Tilly’s, Inc. Form 10-Q Summary
Reporting period: Three months ended May 4, 2019, compared with the three months ended May 5, 2018. The request metadata identifies “2018 Q1,” but the filing is for fiscal 2019 first quarter. Financial statements are unaudited and presented in thousands, except per-share data.
Business Context
Tilly’s operates specialty retail stores and an e-commerce platform selling casual apparel, footwear and accessories. As of May 4, 2019, the company operated 229 stores in 33 states, including 226 full-size stores and three RSQ-branded pop-up stores. It opened one full-size store and closed one pop-up store during the quarter.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $130.3 million | $123.6 million | 5.4% increase |
| Gross profit | $35.7 million | $35.0 million | 2.0% increase |
| Gross margin | 27.4% | 28.3% | Down 90 bps |
| SG&A expense | $35.5 million | $33.6 million | 5.6% increase |
| Operating income | $0.1 million | $1.3 million | Declined $1.2 million |
| Operating margin | 0.1% | 1.1% | Down 100 bps |
| Net income | $0.7 million | $1.2 million | Declined $0.5 million |
| Diluted EPS | $0.02 | $0.04 | Declined $0.02 |
| Cash flow from operations | $(2.3) million | $0.7 million | Declined $2.9 million |
Revenue mix and operating indicators: Retail-store sales increased to $110.6 million from $108.5 million, while e-commerce revenue increased 29.6% to $19.7 million and represented 15.1% of total net sales, versus 12.2% in the prior-year quarter. Comparable store sales increased 2.4%, including e-commerce, while comparable physical-store sales declined 1.4%.
Balance sheet and liquidity: Cash and cash equivalents were $33.9 million and marketable securities were $76.0 million at May 4, 2019, providing approximately $109.8 million of cash and short-term investments. Merchandise inventory was $59.0 million. Working capital was $71.1 million, compared with $119.9 million at February 2, 2019, primarily reflecting the adoption of ASC 842 lease accounting. The company had no borrowings under its $25.0 million revolving credit facility and was in compliance with all covenants.
Lease obligations: Adoption of ASC 842 resulted in recognition of $244.1 million of operating lease assets and $274.7 million of operating lease liabilities at May 4, 2019. Total operating lease payments for the quarter were $19.8 million.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven principally by e-commerce, while comparable physical-store sales declined.
- Gross margin contracted 90 basis points because of higher e-commerce-related distribution costs and increased markdowns, partly offset by improved occupancy and buying-cost leverage.
- SG&A increased because of minimum-wage-related store payroll costs and higher e-commerce marketing and fulfillment costs.
- Operating income fell to near breakeven and net income declined despite higher sales.
- Operating cash flow turned negative, primarily reflecting higher bonus payments and working-capital movements.
- Cash used in financing activities remained significant because the company paid a $29.5 million special cash dividend, compared with $29.1 million in the prior-year quarter.
- Other income increased to $0.8 million from $0.4 million, primarily because of higher interest rates on cash and marketable securities.
Guidance, Outlook, Risks and Unusual Items
- Management expected to open up to 10–15 new full-size stores in fiscal 2019, subject to acceptable lease economics, and expected capital expenditures not to exceed $25 million.
- Management estimated that minimum-wage increases, merit increases, new systems costs and lease-accounting adoption would increase annualized operating costs by approximately $6 million. Comparable store sales growth of approximately 3% would be needed to absorb these costs absent mitigating actions.
- Management expects to fund operations and capital needs with cash, marketable securities and operating cash flow and does not expect to borrow under the revolving facility during the next twelve months.
- The retail industry continues to face declining physical-store traffic, increasing online shopping, competitive pressure, changing fashion preferences, promotional risk, inventory and markdown risk, and potential wage and occupancy-cost pressure.
- A California wage-and-hour matter, Gonzales v. Tilly’s, remained pending, with mediation scheduled by October 31, 2019. A separate matter, Ward v. Tilly’s, was remanded for further proceedings after the California Supreme Court denied Tilly’s petition for review; the company cannot estimate a potential loss.
- Less than 2% of legal settlement coupons issued in September 2018 had been redeemed as of May 27, 2019. The coupons expire September 4, 2019, and management did not expect a meaningful business impact based on redemption levels to date.
- The company identified no store impairments in the quarter, compared with one impaired store in the prior-year quarter.
- The company stated that disclosure controls and procedures were effective and that there were no material changes in internal control over financial reporting.
Investor Verification Priorities
- Verify whether e-commerce growth can offset declining comparable physical-store sales without further gross-margin erosion.
- Track the effect of markdowns, shipping and fulfillment costs, wage increases and other operating-cost pressures on gross and operating margins.
- Assess cash generation after recurring capital expenditures, lease payments and special dividends.
- Review the scale and maturity profile of operating lease liabilities recognized under ASC 842.
- Monitor compliance with the revolving-credit-facility covenants, particularly the $50 million minimum liquidity requirement and the trailing 12-month profitability requirement.
- Follow developments and potential exposure in the pending California wage-and-hour litigation.
- Confirm future dividend policy, as management stated it did not anticipate additional cash dividends beyond those already paid.