TILLY's, INC. quarterly report, Q3 FY2019

Tilly’s, Inc. Form 10-Q Summary

Reporting period: The supplied filing is for the thirteen and thirty-nine weeks ended November 2, 2019, compared with November 3, 2018. Although the request metadata states “2018 Q3,” the filing itself is a fiscal 2019 third-quarter report, filed December 10, 2019.

Business Context and Reporting Period

Tilly’s is a specialty retailer of casual apparel, footwear and accessories serving young men, women, boys and girls through stores and e-commerce. As of November 2, 2019, the company operated 232 stores in 33 states, including one RSQ-branded pop-up store, and operated its e-commerce platform.

The business is seasonal, with the third and fourth quarters generally benefiting from back-to-school and holiday sales. The company reported that physical-store traffic remains under pressure across the retail industry while online shopping continues to grow.

Key Financial Metrics

Metric	Q3 FY2019	Q3 FY2018	39 Weeks FY2019	39 Weeks FY2018
Net sales	$154.8 million	$146.8 million	$446.8 million	$427.9 million
Gross profit	$47.2 million	$43.7 million	$134.6 million	$128.7 million
Gross margin	30.5%	29.7%	30.1%	30.1%
Operating income	$7.7 million	$6.7 million	$20.0 million	$20.5 million
Operating margin	5.0%	4.6%	4.5%	4.8%
Net income	$6.4 million	$5.4 million	$16.3 million	$16.3 million
Diluted EPS	$0.21	$0.18	$0.55	$0.55

Q3 net sales increased 5.4%; comparable-store sales increased 3.1%.
For the first 39 weeks, net sales increased 4.4%; comparable-store sales increased 2.0%.
E-commerce revenue increased 7.4% in Q3 and 16.4% for the first 39 weeks, representing 14.7% and 14.6% of net sales, respectively.
Q3 SG&A increased to $39.5 million, or 25.5% of sales, from $36.9 million, or 25.1%. First-nine-month SG&A increased to $114.6 million, or 25.7% of sales.
Other income increased to $0.9 million in Q3 and $2.3 million for the first 39 weeks, including gains on investments.

Cash Flow, Liquidity and Capital Structure

Cash and cash equivalents were $67.6 million at November 2, 2019, compared with $24.8 million at November 3, 2018. Marketable securities were $62.5 million, producing cash and marketable securities of approximately $130.1 million.
Operating cash flow for the first 39 weeks was $24.5 million, compared with $19.3 million in the prior-year period.
Investing activities provided $4.1 million, including $111.5 million of marketable-security maturities, partially offset by $96.8 million of purchases and $10.6 million of capital expenditures.
Financing activities used $29.1 million, primarily reflecting $29.5 million of dividends paid.
Cash and cash equivalents declined by $0.6 million during the first 39 weeks, compared with a $28.5 million decline in the prior-year period.
The company had no outstanding borrowings under its $25.0 million Wells Fargo revolving credit facility and was in compliance with all covenants. The facility matures June 26, 2020 and is secured by substantially all company assets.
Working capital was $88.5 million at November 2, 2019, down from $119.9 million at February 2, 2019, primarily because of the balance-sheet effects of adopting ASC 842, Leases.
The adoption of ASC 842 added $255.8 million of operating lease assets and $289.4 million of operating lease liabilities to the balance sheet. This accounting change substantially increased reported assets and liabilities without representing funded debt.

Material Changes Versus the Prior Comparable Period

Q3 gross margin expanded 80 basis points, primarily from improved product margins.
Q3 operating income increased 14.4%, while first-nine-month operating income declined 2.9% because SG&A growth exceeded gross-profit growth.
First-nine-month comparable physical-store sales decreased 0.2%, while e-commerce sales continued to grow rapidly.
First-nine-month SG&A included higher e-commerce marketing and fulfillment costs, increased store payroll related to minimum-wage increases and store growth, higher temporary labor costs, and the absence of a $1.5 million legal-reserve benefit recorded in the prior year.
Q3 gross profit included approximately $0.7 million of severance and other transition costs related to a change in merchandising leadership. Management estimated the after-tax impact on Q3 and year-to-date net income at approximately $0.5 million.
Q3 SG&A included a $0.5 million asset write-off related to recent mobile-app development activities.
The company launched an enhanced loyalty program in the second quarter, allowing instant award redemption and extending award expiration from 45 days to 365 days. Loyalty-program deferred revenue was $2.1 million at November 2, 2019, compared with $1.6 million at November 3, 2018.

Guidance, Outlook, Risks and Contingencies

Management expected to finish fiscal 2019 with 14 new store openings and anticipated opening up to 15 additional stores in fiscal 2020.
Capital expenditures were expected not to exceed $19 million in fiscal 2019 and to be approximately $20 million in fiscal 2020, primarily for new-store construction and omni-channel and customer-facing technology.
Management expected to fund operations over the following twelve months using cash, marketable securities and operating cash flow without borrowing under the revolving facility.
Key operating risks include declining physical-store traffic, changing consumer preferences and fashion trends, competition, promotional execution, inventory and markdown risk, e-commerce fulfillment costs, wage inflation, occupancy costs and the ability to open profitable new stores.
The company was involved in wage-and-hour litigation, including a PAGA matter scheduled for mediation in March 2020 and the Skylar Ward case, which had been remanded for further proceedings and was in discovery. The company stated that it could not estimate potential losses or assure that litigation would not materially affect its financial condition, results or cash flows.
The company reported no material changes to previously disclosed market risks or risk factors. Management concluded that disclosure controls and procedures were effective at the reasonable assurance level.

Investor Verification Checklist

Verify that the filing period is fiscal 2019 Q3, not 2018 Q3, and reconcile the November 2, 2019 comparative figures with the company’s annual reporting calendar.
Assess whether e-commerce growth can offset slowing or declining physical-store comparable sales and whether fulfillment and marketing costs remain elevated.
Evaluate the sustainability of gross-margin improvement after excluding the benefits and costs of product mix, promotions and the merchandising leadership transition.
Monitor inventory of $70.3 million, working-capital changes and markdown or shrinkage trends during the holiday season.
Review the effect of ASC 842 lease liabilities and the company’s substantial long-term lease commitments, including $289.4 million of recorded operating lease liabilities.
Confirm continued compliance with the revolving-credit covenants and the June 2020 facility maturity.
Track developments, potential exposure and any reserves related to the pending wage-and-hour litigation.