Tilly’s, Inc. Form 10-Q Summary
Reporting period: Thirteen and thirty-nine weeks ended October 31, 2015, compared with November 1, 2014. The request identifies “2014 Q3,” but the filing is for fiscal 2015 third quarter. Financial statements are unaudited.
Business Context
Tilly’s operates a specialty retail chain focused on casual apparel, footwear and accessories for teens and young adults, selling through stores and e-commerce. The company operated 220 stores in 33 states at October 31, 2015, compared with 207 stores a year earlier. Management describes the business as seasonal, with stronger results typically occurring in the third and fourth quarters.
Financial Performance and Position
| Metric | Q3 2015 | Q3 2014 | First 39 Weeks 2015 | First 39 Weeks 2014 |
|---|---|---|---|---|
| Net sales | $141.7 million | $131.3 million | $391.9 million | $365.5 million |
| Gross profit | $44.6 million | $40.5 million | $117.3 million | $106.5 million |
| Gross margin | 31.5% | 30.9% | 29.9% | 29.1% |
| Operating income | $5.4 million | $8.6 million | $8.6 million | $12.0 million |
| Operating margin | 3.8% | 6.5% | 2.2% | 3.3% |
| Net income | $2.8 million | $5.1 million | $4.7 million | $7.0 million |
| Diluted EPS | $0.10 | $0.18 | $0.16 | $0.25 |
Comparable store sales, including e-commerce, increased 3.9% in the quarter and 2.1% in the first nine months. Growth reflected stronger conversion rates despite lower store traffic. Sales benefited particularly from women’s, kids’ and footwear categories.
Gross margin improved because of higher initial markups and lower buying, distribution and occupancy costs as a percentage of sales. SG&A increased 22.8% in the quarter and 15.0% year to date, driven by corporate payroll and $1.1 million of severance obligations, higher marketing costs, store impairment charges and store payroll.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $46.3 million at October 31, 2015, compared with $49.8 million at January 31, 2015.
- Marketable securities were $30.0 million, producing total cash and marketable securities of approximately $76.3 million.
- Working capital increased to $106.6 million from $98.0 million at January 31, 2015, primarily due to seasonal inventory growth.
- Operating cash flow was $6.4 million for the first 39 weeks, down from $21.1 million in the prior-year period. The decline reflected higher inventory, payment timing, landlord allowance collections and lower operating income.
- Investing cash outflow was $12.4 million, including $17.5 million of capital expenditures and net proceeds of $5.1 million from marketable securities.
- Management expected fiscal 2015 capital expenditures of approximately $24 million to $25 million.
- The company had no borrowings under its $25.0 million Wells Fargo revolving credit facility at October 31, 2015 and was in compliance with its covenants. The facility matures May 31, 2017.
- Capital lease obligations totaled $1.9 million; the filing reports no material changes to previously disclosed contractual obligations.
Material Changes and Unusual Items
- Revenue increased 7.9% in Q3 and 7.2% in the first nine months, supported by 13 net new stores opened during the prior twelve months and positive comparable sales.
- Despite stronger sales and gross margin, operating income fell 37.2% in Q3 and 28.3% year to date because SG&A grew faster than revenue.
- Non-cash impairment charges were approximately $1.4 million in Q3 and $1.7 million year to date for six stores. No comparable impairment was recorded in the first nine months of fiscal 2014.
- The effective tax rate increased to 48% in Q3 and 46% year to date, versus 40% and 42%, respectively, primarily because of discrete tax items involving stock options, restricted stock and a prior-year tax settlement.
- Management disclosed $3.3 million of stock-based compensation expense year to date and $5.3 million of unrecognized stock-based compensation expense at October 31, 2015.
- On October 7, 2015, the company entered into an offer letter with Edmond Thomas and a separation agreement with Daniel Griesemer; the filing does not provide additional compensation terms in the supplied text.
Outlook, Management Commentary and Risks
Management expects mall traffic pressures and the shift toward online shopping to continue into fiscal 2016. It plans to slow the pace of new store openings, focus on existing-store performance and expand omni-channel and digital capabilities. The company expects to fund operations over the next twelve months with cash, marketable securities and operating cash flow without relying on revolver borrowings.
Key risks include fashion and inventory misjudgment, markdown pressure, competition, lower store traffic, consumer spending weakness, seasonal and weather variability, supplier and international sourcing risks, lease obligations, e-commerce and cybersecurity disruptions, labor and regulatory matters, and geographic concentration in the southwestern and northeastern United States and Florida.
The company has established approximately $0.5 million of loss provisions for probable and reasonably estimable legal matters. A California wage-and-hour matter had reached a proposed resolution subject to court approval, while other wage-and-hour and consumer-information class actions remained pending. The company also guaranteed up to $2.0 million of vendor settlement payments; its estimated reasonably possible exposure in the event of vendor default was zero to $1.7 million, subject to offset rights.
Management concluded that disclosure controls and procedures were effective as of October 31, 2015, and reported no material change in internal control over financial reporting during the quarter.
Important Facts to Verify
- Whether the requested period should be fiscal 2015 Q3, as stated in the filing, rather than 2014 Q3.
- The sustainability of positive comparable sales given continuing lower store traffic and the planned slowdown in store openings.
- Whether SG&A growth, severance, marketing costs and store impairments continue to pressure operating margins.
- Inventory levels and holiday-season sell-through, including potential markdown exposure.
- Actual fiscal 2015 capital expenditures versus the $24 million to $25 million expectation.
- Progress and financial impact of the company’s omni-channel initiatives.
- Status and ultimate cost of pending litigation and the vendor settlement guarantee.
- Compliance with the revolving credit facility’s profitability and leverage covenants if operating performance weakens.