Q2 2023 Tillys Inc Earnings Call
Participants
Edmond S. Thomas; President, CEO & Director; Tilly's, Inc.
Michael L. Henry; Executive VP, CFO & Corporate Secretary; Tilly's, Inc.
Jeffrey Wallin Van Sinderen; Senior Analyst; B. Riley Securities, Inc., Research Division
Matthew Butler Koranda; MD & Senior Research Analyst; ROTH MKM Partners, LLC, Research Division
Mitchel John Kummetz; Senior Analyst; Seaport Research Partners
Gar Jackson; Founder & President; Global IR Group
Presentation
Operator
Hello, and welcome to Tilly's Second Quarter 2023 Results Earnings Conference -- Earnings Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Gar Jackson, Investor Relations. Please go ahead.
Gar Jackson
Good afternoon, and welcome to the Tilly's Fiscal 2023 Second Quarter Earnings Call. Ed Thomas, President and CEO; and Michael Henry, Executive Vice President and CFO, will discuss the company's results and then host a Q&A session. For copy of Tilly's earnings 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, August 31, 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 2023, 2nd 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 that will include a Q&A session after our prepared remarks. I now turn the call over to Ed.
Edmond S. Thomas
Thanks, Gar. Good afternoon, everyone. And thank you for joining us today. Our second quarter results exceeded our previously announced estimated outlook ranges for both net sales and earnings per share. The trend of our comp sales results improved to negative high single digits for each of June and July following a negative 11.3% start in fiscal May.
This improved sequential comp sales performance, coupled with diligent expense management, produced better bottom line results than we anticipated for the quarter. Our spring/summer product categories performed better during the second quarter than in the first quarter of this fiscal year, resulting in improved relative performance across all geographic markets with the most significant improvement coming from our home state of California, where 40% of our stores reside.
For the quarter, on a percentage basis, comps were positive in the Northwest, single-digit negative in 8 of our geographic markets, including both Southern and Northern California and double-digit negative in the remaining 5 markets. In terms of store transaction metrics, on a percentage basis, total transactions were down low double digits. While the average transaction value increased by low single digits compared to last year.
From a merchandising perspective, for the second quarter, girls and footwear comped positive, women's and boys were single-digit negative while men's and accessories were each double-digit negative on a percentage basis. All departments improved sequentially from their first quarter performance and most have then improved further from the second quarter performance during August.
We are optimistic that our new Chief Merchandising Officer and new Vice President of Merchandise Planning, both of whom joined us in May will help us continue to improve our performance going forward. In terms of store real estate, we expect to open 3 new stores in each of the third and fourth quarters, bringing our total new store count to 7 for the year. We closed 2 stores during the second quarter. We continue to believe that we have ample opportunities to grow our total store count over the next several years.
However, as we've said in the past, we will be very selective in our approach to new store openings and will only open new stores that reflect what we believe to be appropriate lease economics to drive acceptable profitability relative to the sales environment we expect. Turning to the third quarter of fiscal 2023, which includes the peak of the back-to-school season, total comparable net sales through August 29, including both physical stores and e-com, decreased by 3.9% versus the comparable period of last year, continuing the sequential improvement in our comp sales trends in recent months.
We have seen back-to-school shopping patterns this year that seem to indicate that our customers have been shopping later than in prior years, even seeing stronger results following what we anticipated to be the peak back-to-school shopping weeks for certain stores before them seeing results start to soften in the post back-to-school period.
Given this backdrop amid the broader economic environment, we are anticipating that our comp sales results may likely revert to pre-back-to-school levels following what was a need-based purchasing period during August. Overall, we feel good about our back-to-school and holiday merchandise assortment. And despite ongoing macroeconomic challenges, we are cautiously optimistic that we can produce a better comp store sales trend over the back half of the year than what we produced in the first half. We will continue to manage our business diligently relative to the environment with the goal of improving performance over time. I will now turn the call over to Mike to discuss our second quarter operating results in more detail and to introduce our third quarter outlook. Mike?
Michael L. Henry
Thanks, Ed. Our second quarter operating results compared to last year were as follows: Net sales were $160 million, a decrease of 5%. Net sales from physical stores decreased by 5.3% and represented 81.1% of total net sales compared to 81.5% last year.
While e-commerce net sales decreased by 3.4% and represented 18.9% of total net sales compared to 18.5% last year. Comparable net sales, including both physical stores and e-commerce, decreased by 8.5%. We ended the second quarter with 246 total stores compared to 242 total stores last year. Gross margin, including buying, distribution and occupancy expenses, was 27.7% of net sales compared to 30.9% of net sales last year.
Buying, distribution and occupancy costs deleveraged by 170 basis points and increased by $0.9 million collectively, predominantly from occupancy costs as a result of operating additional stores and carrying these costs against a lower level of net sales this year. Product margins declined by 150 basis points compared to last year's second quarter, primarily as a result of higher markdowns and estimated inventory valuation reserves, but improved by 90 basis points sequentially from this year's first quarter.
Total SG&A expenses were $47 million or 29.4% of net sales compared to $46.8 million or 27.8% of net sales last year. SG&A deleverage as a percentage of net sales due to carrying these costs against lower total net sales. The largest SG&A increases were from noncash store impairment charges of $0.8 million and increased corporate payroll and benefits of $0.4 million, primarily due to the impact of wage increases for employee retention.
Partially offsetting these increases were a variety of smaller savings across several expense line items. Operating loss was $2.7 million or 1.7% of net sales compared to operating income of $5.2 million or 3.1% of net sales last year. Other income was $1.2 million compared to $0.2 million last year, primarily due to earning higher rates of return on our marketable securities this year.
Income tax benefit was $0.3 million or 23.2% of pretax loss compared to income tax expense of $1.5 million or 28.4% of pretax income last year. The decrease in income tax rate was primarily attributable to the low level of pretax loss and certain discrete tax impacts associated with stock-based compensation. Net loss was $1.1 million or $0.04 per share compared to net income of $3.8 million or $0.13 per diluted share last year and an improvement of $0.36 per share sequentially from our first quarter results. Weighted average shares were 29.8 million this year compared to 30.2 million diluted shares last year.
Turning to our balance sheet. We ended the second quarter with total cash and marketable securities of $104 million and no debt outstanding compared to $116 million and no debt at the end of the second quarter last year. We ended the second quarter with inventories at cost up less than 1% per square foot and down 3% per square foot in units.
Total capital expenditures for the first half were $6.3 million compared to $6.9 million last year. We currently expect our total capital expenditures for fiscal 2023 to be in the range of approximately $15 million to $17 million, primarily for new store construction and information technology and distribution systems enhancements.
Turning to the third quarter of fiscal 2023. Based on our quarter-to-date net sales results and current and historical trends, including August typically representing just over half of third quarter net sales volume. We currently expect our total net sales for the third quarter of fiscal 2023 to be in the range of approximately $166 million to $171 million. SG&A to be approximately $50 million, pretax loss to be in the range of approximately $1.8 million to $4.3 million.
Our estimated income tax rate to be approximately 26% and loss per share to be in the range of $0.05 to $0.11 based on estimated weighted average shares of approximately 29.8 million. We expect to have 249 total stores opened at the end of the third quarter, an increase of 2 from 247 total stores at the end of last year's third quarter. Operator, we'll now go to our Q&A session.
Question and Answer Session
Operator
(Operator Instructions) Today's first question comes from Matt Koranda with ROTH MKM.
Matthew Butler Koranda
Thanks for the question. Just wanted to see if I could get a bit more color on why the expected drop-off in comps for the rest of the quarter. It just looks like -- I know you said maybe we're expecting when need-based buying goes away that we expect a bit of a drop off. But correct me if I'm wrong, I think comps got a bit easier last year when we think about September, October. Can you maybe just speak to the dynamics there?
Michael L. Henry
Sure, Matt. We're already seeing it. So we've been tracking performance before, during and after the back-to-school peaks, depending on when various schools went back and we've seen a consistent pattern that as soon as the peak of the back-to-school period is over, we are seeing the business slow down.
You are right, the compares are easier in the final 2 months of the quarter, but we're still seeing that same deterioration regardless of the fact that we're going up against easier compares. August was actually the toughest compare and we had our best months. So it's kind of counterintuitive from a purely comparable basis standpoint, but that is the pattern that we're seeing.
So -- we were barely negative in the second week of August after having a minus 10% in the first week of August, then we were plus 3% in the third week of August and then minus 5% in the final week of August and were down high single digits this week. So -- we're seeing it in the performance of the stores. And as we've heard other companies mention as well, it does appear to us that the back-to-school shopping patterns were much closer in to need kind of a tighter peak.
And then once that need period has concluded, and at this stage, over 90% of back-to-school is done, there's less than 20 stores that are currently in peak. The rest have already completed their key back-to-school peak period. So that's just the dynamic that we're seeing in the results, and we're contemplating that in our outlook.
Matthew Butler Koranda
Okay. Fair enough. And then maybe just could you talk about the -- what's contemplated in the ticket versus transaction within the comp outlook. I mean any changes there maybe just less benefit from ticket on a year-over-year basis? Or anything to call out on that front relative to kind of what you experienced in 2Q.
Michael L. Henry
Our comp dynamics have been pretty consistent most of the year. It's been a decline in traffic and a decline in transactions period. The average transaction value has actually been slightly up interestingly. So there's just fewer transactions occurring, but they are occurring at a similar or even slightly higher rate.
Matthew Butler Koranda
Got it. And that's coming from AUR? Or is that coming from a bigger basket?
Michael L. Henry
It's a low single-digit change. So there's nothing dramatic to call out on either item.
Matthew Butler Koranda
Okay. Got it. And then just one other one for me on the gross margins. I know you don't explicitly put out a gross margin outlook, but you can back into it on an implied basis. And it just seems to look relatively flat in the third quarter versus the second. And I just noted that despite kind of the uptick in revenue. So just wondered if you can maybe speak to the dynamics on the D&O costs, maybe, Mike or just more pressure on merch margin. What's the dynamic there?
Michael L. Henry
Sure. So it's -- as it has been in recent quarters, it continues to be occupancy is the major part of deleverage within the nonproduct cost of goods sold We're starting the quarter with 4 more stores than last year's third quarter. So dollars are added. We're going to end the third quarter with 2 more stores than last year. And carrying those costs against what we're expecting to be a negative comp for the quarter. So it's kind of deleverage.
So it's occupancy that causes most of it. We are anticipating product margins to be somewhat lower than last year's third quarter, but again, sequentially improved in third quarter versus second quarter, and second quarter was improved sequentially from first quarter. So on the worst end of our outlook, it might be 100 basis points of product margin decline. It will be less than 100 basis points on the better end.
Operator
The next question comes from Mitch Kummetz with Seaport.
Mitchel John Kummetz
Can you just talk a little bit about what was working for back-to-school for you guys?
Edmond S. Thomas
Sure. There was no single brand or category that was dominant for sure. We saw improvement from first quarter to second quarter pretty much across all categories, being apparel, footwear, accessories. We saw improvement there. I would say the improvement continued into August in the Boys and Girls category, but I can't call out anything any single category or a brand that drove it. It was across the board.
Mitchel John Kummetz
And then did I hear you correctly, did you say that girls and footwear were positive comp in the quarter?
Michael L. Henry
For the second quarter, yes, Girls and footwear.
Edmond S. Thomas
That's correct.
Mitchel John Kummetz
Can you just elaborate on that? I mean that's pretty good strength compared to the rest of the business. What are you seeing within those segments?
Edmond S. Thomas
The girls assortment was definitely improved over last year so that drove that part of the business. Footwear has been pretty decent for us all year, and it's multiple brands that are driving that, some Nike, some Converse that's driving that business.
Mitchel John Kummetz
Okay. And when you think about like the product pipeline going into holiday, how are you feeling about that?
Edmond S. Thomas
I feel really good about it. I mean, obviously, with the new merchandising leadership coming in just a short while ago, they've made -- they're making whatever changes they have been able to make. And I think they've done a really good job of editing the go-forward assortment. Based on what they feel is the right trends, but also opportunities that they've identified and looking at our business. So I think we're going to be in really -- we'll have a really good assortment for holidays for sure.
Mitchel John Kummetz
Okay. And then lastly, I know that on the last earnings call, you were anticipating some pretty heavy promotional activity in kind of seasonal categories, shorts, swim, sandals. I'm wondering how that played out? How much of a drag that was on the product margin? And how are you situated with your seasonal inventory coming out of the quarter?
Michael L. Henry
I don't think it had a dramatic impact one way or the other. The seasonal categories improved their performance in the second quarter sequentially from first quarter and continued to be better in August.
Generally speaking than they were in the second quarter. You'll remember how just terrible the start to the first quarter was, especially here in California with all of just the torrential rain that we had repetitively through February and March. So we did have a really slow start to the spring season, and we do have a little bit more spring/summer merchandise right now than we did a year ago.
But again, we're expecting third quarter product margins to be sequentially improved versus second quarter and for the decline versus last year to narrow in the third quarter than what it was in the second quarter and what it was in the first quarter. So we've contemplated everything that we think we need to contemplate to deal with -- anything that we need to deal with as we close out the spring/summer season and get deeper into fall as the third quarter moves on.
Edmond S. Thomas
Yes. We'll be -- just to add to that, we'll be in pretty good shape in terms of the quantity of inventory that we have in shorts and swim and so on and so forth because it helps that most of the country has been 100 degrees the last 2 weeks. But those negative trends in the seasonal categories really continued into August, which we anticipated early on and we made adjustments to inventory flow wherever we could.
Operator
The next question comes from Jeff Van Sinderen with B. Riley.
Jeffrey Wallin Van Sinderen
And let me say congratulations on the improving trend. Maybe you can circle back to the CMO situation. Just wondering how much of the holiday assortment is actually going to be owned, so to speak, by the new CMO.
Edmond S. Thomas
I don't know how to put a percentage to it, Jeff. But honestly, there's a lot of things that she felt good about that was on order that we've already taken action. And making adjustments really I would say diving in deeper into some of the brands that are stronger for us than what we had on order that would be one area that I would say we think it's going to be -- there are some trends that we were on. But again, adjusting the forecast going forward to maybe doing heavier receipts in areas where we think are going to be -- where she thinks that we're going to be stronger.
Jeffrey Wallin Van Sinderen
Okay. Fair enough. And then I just wanted to circle back to inventory for a second. If we assume kind of the midpoint of your Q3 guidance, where do you think that we would see inventory per foot be roughly at the end of Q3?
Michael L. Henry
I think per foot, it will be down to some extent. As always, we do everything we can to try to manage inventory as tightly to the sales trends as possible. Q2 sales were down 5%. Our unit inventory per square foot was down 3%, so pretty close there. And we're going to aim to keep that relationship as tight as we can.
Jeffrey Wallin Van Sinderen
Okay. Good. And then just as far as the lease decisions, how far are we through those decisions for this year? And then I guess, what are you seeing on renewals?
Edmond S. Thomas
We're done for this year pretty much unless we see something unusual, it's opportunistic. We have a pretty significant pipeline that we've been working on and when we decide to accelerate the number of stores as part of our expansion, we're going to be in really good shape to be able to turn that -- flip that switch pretty quickly.
As far as renewals go, we're -- so far, so good. The economics have been where -- we're happy with the economics we're seeing on renewals and we'll continue to really scrutinize every lease renewal to make sure that the economics are what we think is going to happen in the future.
Operator
This concludes the question-and-answer session. I would like to turn the conference back over to Ed Thomas for any closing remarks.
Edmond S. Thomas
Thank you all for joining us on the call today. We look forward to sharing our third quarter results with you at the end of November. Have a great evening.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
