural ramp up. The first year usually is weaker than year 2 and then year 3 is typically stronger than the year preceding that as you think about the life cycle of a typical new store. And we'd anticipate that being involved in this as with any new store. It has been sometime since we've opened a number of stores, obviously, in this last 1.5 year or so. Right now, there's only 1 new store that is going to open in the first quarter and it's 5 or 6 that are going to open in the second quarter, is what we know at the moment. Those are the ones that are actually signed and in lease and what have you. The rest haven't yet been determined. So cadence, those would -- the rest would probably be in the back half of the year and don't yet know how many in Q3 or how many in Q4. So it's a little bit difficult to kind of put a range on it for you until we have it more solidified.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Ed Thomas for closing remarks.

Thanks again for joining us. We look forward to discussing our fourth quarter results with you in mid-March. Have a good evening, everyone.

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