Gar Jackson - IR Ed Thomas - President & CEO Michael Henry - CFO

Dave King - ROTH Capital Jeff Van Sinderen - B. Riley FBR Janet Kloppenburg - JJK Research Sharon Zackfia - William Blair

Greetings and welcome to the Tilly's Incorporated Third Quarter Fiscal 2017 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the 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 a 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 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 now turn the call over to Ed.

Thanks, Gar. Good afternoon, everyone and thank you for joining us today. I will summarize of 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-comm 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, improved customer engagement generate additional excitement about Tilly's. Early in the third quarter we launched an all-store 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 the 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 two new store openings during the fourth quarter, the first of the two new stores opened in Providence, Rhode Island, just in-time for Black Friday weekend. The second new store in Houston is scheduled to be 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 newer 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, and this is 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 teams efforts and dedication in driving improved results over the past year and a half 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-comm 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-comm growth was soft, our e-comm business was meaningfully more profitable 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 cost 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 costs. 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 a 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 three 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 two 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 as mentioned earlier. Operator, we will now take questions.

[Operator Instructions] Our first question is from Dave King, ROTH Capital. Please proceed with your question.

I guess first off, maybe for Mike. In terms of the guidance, looks like you're guiding to -- I don't know, 80 basis points of operating margin improvement; if I use the midpoint, I guess -- looks like that's about 200 basis points or more of improvement over last few quarters. Can you talk about what that assumes between merch margins, BDO leverage, looks like SG&A has been trending 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. Thanks.

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 the new system expenses associated with those systems whether it be depreciation, maintenance contracts, and alike 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, maybe up 30 basis points on the product margin side and the net would fall out through the BDO.

And then, in terms of -- looks like the quarter 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 Weekends trended versus earlier in the quarter; any regional call outs you can point to? And then, in terms of the e-comm business, the demand where hiccups that sounded like you're having a third, are those -- sounds like those are now being resolved, have you seen the e-comm biz reaccelerate? Thanks.

On e-comm specifically, the issues we're having were more on our old platform, we are having some operating issues with that before we transition 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 low single-digits that we referenced as basically how that weekend performed as well. And then, Ed has a couple of comments.

And also 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-comm or in-store and we are probably a lot less promotional than most of the people out there.

Our next question is from Jeff Van Sinderen, B Riley FBR. Please proceed with your question.

Congratulations, great to see the strong flow-through on 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 etcetera 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 exploration and stuff but we've made some progress in that, some better than others but certainly we are pleased with 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 have to be right for us to renew a lease. So as there is nothing that I'm anticipating that's unusual, that will happen but certainly it's a slow process and there is 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 in existing markets. 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 one or two stores that will open there, that's what we know so far Jeff.

And then, 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 starts to turn around or is there something else going on in the girls business that we should be aware off?

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 -- was pretty decent in the quarter, it was more on a 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 you're thinking about that?

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 would really drive the business is that there is 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.

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, just wondering how we should think about the cash on the balance sheet? I mean, it's great you have it, but any thoughts on that would be helpful.

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

Our next question is from Janet Kloppenburg, JJK Research. Please proceed with your question.

So Ed, did anything come off California -- you know, it's awfully hot during the quarter in that market. I know you have a lot of stores, so maybe you could talk a little bit about that. And the booking mode of 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, thanks.

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

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 tents [ph] 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 been awfully warm out there as well for November?

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

And obviously, we have a substantial portion of our stores as in the state of California, so it gives our results quite a bit; I think that's how we can say at this point. Footwear; our footwear business was okay, I mean some brands are always harder 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, you got a middle part there.

Yes, there was a middle part. What did we miss?

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

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 in-store events which have been very successful in bringing brand awareness in 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 to other means and marketing, like Social Media and stuff like that but which 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 [indiscernible] planning for next year; like what's the feeling around that?

It's really driven about marketing and bringing brand awareness to markets where we may have little representation. The Rescue brand is a very, very good brand for us, it's our own brand. As a concept, it 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 these stores. The stores will be -- my guess is, we're targeting about 2,500 square feet so that will be small and there will be not only the denim but it will be definitely the Rescue brand which also we have tops and other things other than denim. So we think it will -- we're using it as a marketing tool and eventually it could turn into something bigger, who knows.

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

Yes, eventually; or you know, if -- we are looking for proper location in a particular mall, it might be an entry to -- 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 Rescue by Tilly; so we'll have the Tilly's brand out there.

So you could be maybe developing a second to your concept as well?

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

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

Yes, I think it's our biggest opportunity for next year for sure. So we've had -- we definitely had challenges transitioning as Mike mentioned on the call and we mentioned as that -- we had challenges with our rolling [ph] system in terms of transitioning half 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 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. Please proceed with your question.

Hi, good afternoon. I apologize if these questions were asked actually and I got 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 you will be looking for whether in revenue or returns, and how we should think about any inherent margin pressure that comes from a reacceleration in growth?

So relative to the fourth quarter, we noted that raw SG&A -- we've had a couple of quarters in a row where the rogue [ph] dollar count of SG&A was down, not anticipating that to continue 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 systems 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; those are two 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, 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 seemed an 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, it's going to be a double-digit profit store out the gate [ph] and payback to us in relatively short order within the first couple of years.

And 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 will share with us at some point when you start to reopen or reaccelerate growth?

I'm not sure what exactly is the question.

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

I'll start. I mean we've modeled the stores, the deals around somewhat smaller growth and what's historical because that's the 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 it historically has been in this company and we'll continue to be extremely conservative and careful knowing that the alignment is challenged but the stores will be accretive, day one; so I don't anticipate any challenges but until we get a few open, I'm not -- I don't think there is anything that's going to be drastically different from the way we operate today.

I think part of your question is just about the natural rampup; you know, the first year usually is weaker than year two, and then year three is typically stronger than the year preceding that as you think about the lifecycle of a typical new store and we'd anticipate that being involved in this as it would with any new store. It has been sometime since we've opened a number of stores, obviously in this last year and a half or so. Right now, there is only one new store that is going to open in the first quarter and it's five or six they 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 -- 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. Now, 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 now disconnect your lines at this time. Thank you for participation.