Anne Rakunas - IR Ed Thomas - CEO Michael Henry - CFO

Alex Pham - Mizuho Securities Jeff Van Sinderen - B. Riley Dave King - ROTH Capital Liz Pierce - Brean Capital

Greetings and welcome to Tilly’s Inc Third Quarter 2015 Results Conference Call. At this time all participants are in listen only mode. [Operator instruction]. I’d like to turn the conference over to host Anne Rakunas of ICR. Thank you, you may now begin.

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Tilly’s third quarter fiscal 2015 earnings results. On today’s call are Ed Thomas, President and CEO; and Michael Henry, CFO. A copy of today’s press release is available in the Investor Relations section of Tilly’s Web Site at tillys.com. Shortly after we end this call, a recording of the call will be available as a replay for 30 days in the Investor Relations section of the company’s website. I’d like to remind you that certain statements that we will make in this presentation are forward-looking statements. These forward looking statements reflect Tilly’s judgment and analysis only as of today 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 the forward-looking statements to be made in this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements that is included in our third quarter 2015 earnings release, which was furnished to the SEC today on Form 8-K, as well as our filings with the SEC referenced in that disclaimer. We also note that this call contains non-GAAP financial information, we are providing that information as a supplement to information prepared in accordance with accounting principles generally accepted in the United States or GAAP. And you can find a reconsolidation of this metric to our reported GAAP results in that reconsolidation table provided in today's earnings release. Also for today's call, we have a limit of one hour. So when we get to the Q&A portion, please limit yourself to one question at a time to give others the opportunity to also have their questions addressed. And with that, I will turn the call over to Ed Thomas, Tilly’s President and Chief Executive Officer.

Thanks Ann. Good afternoon everyone and thanks for joining us today. I am thrilled to back at Tilly's and excited to be back in day to day of working with a very talented team. The team retail landscape has never been more challenging, but I believe Tilly's has significant potential and I feel I am in a unique position to help achieve that potential. As some of you know, I served as Tilly's president and co-CEO from September 2005 to October 2007 and have been in retail -- the retail industry for over 30 years. Given my past experience I have been able to hit the ground running in my first of today as CEO diving into every faucet of the business. From my high level initial optimization I believe there are opportunities to strengthen inventory management, drive additional growth through our online and digital capabilities, improve the productivity of our real estate portfolio and lower our cost structure. I have already been able to identify some opportunities for improvement in each of this area and I look forward to working with our team to execute on these targeted improvement. I am in the process of developing a near term action plan, this plan will identify several immediate initiatives that we believe will begin to generate improved operating results and deliver long term shareholder value. I expect to share further details regarding this plan with you during our fourth quarter earnings call in March. That said, there are few key issues that I would like to briefly discuss now. First, I believe we can further improve our inventory management, after the solid performance we saw in August and September we were a little surprised by the level of deceleration of our business during October. As a result we ended the quarter with inventory at the high end of our original outlook. I believe we have opportunities to improve our management of inventory by changing our approach in messaging related to promotions, making our inventory flows more timely and micro-merchandising to geographic differences in climate and brand performance. I expect us to be better at managing inventory levels closer to the comp store sales performance going forward. Second, we need to carefully evaluate our existing real estate portfolio and slow down the rate of our new store growth over the near term. We will continue to open a small number of new stores over the next year, where we believe we have an outstanding opportunity, but our primary focus will be to improve the performance of the stores we already have. We have evaluated our real estate portfolio and realized that a number of stores opened in recent years haven't matured at what we feel as an expectable rate and many of this stores are in very good malls. I believe some of this under performance is self-inflected and we can do a number of things to get these stores back on a good trajectory. Third, I believe this company has a major opportunity to continue to grow and improve our online and digital capabilities through omni-channel execution. Since replatforming our website in the third quarter of last year, the Company has experienced meaningful online growth in each quarter, but I believe there is even more opportunity here. We need to develop the capabilities to allow customers to buy online pick-up in-store and ship to store. We also need to optimize our mobile app and integrate all of this into our loyalty program. Omni-channel execution is a very important goal and I feel we are behind where we should be in this area. This will be a key focus for us in the near term more to come on these topics and others as I get deeper into the business with a little more time behind me. Now turning to specifics on the third quarter, total comp for the quarter was up 3.9% which was better than our outlook of up low single-digit, like many retailers our online business was significantly stronger than our brick-and-mortar stores. All product categories comp positive with the exception of footwear which was down slightly. Our business was particularly strong in women, boys and girls. Our EPS for the quarter was $0.10 which included $0.06 of non-comparable charges for severance obligations and non-cash store asset impairment charges. In absence of these items, our non-GAAP EPS was $0.16. Now I'll turn the call over to Mike to provide an overview of our fiscal 2015 operating results in more detail and introduce our fourth quarter outlook. Mike?

Thanks Ed and good after everyone. Our third quarter operating results for fiscal 2015 compared to fiscal 2014 were as follows. Net sales increased 8% to $142 million from $131 million. Total comparable store sales including e-commerce were up 3.9%. As Ed mentioned all departments comped positive with the exception of footwear which was down slightly. Our comps are driven by stronger conversion offset by lower traffic versus the prior year period. We ended the quarter with 220 stores compared to 207 at this time last year, a 6% increase in store count. Gross Profit increased 10.1% to $44.6 million from $40.5 million due to the sales growth. Gross margin improved to 31.5% compared to 30.9%. This 60 basis point improvement was primarily attributable to approximately 40 basis points from leverage of buying distribution and occupancy cost and approximately 20 basis points from better product margin. SG&A expenses were $39.3 million compared $32 million and deleveraged 330 basis points. Third quarter SG&A includes $2.4 million of charges related to separation obligations for our former CEO and non-cash store active impairment charges related to 6 stores. Third quarter SG&A also includes a time shift in marketing activities into Q3 this year from Q2 last year as described during our last earnings call. Our income tax rate for the third quarter was 48.0% compared to 40.2% in the third quarter last year. This rate increase was primarily due to stock option expiration that increased third quarter income tax expense by approximately $0.4 million. Due to our limited history as a public company when stock option expiration or forfeitures occur, we must write-off previously recognized deferred tax assets to the P&L rather than offsetting them against the longstanding APIC pool within equity. Net income inclusive of non-comparable SG&A items and tax rate impact from stock option expiration just noted was $2.8 or $0.10 per diluted share compared to $5.1 million or $0.18 per diluted share last year. Non-GAAP net income excluding those items was $4.5 million or $0.16 per diluted share. Weighted average diluted shares for the quarter were 20.4 million. Turning to the balance sheet, we ended the third quarter with cash and marketable securities of $76 million, a 24% increase versus last year and no debt under our credit facility. Inventories were at 6.5% on a per square foot basis compared to our comp increase of 3.9%. This inventory result while at the high end of our original expectations entering the quarter is higher than we would have liked; however, our inventory aging is slightly healthier than at this time last year and we believe we will be able to manage our inventory during the peak holiday selling season in a manner that will result in modestly lower but still healthy product margins. Cash used for capital expenditures during the first three quarters of fiscal 2015 was $17.5 million compared to $19.8 million last year primarily for new and remodeled stores and improving our digital capability. We expect CapEx to be in the range of $24 million to $25 million for the full fiscal year. Turning to our outlook for the fourth quarter of fiscal 2015, based on current trends, we expect comparable store sales to be in the range of minus 2% to minus 4%, operating income to be in the range of the $7 million to $9 million and net income per diluted share to be in the range of $0.10 to $0.12 versus $0.25 last year. The primary factors driving EPS down year-over-year are the negative comps and the continuation the stock option expiration that will push our tax expense higher in the fourth quarter resulting in an effective tax rate of approximately 60%. We expect to end the fiscal year with 224 total stores and with inventories approximately flat to down slightly on a per square foot basis. Diluted share count is anticipated to be approximately 28.5 million shares. With that I turn the call back over to Ed.

Thanks Mike. I'm excited to be back at Tilly's and look forward to working with the team to improve and grow the business. The Tilly's brand has broad national appeal, the company has a talent in management team, good cash flow and a debt free balance sheet. Leveraging this solid foundation we will make decisions with a long term view, but with a sense of urgently to begin driving better result as soon as possible. Given the slower start to the fourth quarter we are and will continue diligently managing our inventory to better position ourselves entering fiscal 2016. With that I'd now like to open up the call out for question. Operator?

Thank you. At this time we will be conduction a question-and-answer session [Operator Instructions] Our first question comes from Betty Chen of Mizuho Securities.

This is Alex Pham on for Betty. Congratulations on the solid third quarter. I was just wondering on the store target you mentioned Ed on the call that you had a handful of underperforming stores, I was just wondering if the plan going forwards is to close those stores and if you are going to revisit that 500 store long term target was I believe a 100 outlet stores.

I think our position on that is, there is no need to really close any stores other than the normal course of business. In terms of store growth I believe -- it’s hard to figure out in this environment how many [indiscernible] is the maximum potential, but certainly the company has tremendous potential to keep growing stores. So there is nothing fundamentally wrong, we just think that, I think that there is a lot more upside in stores that we have and that's what we are going to focus on in the short term.

Great and then I was just wondering in terms of the Q4 guidance, I was wondering if you could talk a little bit about some of the comp drivers for holiday and maybe into 2016. It definitely seems like traffic has been challenging for most retailers, maybe talk about some of the low hanging fruit in terms of product categories or opportunities that we think we have for again a holiday and maybe in 2016?

Well. I think as I mentioned most of our categories for the quarter performed positively which is a good sign. I'm very encouraged by -- we talked a lot about inventory management and it really -- the quality of the inventory in the mix overall was very good. So I would expect, we've seen a pretty significant uptick in our e-com business which I think we are seeing very similar to many retailers, a little bit of a shift away from the actual physical store visit to online, but what we are seeing even recently in the most -- in last couple of days, we’re seeing very strong online business which indicates to me that we really don’t have to do anything materially different then what we already planned and what we did for Black Friday, it was planned and so it wasn’t unusual. I think we were one of the few retailers that did not run a 50% or higher off the whole store and overall we are pleased with our results and certainly will be more profitable as a result.

Thank you. Our next question comes from Jeff Van Sinderen from B.Riley.

Let me just say welcome back to Tilly's Ed. Just as a follow up to what you were saying on Black Friday, maybe you can just give us a better sense of what you saw the kind of progression of how that's playing into your thoughts on Q4, maybe you can just give us a sense of what you saw in brick-and-mortar traffic conversion and I know you said e-com was up, so anything there? And then also if you could just maybe give us a better sense of how you are going about the process of looking at your real estate?

Okay. Jeff the traffic in general of a Black Friday pretty much across the country was down. There is no question about that, I think our conversion was pretty good and again we saw very strong sales on our online business and that's continued on post Black Friday. So I think it's really hard, in all the years I've been knowing this it's the hardest thing to do is forecast what traffic and sales are going to be, but I'm encourage with what I've seen over the past few days and I would expect that momentum to continue. Regarding real estate the quality of our portfolio is very good. So there are very few stores that I can see and knowing a lot of the locations we’re in from my prior life, I just think we have a greater potential to develop sales in those stores and there is a lot of -- there is no major surgery that has to be done. It's more some tiny stuff that I think we can tweak to drive sales and drive the productivity in those stores up.

Does that answers your question?

Yes thank you very much and good luck for the rest of quarter.

Thank you. Our next question comes from Dave King from ROTH Capital.

I guess maybe following up a little bit on Jeff’s’ question, but just I am thinking about the outlook a little bit. So despite the lower sales or where our slower sales growth rate effecting for the fourth quarter. It still seems that the operating income I guess it's little bit better than I would have expected. I guess, can you talk a little bit about the geography of that, whether that -- to what extend there is BDO deleveraging in there. It sounds like product margins are going to be modestly lower, I think if I heard the comment correctly and then to what extend is that maybe slower growth in OpEx and what are the drivers there? Thank you.

Yes Dave, its Mike. So the general comp leverage points we talked about in past remain the same. First us to begin to get leverage on buying distributional occupancy, we generally needed two to three positive comp on SG&A, we basically need a three or four when you are looking at an annualized basis. The product margins on a negative comp you might be expecting a little bit tougher on product margins than what we are. We expect as I said that they will be modestly lower but still quite healthy, as they company has had quite a track record of delivering healthy product margins from quarter to quarter for many years and we expect that to continue. Even on the negative comp, one of the areas within BDO expenses is distributions, we continue to get great labor efficiencies out of our new e-com fulfillment center that we opened a little over a year ago. We are annualizing against some of those things now. But the team continues to deliver great labor efficiencies and we see the benefit of that within BDO expenses. And then in terms of SG&A, in Q3 obviously there is lots of noise in there because of the severance and the impairment and the marketing shift and what have you, but Q4 has been the largest revenue quarter of the year, actually gives us a lot more wiggle room with which to leverage SG&A even on a more modest comp. So that’s kind of directionally what you're looking at there.

Okay so it's -- did that -- did the function of leverage I guess, because if I even look back to year ago, I want to save that the seasonal uptick in SG&A might have been a little more pronounced in 4Q or the 3Q and what it seems like you’re sort of guiding to now is there any slower growth in marketing spend or slower growth in anything in particular that maybe occurring or it is just the leverage?

No nothing in particular, we are always very cost conscious in this business and trying to find ways to be more efficient in what we do, we have been pretty darn tight on headcount addition over the last year, plus just trying to hold the line on expenses the best we can. So it's probably not increasing as much as you might anticipate on the comp guidance that we gave.

[Operator instruction]. Our next question comes from Liz Pierce from Brean Capital.

Thanks good afternoon, welcome back Ed. Question on the micro merchandising in terms of -- how do you plan to do that and like what percentage of stores would you say need that fixed, because it seems like just giving how this stores are kind of geographically concentrated. It wouldn't seem that there were that many that might need that kind of fix.

Well I think -- it’s hard to determine exactly how many stores, but certainly things like some stores not getting our fully assortment of goods, that’s something that applies to a number of stores. Whereas the climatic adjustments in the timing of when we get certain [indiscernible] type of goods or summer goods into certain of our warmer weather stores, that’s a much smaller part of the population. But you know that we have the tools in place to be able to do that, it’s not as if we don’t have the information or the system to be able do it. It’s just looking at them and understanding the results on a store-by-store basis a little bit better then I think what's been done in the past.

And so Ed I presume as a follow up on that, I mean the people -- so you said you have the tool and systems and I presume then the people are in place. This is not something you’re going to have to add to, it's just a matter of what they do with the data?

Yes Liz, we defiantly have very talented experience team that -- just it's kind of a different point of view, a little bit different point of view for them to took a look at, so it's not going to require any major investment on people or systems, it's really us just looking at things a little bit differently then what -- maybe what's been done in the past.

Okay and I presume what you are getting out of the online experience is shedding additional light into that?

Well certainly online is, as I said there so much information you can get from your online business and it’s pretty instant, so yes it's been very helpful. But we're looking at things like choice comp among stores and as it’s consistent from store-to-store that really has nothing to do with online only, but we do know from for example we do know in certain parts of the country where we may be a little bit underperforming in certain stores, the online business for those geographic area is actually pretty good. So it's really subtle adjustments to what we've been doing historically.

Okay I will stop there and best of luck for Q4.

Thank you. And you next question comes from Dave King from ROTH Capital.

Thanks for the follow up, I guess just one quick one and I appreciate all the color in terms of strategic vision outlook, especially with you only being on the job for 50 days or so. I guess there is one more, maybe more -- I’m thinking about not just fundamental driver, but fundamental strategy maybe more on just capital allocation. Cash balance continues to generally move higher and remain really strong, I guess what are the thoughts about buybacks and/or returning capital in anyway, any initial thoughts you can share I think would be helpful? Thank you.

Obviously being here only 50 days it's hard to -- I haven’t even had time to put a full strategy together, so I do know in fact that the Board -- our Board refused [ph] use of cash and investment -- and capital investments on a pretty regular basis, so I think at this point really it's giving me more time to determine where we're going to invest, the store count and so on and so forth before we really decide on any firm action.

Thank you. This concludes the time for today. Thank you for joining today's conference you may now disconnect.