Tilly's, Inc. (TLYS) CEO Ed Thomas on Q4 2018 Results - Earnings Call Transcript

Tilly's, Inc. (NYSE:TLYS) Q4 2018 Earnings Conference Call March 14, 2019 4:30 PM ET

Company Participants

Gar Jackson - Investor Relations

Ed Thomas - President and Chief Executive Officer

Michael Henry - Chief Financial Officer

Conference Call Participants

Dave King - ROTH Capital Partners

David Buckley - Bank of America Merrill Lynch

Jeff Van Sinderen - B. Riley FBR

Mitch Kummetz - Pivotal Research

Operator

Ladies and gentlemen, greetings and welcome to Tilly's, Inc. Fourth Quarter Fiscal 2018 Earnings Results Conference Call. [Operator Instructions] As a reminder, this program is being recorded. It is now my pleasure to introduce your host, Gar Jackson of Investor Relations. Thank you. You may begin.

Gar Jackson

Thank you, operator. Good afternoon, everyone, and welcome to the Tilly's fiscal 2018 fourth 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, 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 the same section, shortly after the conclusion of the call, you will also be able to find a recorded replay of this 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, March 14, 2019, 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 fourth 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 will now turn the call over to Ed.

Ed Thomas

Thanks, Gar, and good afternoon, everyone. Thank you for joining us today. Tilly's continued its positive momentum by posting its strongest quarterly comp result since Q3 of fiscal 2011 and its strongest consecutive three quarter run of comp store sales results since becoming a public company in early 2012.

Our fourth quarter comp sales increase of 6.4%, which includes e-commerce and earnings per share of $0.29, were both above our original outlook ranges, which estimated a 2% to 5% comp store sales increase and earnings per share of $0.22 to $0.26.

E-comm sales increased 49.6%, representing our strongest e-comm comp result since Q4 of fiscal 2010. Even when considering last year's fourth quarter e-comm sales decline of 12%, associated with our omni-channel system transitions, our combined two-year fourth quarter e-comm comp of 37.6% still represents our best single quarter e-comm comp result since Q1 of fiscal 2011.

Comp sales in stores decreased 0.9%, compared to being up 2.3% in last year's fourth quarter. These fourth quarter results were largely driven by strength of our multi-branded assortment. Footwear was particularly strong with a 20% increase over last year.

Men's posted a high-single-digit percentage sales increase, driven mostly by branded graphic tees. Boys, women's, and accessories were also positive. Girls was down high-single digits, primarily due to certain fashion trends that worked in women's, but did not work well in girls.

Turning to fiscal 2019, as we announced prior to the ICR Conference in January, we currently anticipate opening approximately 10 to 15 new full-size stores for the year. As we have stated previously, we will only open new stores, if we are able to obtain what we believe are appropriate lease economics.

Generally speaking, mall traffic is still down according to every industry report we read, and retailers are still closing stores, lease economics need to reflect that reality. We remain very selective in our approach to new store openings and will only open new stores that we project to be accretive to our bottom line.

As for RSQ pop-up shop, we continue to evaluate opportunities to add more of them, but do not have any specific plans to do so now. We just recently closed our first RSQ pop-up in Dallas upon initial lease expiration at the end of February, leaving us with three remaining.

In terms of marketing, we recently hired a new VP of marketing, who brings tremendous branding experience to us with her 16 years of experience at Mattel. Under her leadership, we will aim to drive greater brand awareness and continue to find creative ways to drive store traffic, enthusiasm and loyalty for the Tilly's business.

We are also excited to announce the launch of our new partnership with the High School Esports League. This league is the largest Esports league at the high school level, encompassing approximately 1,200 schools nationwide. We are donating an Esports academic scholarship and conducting a two-week, all store augmented reality event this spring that will include a number of exciting prizes.

Esports are growing at a tremendous rate, particularly among some of our key target demographics. And we believe Tilly's is well positioned to support this emerging and highly popular activity, while also driving additional customer engagement for us. Another key focus for us in fiscal 2019 is to continue to improve our customer-facing technologies.

Among the priorities for this year are the launch of an expanded loyalty program and enhanced mobile app, a buy now, pay later program, same day delivery from selected stores, and a ship-to-store program. Specific launch timing of several of these items is still being determined, but each of these efforts aims to strengthen customer engagement and convenience, and to drive further improvement in our business.

In closing, we continue to deliver solid operating performance as evidenced by our best three quarter run of comp sales in seven years. For the third consecutive year, we also paid a special cash dividend in February.

Although the first quarter is off to a soft start, we believe this is largely attributable to the later Easter this year and the unseasonably cold weather across much of the country, particularly in our home state of California, where 95 of our 228 total stores reside, which has resulted in weak sales across all spring categories.

We believe our business will improve as we get close to the Easter and into warmer weather patterns that are more aligned with our spring assortment, which should allow us to deliver a positive comp for the quarter.

Now, I will turn the call over to Mike to provide more details on our fiscal 2018 fourth quarter operating performance and to introduce our fiscal 2019 first quarter earnings outlook. Mike?

Michael Henry

Thanks, Ed. Good afternoon, everyone. The following commentary will compare our fourth quarter operating results for this year's 13-week period ended February 2, 2019 versus last year's 14-week period ended February 3, 2018.

Total net sales of $170.6 million, increased by $6.3 million or 3.8% from $164.3 million last year, despite the fact that last year's extra week contributed approximately $7.1 million to last year's total net sales.

Total comparable store net sales for this year's 13-week period increased 6.4%, compared to flat total comp sales for last year's 14-week period. E-comm sales increased 49.6% and represented approximately 20% of our total net sales this year, compared to a 12% decrease and a 14% share of our total net sales last year.

Store comps decreased 0.9% and represented approximately 80% of our total net sales this year, compared to an increase of 2.3% and an 86% share of our total net sales last year. We ended fiscal 2018 with 229 total stores, including four RSQ-branded pop-up stores, compared to 219 full-size stores at the end of fiscal 2017.

Gross profit, including buying distribution and occupancy expenses, was $52.2 million or 30.6% of net sales, compared to last year's $51.4 million or 31.3% of net sales. The 70-basis point decline in gross margin was due to a $2.4 million increase in distribution costs, primarily resulting from higher e-comm shipping expenses associated with our strong e-comm net sales growth.

Total occupancy costs increased by approximately $0.5 million, due to having 10 net new stores this year, but these costs improved by 20 basis points as a percentage of net sales due to achieving higher total net sales.

Product margins improved by 20 basis points, primarily due to lower markdowns, partially offset by lower initial markups attributable to a product mix shift toward branded merchandise.

Regarding the legal settlement coupons, we issued in early September 2018, less than 1.5% of the total coupons issued had been redeemed to date. Redemption transactions have represented less than 0.2% of total transactions and less than 0.5% of total net sales, resulting in no material impact on our comp sales or operating results.

While there can be no guarantee that redemption activity will remain immaterial prior to coupon expiration on September 4 of this year, we are not expecting any meaningful impacts to our business during the final six months of the redemption period.

Total SG&A expenses were $41.2 million or 24.2% of net sales, compared to $40 million or 24.3% of net sales last year. Although SG&A increased by $1.2 million, it leveraged due to our achieving higher total sales.

The primary SG&A dollar increase was from higher corporate bonus provisions of approximately $1.1 million associated with improved operating results for the year. SG&A also includes approximately $0.9 million of expense reductions from the negotiated resolution of certain vendor disputes.

Operating income was $10.9 million or 6.4% of net sales, compared to $11.4 million or 7% of net sales last year, primarily due to last year's extra week of sales noted earlier, which helped leverage our relatively fixed expense base last year.

Income tax expense was $3.1 million or 26.4% of pre-tax income, compared to $5.2 million or 43.5% of pre-tax income last year. The reduction in tax rate was primarily due to the new corporate tax rates enacted in 2018.

Net income was $8.7 million or $0.29 per diluted share, compared to $6.7 million or $0.23 per diluted share last year. This year's EPS included a benefit of $0.02 from the negotiated expense reductions noted earlier. Weighted average diluted shares for the quarter were 29.8 million versus 29.5 million last year.

Turning to our balance sheet. We ended the quarter with cash and marketable securities, totaling $144.1 million and no debt, compared to $136 million and no debt at the end of fiscal 2017. In February 2019, we paid a special dividend to stockholders for the third consecutive year, totaling approximately $29.5 million in the aggregate or $1 per share.

Our 6.4% comp sales increase exceeded inventory per square growth of 2.7%, and we ended the quarter with a more current inventory aging compared to last year at this time. Total capital expenditures for fiscal 2018 were $14.9 million, compared to $13.8 million last year.

Now, turning to our outlook for the first quarter of fiscal 2019. Based on current and historical trends, particularly for years in which Easter occurred later in the year, as is the case for this year, we are expecting total net sales to range from approximately $128 million to $130 million based on a low-single-digit percentage increase in comparable store net sales.

As Ed noted earlier, the first quarter is off to a slow start, which we believe is due to unseasonably cold and wet weather, particularly here in California, where 95 of our total stores reside. Total comps are down low-single digits thus far in the first quarter, although we did have our first positive comp week of the quarter last week.

With a later Easter this year, sales are expected to be more back-end weighted for the quarter and we believe we can still deliver a positive comp for the quarter. Based on an anticipated continuation of the product mix shift towards branded merchandise and strong e-comm net sales growth with attendant costs, we expect pre-tax operating results to range from a loss of approximately $0.4 million to income of approximately $1.2 million and earnings per share to range from a loss of $0.01 to income of $0.03.

This outlook assumes no non-cash store asset impairment charges, an effective income tax rate of approximately 27% and weighted average diluted shares of approximately 30 million. We expect inventories per square foot to remain flat to slightly up versus last year's levels.

In terms of new store openings for fiscal 2019, we expect one store to open near the end of the first quarter and another in the middle of the second quarter. We currently have nine additional unsigned new stores in negotiation for this year. We anticipate any additional openings will most likely occur in-between the back to school and holiday seasons at this time.

Operator, we’ll now take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Dave King with ROTH Capital. You are now live.

Dave King

Thanks. Afternoon, guys.

Ed Thomas

Hi.

Dave King

I guess, first on the on the guidance, just curious about some of the items driving the confidence in getting back to a positive comp, I guess what sort of in-store traffic is assumed from here versus the decline, I think, you had in Q4 and then on the e-commerce side, how has that business trended so far in Q1 versus what's sort of embedded in the guidance?

Michael Henry

Okay. Traffic was actually up just under 1% for the fourth quarter. It's been down so far in the first quarter, but with a later Easter, that's somewhat to be expected. We think traffic will be somewhere around flattish for the quarter by the time all is said and done. Later Easter looking at the last two years where Easter was as late with year 2014 and 2017. The cadence of the quarter relative to where we are now still suggests that we should be able to deliver a positive comp. And that's what's giving us the confidence that we can get there.

We're obviously off to a slow start and that's been – we've had negative comp in all markets. On the store side, e-comm is up 25% quarter to date so far. We would actually expect e-comm to be up stronger than that by the time the quarter is over. Those are the factors that go into, if I missed anything, let me know.

Ed Thomas

Yes, and then just to add to what Mike said. We can clearly say in terms of performance that the categories are the softest for us. A very seasonal category is warmer weather-related like shorts and swim. So, we know – we've seen a little – where we've seen a little bit of pop up of warmer weather, those categories have performed better. So, that's kind of where we're at.

Dave King

Okay, perfect. And then just a clarification on that improvement in e-comm from the 25%, I assume and that's some of those same category things, but also the timing of Easter that you think will help to reaccelerate e-comm?

Ed Thomas

Yes.

Michael Henry

Yes. Same dynamic. Even though e-comm is up right now, the same dynamic of spring category is being down versus winter products being up applies.

Dave King

Okay, perfect. And then maybe switching gears on the 120-basis point increase in distribution costs, how much of that was related to shipping? And then I guess just on overall gross margin, to what extent did the increase branded mix or higher IMUs way versus maybe better full-price business through e-comm maybe helping to offset that? Thank you.

Michael Henry

Yes. So, the e-comm shipping in particular was the great majority of that 120-basis point increase in distribution costs, along with some other fulfillment-related costs that go through the distribution line. On product margins, IMUs were down about 30 basis points, but that was offset by lower total markdowns, given that we had cleaner inventory as we finished the year. We also got a little bit of favorability in the margin line from when we've completed our year-end physical inventories. We got a little bit of shrink favorability out of that. And then again, just lower markdowns on cleaner inventory.

Dave King

And the full-price business for e-comm that –?

Michael Henry

It was quite healthy.

Ed Thomas

Mostly, gotten better.

Michael Henry

Yes, that's right. The e-comm comp was not purely a clearance-driven mechanism, nor has it been so far in the first quarter. So, we're actually pleased with what we're seeing in reg price business. We just do have the challenge of the seasonal issue right now.

Dave King

Perfect. Alright. Thanks for taking all my questions.

Ed Thomas

Thank you.

Operator

Thank you. Our next question comes from the line of David Buckley with Bank of America Merrill Lynch. You are now live.

David Buckley

Hi, guys. Thanks for taking my question. How should we think about e-comm growth rate this year? What percentage of your total business do you think it can grow to and then in the fourth quarter, how big was the branded penetration versus historic levels and how do you see that growing this year? Thank you.

Ed Thomas

I'll start with the answer to e-comm. I'm expecting it to be double-digit growth about for the year for sure. How fast it accelerates? I mean, we've claimed that most of the issues we experienced last year in the fourth quarter related to omni-channel, and that's helped us optimize our inventory as it relates to e-comm sales. And, we're seeing enough positive signs there and momentum where we expect it to continue very strong.

Michael Henry

Yes, and then on the branded penetration, for the fourth quarter, branded was a little more than 200 basis points higher in penetration than it was a year ago. So, fourth quarter in particular, branded was 76% of the business versus just under 74% of the business for fourth quarter last year. And then for the year as a whole, it moved from 26 to 25 proprietary – sorry moved from 26% to 25% on full year basis.

David Buckley

Thank you.

Operator

Thank you. Our next question comes from the line of Jeff Van Sinderen from B. Riley FBR. You are now live.

Jeff Van Sinderen

Thanks for taking my question. Just on the mix shift of branded. I'm just wondering, is there something going on that you think would change that or do you expect us to continue to shift or gear a little bit more toward branded beyond Q1, I guess? And also, how should we think about merch margin around that?

Ed Thomas

I don't think – I wouldn't expect it to shift materially one way or the other from – we've been pretty consistent over the years of maintaining the – our proprietary merchandise mix as a percent of – percentage of sales versus branded. Sometimes, there might be a brand that emerges as a really hot brand that might skew that mix a little, but there’s nothing strategically that we're doing differently in terms of brands versus private label.

Jeff Van Sinderen

Okay. And then with some of the other retail liquidations out there, I'm just wondering how you're thinking about overall proprietary, Tilly's branded merchandise and if we should read anything in to your comments on the RSQ pop-ups, it just would seem to me like maybe there's an opportunity for you to gain some market share with some of the closures out there?

Ed Thomas

Yes. Well, clearly there's no shortage of real estate, that's for sure. And I think over time with – a lot of the closures we've seen more – like a Charlotte Russe, I'm hoping over time, we'll pick up some market share in the women's segment, which is an area of opportunity for us for sure. But I'm not expecting any – it's still a moving target in terms of how many stores are going to close and who is closing and I think the days of retail reorganizations are pretty much done. So, I think – I don't think we'll see a lot of these companies come back other than maybe online-only business. So, I see it as an opportunity, but there's going to be a gradual pickup of market share, and it's not going to happen overnight.

Jeff Van Sinderen

Right. Do you think that the landlords are starting to get it? I mean, with all the real estate that's out there that's vacant. I mean, obviously something has to go in there. They wanted to be leased. They don't want it to be dark. I'm just wondering what your latest thought is, I guess, on the real estate situation. Are you getting fair terms on renewals? And how are you thinking about the stores coming up for decision this year?

Ed Thomas

Yes, I think we've seen improvement in it for sure. Is it as good as – is it as good as what I want it to be? Not yet, but it's – we've definitely seen progress from our negotiations with landlords. And I think you know me well enough, Jeff, because I don't like to pay rent. So, I mean – it's definitely better and we've had – we have good working relationships with the major landlords and we've had pretty good progress.

So, I think the challenge now is, particularly in malls versus [indiscernible] is, what are the landlords going to do to fill up the space? And there's not a lot of new emerging growth retailers out there that can take that space. So, we have that we to – we have very – in addition to economics, we're very careful about where we're going – where we're going even within the property, where we're going to make sure that the co-tenancy is going to be good around us.

Michael Henry

And we still have a lot of flexibility coming, lot of decisions to be made, we'll have roughly 75 decisions that we have to make this year in 2019 and then over the course of the following two years, I think the latest number is 65 or 66 more to make over 2020 and 2021. So, that's a 140 of our total 228 stores that are going to have to be addressed one way or another and we're certainly going to keep fighting for every inch we can gain.

Ed Thomas

The good thing is that, we have so much flexibility with our leases in turn we try and kick out clauses and it gives us a lot of flexibility in terms of what we can do, if the economics are not right and so on and so forth. So, we – real estate portfolio is in pretty good shape because of that.

Jeff Van Sinderen

Okay, good to hear. And then one more, if I could just throw it in. Is there any change on your thinking around the longer-term target of getting to high-single-digit operating margin?

Michael Henry

No, that hasn't changed at all. Sorry, I was writing something down as you asked your question. No, that really hasn't changed. For the last couple of years, we had been saying that our – the year that Ed and I joined was the lowest profit year in the company's history. And we thought we could get the company back in the mid-single-digit territory over a reasonable period of time.

We've done that each of the last two years. The profitability of the business has improved each of the last three years. This business used to perform at a double-digit rate, certainly pre – becoming a public company, but it was a lot more productive in terms of topline sales per square foot.

And so, we do need stronger topline performance to be able to get there. We can't kind of cut expenses and save our way there. It's got to come from better topline productivity to get there, but we still believe we can do it. We've been improving our under-performing stores over the last – actually more than two years running now.

Those have continued to improve. And we still think we've got more work to do there and more work that we can achieve. So, as long as we can keep driving positive comps, the opportunities are there for us to further improve the profitability of the business.

Jeff Van Sinderen

Okay. Thanks, and best of luck for the remainder of Q1.

Michael Henry

Thanks.

Ed Thomas

Thanks, Jeff.

Operator

Thank you. Our next question comes the line of Mitch Kummetz from Pivotal Research. You are now live.

Mitch Kummetz

Yes, thanks for taking my questions. So, Mike, you mentioned – your low-single-digit QTD comp and I think you said negative across regions in the store. It sounds like California is the worst of that. Is there any way you kind of parse out California versus the rest of the business? I mean, if I had to guess, I'd say California is probably down doubles, but you tell me?

Michael Henry

No, it's not the absolute worse, but it's not good. All markets were negative. We had three markets that were in low negative double digits. SoCal is down just shy of 10% right now. NorCal is down 8%.

So, when we've got 95 of our 228 stores in California and in the aggregate, call it down 9%. That's tough and certainly is part of the hole that we have to dig out of during the remainder of the quarter.

Mitch Kummetz

And then you mentioned, I think you said that California was positive comp last week. First, I just wanted to just confirm that that's what you said. And if that's the case –

Michael Henry

The total business it was.

Mitch Kummetz

Was it better? I mean, is California still dragging or I guess I'm try to get out is, what's the level of pent-up demand do you think in some of these markets that have been hurt the most by the weather? Are you starting to see that come as the weather turns?

Ed Thomas

Yes. Wherever we've seen improvement in weather even it is for one day, we've seen improvement in that business and those markets where it's been down. So, I think there's a lot of pent-up demand and I think we'll get our fair share of that once the weather breaks more consistently positive. Okay.

Mitch Kummetz

Got it. And then on the Q1 guide, I guess a couple things on the margin. So, I mean, it sounds like you would expect e-commerce to be a lot stronger than stores. I know in the quarter you had just reported that that had a negative impact on the gross margin. I think you said 120 basis points because of higher distribution costs. How do you think about that kind of line item in the first quarter as e-comm continues to outpace the stores?

Ed Thomas

Well, I think the biggest challenge is shipping. And the same thing as Mike called out, we're working on a number of things to optimize our inventory and that – but one of the things we want the first retailers to put in through omni-channel for giving us the ability to ship from the distribution center dedicated to e-comm or stores. So, that's worked really well since we fixed the initial issues last year and that's worked really well.

Now, what we're working on is trying to improve the initial allocation of inventory between store channel and e-comm channel. And over time that should help us reduce our shipping expenses, but I don't expect it to be any different – materially different for a while.

Michael Henry

Yes, in Q1 in particular to get to the numbers underneath it, it'll be similar in nature to what we saw in Q4. If e-comm is going to stay, call it somewhere 30%, 35% up by the time all is said and done, hopefully store is getting closer to flattish. You might see similar type of relationships as what we just reported for fourth quarter.

As I look at the pre-call consensus numbers that are out there, it looks like the gross margin rate is a little higher than what we're expecting and SG&A is a little lower than what we're expecting based on how we started the quarter. So that's part of the difference there.

As I think about the rest of the year and kind of looking at the numbers out there, everything looks fair to me. As long as we can achieve – as long as we can achieve those positive comps, I don't see anything in the remainder quarters of the year that indicates concern for me.

Mitch Kummetz

And then on the quarter you reported, the merch margin look good on lower markdowns. Is there any concern in terms of risk on seasonal inventory in Q1 given the slow start to the season? I mean, you mentioned – Ed you mentioned that some of the seasonal product has been slow. I don't know. I mean are people starting to break price, are you concerned about having to start to promote to get that going?

Ed Thomas

I'm not concerned. I mean, where inventory is in great shape even with the sales being a little bit off in those categories, this isn't the first time that we've seen this happen over the years where this – I think it was last year or two years ago, we had we started off the year like this.

Michael Henry

Yes 2017 is when we had the torrential rain, especially out here in the West.

Ed Thomas

Yes, and so we had a similar start to the year. And I'm not concerned about what's going to happen with competitors promoting this product and stuff like that. So, we're in good shape and the product has a long – most of the product [at seasonal] has a long shelf life. So, we should be fine.

Mitch Kummetz

Got it. And then lastly, I know you're not giving full your guide, but, Mike, how should we be thinking about leverage points for the year in terms of SG&A fixed cost leverage there and then occupancy on the gross margin line?

Michael Henry

Yes. With things like minimum wage increases that we just absorbed starting January 1, freight costs going up the other portions of e-comm costs that flow through SG&A assuming consistent strong e-comm sales performance. We're looking at needing about a three to keep SG&A relatively stable as a percent of sales.

On the buying, distribution and occupancy costs, it's more of a question mark because it depends on what we're able to negotiate in occupancy line in particular that could help offset some increases in the distribution line that are likely to come from the e-comm shipping and other fulfillment costs relating to e-comm that flows through that particular line. And then of course, depending on where comps lend out, it obviously changes things.

Mitch Kummetz

Got it. Alright. Thanks, guys. Good luck.

Ed Thomas

Thank you.

Operator

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

Ed Thomas

Thanks again for joining us today, and I'd like to call out and acknowledge the outstanding job that our teams have done during this very difficult retail environment over the last couple of years. We look forward to discussing our first quarter results with you in late May. Have a good evening.

Operator

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