Tilly's, Inc. Q4 FY2022 Earnings Call

Good afternoon, and welcome to the Tilly's Fiscal 2022 Fourth 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 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 9, 2023, and actual results may differ materially from current expectations based on various 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 2022 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 1 hour and will include a Q&A session after our prepared remarks. I will now turn the call over to Ed.

Thanks, Gar. Good afternoon, everyone, and thank you for joining us today. Our fourth quarter results exceeded the revised sales and earnings outlook ranges we provided in early January in connection with the annual ICR conference. Overall, fiscal 2022 was a very challenging year for us and our customers, particularly in light of one of the worst inflationary environments over the past 40 years. Fiscal 2023 has gotten off to a slow start thus far as we have anniversaried last year's February comparable net sales increase of 15.4% while also experiencing unseasonably cold and wet weather over the last several weeks, particularly here in California wherein approximately 40% of our stores reside, and we've seen a meaningful decline in our business relative to our fourth quarter run rate. From March onward, we are going up against negative double-digit monthly comp results for the remainder of the year. Consequently, we believe we will see an improving trend in our business very soon. And despite a slow start to the first quarter, we are cautiously optimistic about the spring/summer season overall based on the product newness that has just started to roll out to stores in recent weeks. In men's, we expect graphic tees will continue to be a leading product for us, and we have a variety of new fabrics and silhouettes in short-sleeve button-up shirts. Within men's bottoms, we expect to see growing interest in non-denim shorts and pants with an improved inventory position compared to last year. In women's, we are optimistic about newness and trend color and silhouettes. We are investing more in fashion tops in a number of ways, and we expect to have compelling offerings in bottoms with new silhouettes emerging to complement a strong cargo trend. We also have seen growing interest in our swimwear, dresses, and skirt offerings compared to last year. In footwear, we believe we have a strong brand portfolio for both genders. In accessories, we believe we have improved our women's collection in particular with trends that are more feminine and current. Additionally, we will have an expanded home collection compared to last year, and we are optimistic about a new lower-priced designer sunglasses business. For boys and girls, we expect to be in a much better inventory position on branded graphic tees than we had last year when we were experiencing supply chain issues. Altogether at this time, we feel good about our spring assortment and believe we will see more favorable comparable results for the remainder of the quarter and fiscal year based on the significantly easier comparisons we will be going up against from hereon in. In terms of store real estate, we currently expect to open approximately 10 new stores during fiscal 2023, with 1 store set to open near the end of March, 4 expected in the third quarter and the remainder expected to open between the back-to-school and holiday seasons, subject in each case to finalizing acceptable lease terms. For existing stores, we have nearly 80 lease decisions to make this year and are just over halfway through those decisions. Given the current environment, we continue to approach all these renewals with reasonable conservatism to contain lease costs as much as possible. If we are unable to negotiate what we believe to be reasonable lease costs, we will close stores as necessary to protect our overall profitability. At this time, we are aware of 2 planned store closures in 2023 based on the current status of negotiations, one of which closed in late February. Our anticipated capital expenditure priorities in fiscal 2023 beyond new stores include an upgrade to our mobile app, updating our warehouse management systems to allow for more efficient inventory management across facilities and continuing IT infrastructure and cybersecurity investments to better position ourselves for future growth. We currently expect our total capital expenditures for the year, inclusive of new stores, to be within the $15 million to $20 million range. In terms of other uses of capital, we are taking a wait-and-see approach to fiscal 2023 before we consider any additional significant capital outlays, including cash dividends or potential repurchase of stock, and would not anticipate incurring such outlays until we feel more confident that we have a stable economic environment underneath us and are able to generate improved sales performance. In closing, although potential recessionary impacts on our customers remain a significant concern, we are cautiously optimistic about our prospects for improving operating results during fiscal 2023 relative to 2022, given the significantly lower comp sales comparisons we will be going up against for the remainder of the year. I will now turn the call over to Mike to provide additional details on our fiscal 2022 fourth quarter operating performance and introduce our fiscal 2023 first quarter outlook.

Thanks, Ed. Good afternoon, everyone. Our fiscal 2022 fourth quarter results compared to last year's fourth quarter were as follows: Total net sales were $180.4 million, a decrease of 11.8% compared to a company fourth quarter record of $204.5 million last year; total net sales from physical stores were $135 million, a decrease of 11.3% compared to $152.2 million last year; net sales from physical stores represented 74.9% of our total net sales compared to 74.4% of total net sales last year; e-commerce net sales were $45.3 million, a decrease of 13.4% compared to $52.3 million last year. E-com net sales represented 25.1% of total net sales compared to 25.6% of total net sales last year. We ended the fiscal year with 249 total stores, a net increase of 8 stores compared to the end of fiscal 2021. Gross profit, including buying, distribution, and occupancy expenses, was $52.4 million or 29.1% of net sales compared to a fourth quarter record of $70.4 million or 34.4% of net sales last year. Product margins declined by 290 basis points compared to last year's near historical peak fourth quarter product margins, primarily due to higher markdowns needed to manage inventory levels. Buying, distribution, and occupancy costs deleveraged by 240 basis points collectively despite being $0.4 million lower than last year with 8 net new stores due to carrying these costs against lower net sales. Total SG&A expenses were $53.5 million or 29.7% of net sales, compared to $53.1 million or 25.9% of net sales last year. Primary dollar increases in SG&A were from labor-related expenses across store payroll, corporate payroll, and e-com fulfillment. These increases were partially offset by a $1 million reduction in bonus expense due to the lack of any bonus accrual this year. Operating loss was $1.1 million or 0.6% of net sales compared to operating income of $17.3 million or 8.5% of net sales last year as a result of the combined factors just noted. Other income was $1.1 million compared to other expense of $0.4 million last year, primarily due to earnings significantly higher rates of return on our marketable securities compared to last year, and the write-off of certain unamortized costs associated with transitioning our credit facility last year. Pretax results were essentially breakeven compared to pretax income of $16.9 million or 8.3% of net sales last year. Income tax benefit was $0.3 million compared to income tax expense of $4.9 million, or 28.7% of pretax income last year. This year's income tax benefit was primarily due to certain allowable deductions and tax credits. Net income was $0.3 million or $0.01 per diluted share compared to net income of $12.1 million or $0.38 per diluted share last year. Weighted average diluted shares were 30 million this year compared to 31.4 million last year. Turning to our balance sheet, we ended the fiscal year with total cash and marketable securities of $113 million and no debt outstanding compared to $139 million and no debt last year. We repurchased approximately $11 million worth of company stock during fiscal 2022. We ended the fiscal year with total inventories at cost down 8% per square foot and down 15% in total units compared to last year. Total capital expenditures for fiscal 2022 were $15.1 million compared to $13.4 million last year, the increase being primarily due to the increased cost of new store openings. Turning to the first quarter of fiscal 2023, total comparable net sales through March 7 decreased by 19.9% compared to last year, with a 21% decrease in fiscal February and a 17.3% decrease thus far in fiscal March. Based on current and historical trends, we currently estimate that our total net sales for the first quarter of fiscal 2023 will be in the range of approximately $122 million to $133 million, translating to a comparable store net sales decline in the range of approximately 11% to 18.5% for the first quarter of fiscal 2023 compared to last year. We expect our SG&A to be in the range of $43 million to $44 million. At these sales levels, we would expect to report an estimated loss per share in the range of $0.27 to $0.41 for the first quarter of fiscal 2023 with an estimated income tax rate of 27% and total shares outstanding of 29.9 million. We currently expect to have 249 total stores at the end of the first quarter compared to 241 at the end of last year's first quarter.

Just wanted to follow up on Q1 so far. Just anything you're noticing in the difference between regions. Obviously, the weather in Southern California hasn't been spectacularly wonderful. Maybe also touch on kind of the promotional backdrop, if you would. And then maybe touch on inventory out there. It seems like most folks have kind of brought down their inventory levels. And then if you could touch on new store performance that you experienced in 2022 and how that plays into your store opening plans.

In terms of performance, we are seeing declines across every region in the country. In California, where we have many stores, the impact has been more significant due to challenging weather over the past couple of weeks. This has been a definite hurdle. Traffic is down across the chain, and sales have declined as a result. Regarding inventory, we entered the quarter with a very clean inventory. I would have preferred to see a bit more newness at the start of the quarter, but we are in a solid position now. Some of the newness relates to seasonal categories like swim and more spring/summer merchandise, which likely wouldn't have sold well given the tough weather conditions. I believe you asked me four questions, so I may have missed something.

He was asking about the promotional environment.

Regarding the promotional environment, I don't notice anything unusual. Promotions don't seem to be bringing customers into stores; rather, it appears to be partially due to economic challenges that many customers are facing. It's also important to ensure we have a compelling assortment of merchandise, which I believe we do. Our customers may just be facing more challenges than others. Promotionally, while there is an increased amount of clearance inventory in the market—more than we typically see, likely due to several companies being over-inventoried—I don't think this poses any abnormal challenges for our company.

Okay. I have a lot of questions wrapped into one. I was wondering about the new store performance you experienced in 2022 and how that influences your store opening plans for 2023.

The new stores overall exceeded their plans. We opened locations in various regions of the country, and one of our latest openings is in Cerritos, which has set records for us. This store is slightly larger than the average at about 9,000 square feet, and the results have been outstanding. There is a good amount of real estate available, as you might expect. We are focusing on areas where we believe expansion makes sense, maintaining our strategy of pursuing both off-mall and mall locations, with the right economics in mind. We're being very deliberate in our approach. Currently, I estimate we will likely open 10 or 11 stores this year, although that could change if our business picks up speed.

Okay, that's helpful. I have one more quick question. Do you have any updates on the search for a new Chief Marketing Officer?

It is actively in process. So a lot of good candidates.

Some of my questions have already been addressed, but regarding the first quarter guidance, it seems you anticipate improvements in March and April. Can you clarify if those expectations are based on easier comparisons or if you're anticipating a recovery in demand following the adverse weather conditions we've experienced in California? I would appreciate any insights on your assumptions.

Sure, Matt, this is Mike. Yes, our compares get meaningfully easier from here forward. So we noted in our prepared remarks that we were going up against a positive 15.4% comp from February. And then as you go into March week 1, last year, we were down 3%, then down 8%. Then down 27%, 24%, 38% to finish March with a minus 23%. And then April was a minus 16% with just very consistent negative double digits all month long. And then that really carries all the way through the year. So negative double-digit comps every month for the rest of the year. We do think that the weather out here in the West had a pretty negative impact on us, on top of going up against our last month of double-digit comps from last year. California, both Southern and Northern, are our 2 weakest areas of performance so far, and they had the largest drop off of performance from where they were in Q4. As Ed mentioned, all areas are negative. But in the fourth quarter, Southern California, in particular, was our strongest performing market. It is now our weakest. So there's been a really big swing there of 14 comp points to the negative. Somewhat similar in Northern California, it was our second or third best performing area in Q4. It is now our second worst, and it has dropped by 7.5 comp points so far from the Q4 run rate to now. So seeing that dynamic and understanding just the craziness of the weather we've had out here for the past several weeks, we do believe at this time as we start to go up against those weaker comparisons and hopefully get some more normalized spring-type weather, that we'll see the business turn. It hasn't happened in stores yet. We have seen some movement in e-com, I would tell you. E-com has had a few positive days here and there, not consistently. But it is in the negative single digits as opposed to stores are still at minus 20 at this point. So it's another thing, like we're starting to see signs of life on the e-com side of the business, it just hasn't carried over to stores yet. So that's how we're thinking about things as we sit here right now.

Okay, that was very helpful. Regarding inventory, you have a clean outlook on a square footage basis. Ed, you mentioned feeling somewhat more optimistic about newness compared to the fourth quarter. Do you see any areas where you might need to increase inventory to meet consumer demand? Also, Mike, could you share your thoughts on inventory trends for the year? Should we expect a return to normal seasonal patterns this year, possibly with some inventory buildup in the first quarter? Any insights on trends or expectations throughout the year would be appreciated.

Matt, I feel very positive about our current inventory. There is significantly more new product available than there was three weeks ago. I'm optimistic about all categories, including men's, women's, footwear, and accessories, which are all fresh with new items. Early feedback on sales performance has been encouraging, though it is still early. I am confident about this situation. Mike can provide insights on the inventory ramp-up and our expectations moving forward.

Yes, you can expect the usual discipline from us as we manage inventory closely in line with sales trends. We finished the year with an 8% decrease in square foot costs and a 15% drop in unit sales. This indicates we did not carry over a significant surplus of inventory into the first quarter. We are optimistic about achieving better results in the remainder of the first quarter. We are continually adjusting our inventory plans on a weekly basis, so anticipate our usual tight management in relation to sales.

Just got a couple on the margin. Let me start with gross margins for Q1. You didn't give a number or a range in the press release, but I think you gave us enough to back into something. But I guess my question is more on the puts and takes in Q1. Like if you break out gross margin by kind of your bigger buckets, whether it's sort of product margin, distribution expense, occupancy, can you give us a better sense as to how you see those playing out for the quarter?

Sure. The variability from the better end to the worst end of our range is very largely product margins. If our sales are going to be $10 million lower, we're going to be more aggressive on markdowns to keep inventory clean and we've contemplated that. At these sales levels, the dollars of occupancy and distribution and buying really don't change all that much. Occupancy is relatively fixed. We have 248 stores as we sit here right now. There'll be a store that will open later this month. But the dollars from the top of our range to the bottom of our range really don't move that much. So you've got about $25 million of occupancy dollars. You've got a little under $10 million of distribution costs, and you've got a little under $2 million of buying costs, and that's really not going to move all that much. A couple of hundred thousand here or there, not by millions. So it really isn't product margins that the variability would exist to be responsive to keeping inventory clean.

Okay, that's helpful. Thanks, Mike. And then on the SG&A, so the dollar range you gave, $43 million to $44 million, I believe that's up a little bit year-over-year despite the sales decline. I mean again, I'm sure there's a lot of fixed expense in that SG&A number. But I guess I'm mostly interested in kind of what are you seeing in terms of wage trends, especially in store? And are there any other expenses you might want to call out?

Yes, you're correct, Mitch. The main concern is store payroll. In the first quarter, our average hourly wage is 7% higher than it was last year. This poses a challenge, especially with comparable sales down 19.9%, while wages have increased by 7%. We're making efforts to keep store payroll hours as tight as possible and have been operating with fewer average hours than last year, just like we did throughout all of last year. However, the continuous rise in minimum wage puts added pressure on our budget, making it difficult to determine what's considered normal after the past three years. Traditionally in retail, payroll can be adjusted more effectively as sales fluctuate. Yet, with rising minimum wages, the operational efficiencies we achieve through reduced hours are masked because each hour now costs significantly more. Compared to last year, it’s 7% higher, and compared to pre-pandemic levels, it's 24% higher than in 2019. That’s a striking figure. This is why you may not notice as much positive movement in SG&A as you might typically expect.

This concludes our question-and-answer session. I'd like to turn the conference back over to Ed Thomas for any closing remarks.

Thank you all for joining us on the call today. We look forward to sharing our first quarter results with you in early June. Have a good evening. Thank you.

The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.