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Call End: 17:01

Tilly's Inc (NYSE:TLYS)

Q2 2014 Earnings Conference Call

August 27, 2014 04:30 pm ET

Executives

Anne Rakunas - Investor Relations

Daniel Griesemer - President, Chief Executive Officer, Director

Jennifer Ehrhardt - Chief Financial Officer

Analysts

Alex Pham - Mizuho Securities

Jeff Van Sinderen - B. Riley

Dave King - ROTH Capital

Richard Jaffe - Stifel

Stephanie Wissink - Piper Jaffray

Sharon Zackfia - William Blair

Nick Hyatt - SunTrust Robinson Humphrey

Operator

Good day, Welcome to the Tilly's Incorporated Second Quarter Fiscal 2014 Results Conference Call. Today's conference is being recoded. At this time, I would like to turn the conference over to Anne Rakunas. Please go ahead ma’am.

Anne Rakunas

Thank you, Anne. Good afternoon, everyone. Thank you for joining us today. On our call, I will be providing you with an overview of our second quarter performance and the key factors that drove our results. I will then review the advancement of our 2014 strategic initiatives during the quarter. Then Jenifer will review our financial results in more detail and provide our outlook for the third quarter of fiscal 2014.

I will provide a few closing comments. Then, we will open the call for your questions.

Daniel Griesemer

Thank you Anne and good afternoon everyone. Thank you for joining us today. On our call, I'll be providing you with an overview of our second quarter performance and the key factors that drove our results. I will then review the advancements of our 2014 strategic initiatives during the quarter. And then Jennifer will review our financial results in more detail and provide our outlook for the third quarter of fiscal 2014. I'll provide a few closing comments. Then we'll open up the call for your questions.

Our sales and earnings for the quarter were in line with our expectations and reflect the continuation of challenging market conditions combined with the planned reduction in our clearance inventory. Despite continuing traffic headwinds, we successfully managed our inventory in season. As a result, we ended the quarter with healthy product margins significantly less some goods than last year and inventory about flat on a per square foot basis.

We also maintained our pr-esteemed balance sheet and grew our cash over the prior quarter. As we begin the third quarter, our merchandize offering is well positioned for the important back-to-school selling period. Although traffic headwinds continue, I am encouraged by improvements in sales trends so far in the third quarter, including strength in our regular prices business.

During the second quarter, we made further progress on our 2014 growth initiatives. As we previously outlined, these include increased product differentiation and innovation, a greater emphasis on our digital platform and evolving our real estate strategy.

We firmly believe these initiatives are laying the foundation for increased market share and improved profitability. First, in terms of product differentiation and innovation, we continue to add action sports inspired products and brands that are new, unique or exclusive to Tilly's.

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Our new brands, brand extensions exclusive and collaborations performed well and strengthened our confidence in its product strategy. We introduced several new brand including Asphalt Yacht Club, baker Spitfire and [ICNY].

We delivered a number of exclusive products, including styles from Volcom and RVCA, Vans and LRG. We also introduced several new or exclusive collaboration, including offerings from NAS, Nike, Vans and most recently the Asphalt Yacht Club (Inaudible) Houston collection.

I'm happy to share that on Sunday (Inaudible) became the Street league super crowned world champion wearing one of all our exclusive T-shirt styles from this collection. We also expanded our offering of Full Tilt sport and patrons of peace and juniors and ethical boxers and accessories and offer a dominant assortment of men's joggers and on-trend Junior fashion tops to highlight just a few.

Also, we rolled out the key back-to-school footwear initiative late in the second quarter, which was well-received and helped to drive improved footwear comparable-store sales. We are pleased that this initiative has continued to strengthen our footwear business so far in the third quarter.

Turning to our digital platform, during the quarter, we continued the upgrade of our e-commerce and mobile platforms and are on track for a rollout this fall. We believe these upgrades will continue to strengthen our well-developed omnichannel capabilities and significantly improve our customers' experience as we connect how, when and the way they want. We believe these efforts will better position us to take advantage of the extraordinary e-commerce opportunity ahead of us.

Our Tilly's Hookup loyalty program continued to significant growth as we expect to pass the one million-member mark in the next few weeks. The response to our program has been incredible, allowing us more ways to engage, interact and communicate with our customers.

Our new state-of-the-art e-commerce fulfillment center is fully functional and as expected we have entered the fine-tuning phase of operations to maximize efficiency over the long-term consistent with our history of operational excellence. We believe our e-commerce business will be a key driver of our long-term growth and we are well prepared to efficiently capitalize on this opportunity.

Looking at the progress related to our real estate strategy, we opened six new stores in the second quarter including two outlets and closed one store for a total of 203 stores at the end of the quarter. To-date, we have opened a total of 13 stores in fiscal 2014 in both, our heritage and new markets.

Examples of markets where we have recently opened new stores with a strong customer response include Minneapolis, Sacramento and Chicago. A highlight of the real estate strategy has been strong collective performance of these stores year-to-date under the new store economic model we announced in the first quarter.

We remain on track to open at least 18 new stores in fiscal 2014 and are on target with our outlet plans as well. We are adhering to our rigorous and disciplined approach to our real estate selection process focusing on only the best locations in deals and are pleased that the pipeline of opportunities in the venues where our new and existing customers want to shop remains strong.

Now I would like to turn the call over to Jennifer for more detail on our financial performance in the quarter and to update you on our third quarter fiscal 2014 outlook. Jennifer?

Jennifer Ehrhardt

Thank you, Dan. Good afternoon, everyone. For the second quarter net sales were $123.1 million compared to $123 million in the second quarter of 2013. Comparable store sales decreased by 7.1% compared to the same period in 2013, reflecting the continuation of challenging market conditions combined with the planned reduction in our clearance inventory as Dan previously discussed.

Comparable store sales reflect relative strength in Juniors, kids and footwear and continued softness in men's and accessories. The improvement in footwear was driven by a key back-to-school initiative rolled out late in the second quarter. Our second quarter comps reflect decreases in traffic and conversion, partially offset by increased average transaction value.

Gross profit was $34.7 million or 28.2% of net sales compared to 30.8% of net sales in the second quarter of 2013. The decline was primarily due to de-leverage of occupancy cost and a 40-basis point decrease in product margin.

During the quarter, we remained focused on delivering healthy product margins while ensuring we ended the quarter with significantly less summer goods than last year.

Selling, general and administrative expenses were $32.3 million or 26.3% of net sales compared to SG&A rate of 24.9% in the second quarter of 2013 and primarily reflect de-leverage on store payroll.

Our operating margin was 1.9% compared to 5.9% in the second quarter of 2013, reflecting the previously discussed de-leverage of occupancy and store payroll cost and slightly lower product margins.

Net income was $1.3 million or $0.05 per diluted share based on a weighted average diluted share count of 28 million shares and an effective tax rate of approximately 46%, which was higher than expected due to certain vested stock option forfeitures in the quarter. This compares to net income in the second quarter of 2013 of $4.3 million or $0.15 per diluted share based on the weighted averaged diluted share count of $28.1 million shares and an effective tax rate of 40%.

Turning to the balance sheet, we ended the quarter with cash and remarkable securities of $57.4 million, an increase of 13% over the second quarter of last year. We had no borrowings and no debt outstanding under our revolving credit facility at the end of the quarter.

Cash used for capital expenditures during the quarter totaled $6.7 million compared to $12.4 million in the second quarter of 2013 and was primarily related to new stores and remodels and the completion of our e-com fulfillment centre.

Inventory totaled $70.4 million at the end of the quarter, approximately flat on the per square foot basis compared to the prior year. We remained focused on continuing to deliver healthy product margins and maintaining strong inventory management.

We expect a slight improvement in product margins, in the third quarter and inventory per square foot at the end of the third quarter to be flat to slightly up in comparison to the prior year period.

Our outlook for the fiscal 2014 third quarter reflects the improved sales trends experienced to-date while also recognizing the potential for continuation of traffic headwinds. We expect third quarter comparable store sales to decline in the mid-single digits. Net income per diluted share to be in the range of $0.09 to $0.13. This assumes an anticipated effective tax rate of approximately 41% and weighted average diluted share count of 28.1 million share.

Third quarter 2013 net income was $6.1 million or $0.22 per diluted share based on a weighted average diluted share count of $28.2 million shares. We continue to expect capital expenditures to decline in fiscal 2014 to between $24 million to $28 million as our new e-commerce fulfillment centre is complete.

The majority approximately $22 million relates to the opening of at least 18 new stores during the year and remodels and refreshes of our existing stores as well investments to further improve capabilities across our digital channels as we have discussed.

Our business continued to generate solid cash flows and we remain debt free with sufficient resources to fund our growth initiatives. We remained committed to stringent cost discipline as we continue to invest in our business for long-term growth.

Now, I would like to turn the call back over to Dan for some closing remarks, Dan?

Daniel Griesemer

Thanks, Jennifer. I am not satisfied with our results. However, I am proud of our team's ability to remain focused on the long-term health and growth opportunities of our business.

While I am aware of the overall challenging retail environment improvements in sales trends so far in the third quarter give us confidence that we have the right strategies and plans in place to best position our business for the second half of the year and beyond.

We remain disciplined and committed to pursuing opportunities that we believe will increase our market share, deliver strong product margins and improved profitability in the long-term.

I would now like to open up the call for your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) We have our first question from Betty Chen with Mizuho Securities.

Alex Pham - Mizuho Securities

Hi, there. It’s Alex Pham on for Betty.

Daniel Griesemer

Hi Alex.

Alex Pham - Mizuho Securities

Dan, I was just wondering. Hi. I was just wondering if you could talk a little bit about the competitive landscape. You know definitely traffic has been down across the board for many retailers and just wondering if you could talk about on the strategies that you guys were going to implement in terms of being able to combat that traffic decline in the back half.

Daniel Griesemer

Yes. We believe the competitive environment will remain relatively promotional as we have seen them do pretty much all year and certainly through back-to-school we remain intently focused on the things that we can control and that's the product offering, the experience in any channel the customer chooses to access us and controlling the overall costs and an execution, so it really is around focus on the product as I have articulated already and certainly opportunities to our deal digital channels. Those are the areas we are focusing on.

Alex Pham - Mizuho Securities

Great. Thanks and best of luck.

Daniel Griesemer

Thank you.

Operator

We will take our next question from Jeff Van Sinderen with B. Riley.

Jeff Van Sinderen - B. Riley

Good afternoon. I wonder if you could just give us a sense of what the brick-and-mortar comp was versus the e-com business. How much the e-com business grew in the quarter? Then maybe are you expecting that to remain pretty similar in Q3.

Then also maybe you could just touch a little bit more on what you are seeing drive the improvement that you are seeing so far for back-to-school. Are you seeing positive comps, is it transactions is running positive, (Inaudible) anything you could say there?

Also, if you exclude the clearance merchandize, I know you mentioned full price selling was getting better. Is that excluding the clearance merchandise? Then also if you can just speak to whether or not you are more or less promotional versus last year excluding clearance?

Daniel Griesemer

Well, there's a lot here.

Jeff Van Sinderen - B. Riley

I know.

Daniel Griesemer

Sure. I think, I think I took a lot of the notes essentially the e-commerce performance was better than the brick-and-mortar. We look at the total as a combined total channel-agnostic. We are reviewing that as the way we are going forward.

Q3, we have seen a general improvement in all trends in the business. That's coming from improvement in traffic, improvement in conversion, improvement in average dollars sale. Category. all categories have generally improved lead particularly by Men's and accessories e-commerce is better across the board.

We think that it estimate that 200 basis points in comp drag were created by lack of clearance in the quarter and we have seen these trends improve at the beginning of the second quarter was soft. Business improved in June and July and we have seen it continue to improve thus far in the third quarter and that includes performance and regular price excluding clearance impact.

Jeff Van Sinderen - B. Riley

Okay. That's a great summary. Thanks. I will let someone else jump in.

Operator

Thank you. We will take our next question from Dave King with ROTH Capital.

Dave King - ROTH Capital

Thanks. Good afternoon. I guess, there was a lot of question. I guess follow up on one of Jeff's. In terms of the e-com business, did I hear you right in your response, Dan, that e-com business in the quarter, how did that trend versus the prior quarter? What I'm looking for is also just kind of a sense of how much the lack of residual inventory on the e-com business kind of weighed there, because it sounds like on the overall there is probably 200 basis points, if I heard you correctly, so just better understanding of that would be helpful?

Daniel Griesemer

Yes. e-commerce was down slightly in the quarter, regular price business was up and the large headwind that e-commerce experience was the clearance performance. As I said, we've seen all of it improve as we have gotten into the third quarter, but that's really what drove the e-commerce performance better than the total but still just slightly negative.

Dave King - ROTH Capital

Okay. That helps. Then maybe turning to the guidance, Jennifer, it sounds like in your remarks you said that product margins for the third quarter you thought you guys were expected them to be up. I guess, I am just looking for some color on that with inventory on square foot basis at least as we see it at quarter end kind of being flattish given the midst kind of the declines then. Then reconciling that with what the EPS guidance is I am trying to figure how we should be thinking about that in both the product margin versus the leverage, kind of basis. Then maybe a different being kind of how we should be about SG&A.

Jennifer Ehrhardt

Sure. Product margin being slightly up in the third quarter is what we have reflected in our guidance and that's looking at considering last year in the third quarter it represented, our product margin actually represented one of the highest that we have had in the quarter and six years. Reflecting that is where we are coming out with the slight improvement in product margin. We should expect in the third quarter the normal de-leverage that we typically have taken on occupancy to get to the gross profit. Then as well when we move down to SG&A, similar normal de-leverage on our payroll, as well as increased opportunities for marketing spend in the third quarter.

Dave King - ROTH Capital

Okay. Then how much should we thinking about in terms of that marketing spend delta generally?

Jennifer Ehrhardt

We are not disclosing that, but I think it has a pretty meaningful impact on overall gross profit and operating income when you look at that in the quarter.

Dave King - ROTH Capital

Okay. Fantastic. Thanks.

Operator

We will take our next question from Richard Jaffe with Stifel.

Richard Jaffe - Stifel

Thanks very much. Hi, guys. Dan, just a question following on your comment. Obviously, the new brand, the unique and exclusive products, the collaboration are really important for the business and driving traffic, could you give us a sense has that becomes half of your business three quarters. If it is a source of success and clearly a point of differentiation in a highly competitive market, is their chance to do more to make the store skewed more heavily towards exclusives and new product to create an environment that much more exciting and perhaps driving sales as well?

Daniel Griesemer

Yes. It is an meaningful percent. It is, as we have said, going to increase in the amount of these kind of things that we are doing as the year progresses. We have made great strides going back-to-school offering and look to continue to do that going forward as we work on further innovation and differentiation of our offering.

It is certainly, you are pointing out a good opportunity and we recognize it and want to continue in that direction, but it isn't just coming from new brands. It's also working with our long established and highly productive very important brands to make sure that what we have from them is unique and differentiated as well.

Richard Jaffe - Stifel

We should look for incremental improvement, 3Q, Q4, then into spring 2015. Is that that safe to say?

Daniel Griesemer

It appears that the things that we are doing are working given the strength in improvement in trends we have seen for back-to-school so far I think we recognize it is an important component of making sure this offering is as compelling to our customers as possible, so that that would be safe to say that you would expect to see more of it.

Richard Jaffe - Stifel

Given that and your very cautious guidance for the third quarter, could you just reconcile what you have seen as an improving trend and a better mix coming down the pike and yet about a 5% comp decline and earnings decline. Could you just sort of talking through that?

Daniel Griesemer

While we are certainly encouraged by the trends we have seen thus far in the quarter, we also realized that there has over the last several quarters been meaningful traffic headwinds and that we have also had a historical pattern of post peak time telling softness and we are incorporating all of those views into our guidance which gets us overall at an improvement in the overall environment from the high single digits to the mid-single digits, but I caution given some historical patterns that we have seen.

Richard Jaffe - Stifel

Okay. Thanks so much.

Daniel Griesemer

Okay. Thank you.

Operator

We will take our next question from Stephanie Wissink with Piper Jaffray.

Stephanie Wissink - Piper Jaffray

Great. Thanks so much. It's actually Maria (Inaudible) on for Stephanie. I just had a couple of quick questions. I was just wondering if you can talk a little bit about how the brands have been supporting value-based promotions for assortments in order to allow you to compete in the promotional environment in the back half.

Daniel Griesemer

One of the things that has always been a cornerstone of Tilly's success has been the incredible relationships we have with the brands and the brand community here in Southern California cross action sports and it is true decades of dealing with them with a high level of integrity that has positioned us to be able to take advantage of a lot of different things, including making sure there's the right value component in our offering, but a lot of that value also can come from other places and we had a highly regular price business deal. Overwhelming majority of our business is regular price, but we have great support and partnership across all product categories and all brands.

Stephanie Wissink - Piper Jaffray

Great. Thank you. Then if I can just squeeze one more, can you just talk a little bit about how denim has been performing. Obviously it's been quite challenging in the season so far, but can you also talk about what percentage you are expecting? Thank you.

Daniel Griesemer

Yes. Denim is still is a large percentage and it obviously is not the hot trend category this fall. We acknowledge that recognize it is still a very big business, but we were able to direct our assortments into things as I've mentioned the Jogger Pants, particularly in men's end and denim alternative bottoms on the junior side, so I think we are well positioned from a trend standpoint in our offering. It's still a big part and a big important part of business, but it seems like there's other categories making up to softness that's going on there.

Stephanie Wissink - Piper Jaffray

Great. Thank you so much. Best of luck.

Daniel Griesemer

Thank you.

Operator

Thank you. We will take our question from Sharon Zackfia with William Blair.

Sharon Zackfia - William Blair

Hi. Good afternoon. I think, I am going to ask a question that was already asked, but ask it in a different way. I guess, the guidance for the third quarter kind of implies a similar operating margin declined to what you saw in the second quarter, but on a slightly better comp and it sounds like better merchandise margins. Can you help us kind of reconcile the difference? Is that the marketing end that you were referencing?

Jennifer Ehrhardt

Yes. On operating income, Sharon, in Q2 definitely was disappointing on the decline at almost a 68% [over]. Our Q3 guidance reflects another disappointment, but an improvement decreased on that decrease of down 41%, so definitely most of that if you are kind of going back to what we discussed is going to be highly and driven by the deleverage in occupancy and the deleverage and payroll. As you referred, the opportunities for some additional marketing activities in the quarter slightly offset by improved product margins.

Sharon Zackfia - William Blair

Right, but I think the operating margin kind of the implication is still down 400 basis points year-over-year roughly for the third quarter which is what you saw in the second quarter. I guess I am surprised that you wouldn't see some sort of abatement there on the year-over-year comparison if merchandise margins a little bit better and the comps a little bit better.

Daniel Griesemer

It's a much bigger volume quarter - those for 400 basis point change delta that you are referring to is on a higher number and a bigger base. I think that's where the disconnect might be coming from, Sharon.

Sharon Zackfia - William Blair

Okay. Maybe just a separate question, are you seeing any difference in kind of the appetite for your product assortment either in California versus the rest of the country and kind of the West Coast versus Midwest East Coast discussion?

Daniel Griesemer

No real meaningful on differences there to highlight. The improvements that we have seen as we have begun the third quarter have been pretty consistent regionally as well.

Sharon Zackfia - William Blair

Okay. Thank you.

Daniel Griesemer

Thank you.

Jennifer Ehrhardt

Thank you.

Operator

(Operator Instructions) We will take a question from Pam Quintiliano with SunTrust Robinson Humphrey.

Nick Hyatt - SunTrust Robinson Humphrey

Hi. This is Nick Hyatt - SunTrust Robinson Humphrey. I am on for Pam. Thanks for taking our question. I am wondering if you can talk us through your thoughts on new trends that you are seeing. I know you talked about men's Joggers and I think juniors fashion, so I am wondering if you can talk about any other trends you are seeing and what is and is not resonating.

Daniel Griesemer

Well, I think if you went into our store right now or went online, you would see some of things that we think are happening in the action sports industry and across the lifestyle. It's really around fashion trends that have been manifest themselves for quite some time the active influence that has made the jogger relevant seems to be happening on the guys' side. There is also some influence as we talked about expanding our full-tilt offering on the junior side.

The junior trends that that are important to us right now, we call it vintage romance and the 90s muse, which kind of capture kind of the whole look and feel that things that are going on there, so those are the trends all you have to do is go online or look at a store and you kind of see the things that we think are trending and important right now.

Nick Hyatt - SunTrust Robinson Humphrey

Okay. Thanks. Good luck on the quarter.

Daniel Griesemer

Thank you.

Operator

That concludes today's question-and-answer session. Mr. Griesemer, I will turn the call over to you for any additional or closing remarks.

Daniel Griesemer

Okay. Great. Thank you. Thanks again for joining us. We look forward to discussing our third quarter results with all of you in early December. Have a good evening.

Anne Rakunas

Thank you.

Operator

This concludes today's conference. Thank you for your participation.

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