Tilly’s, Inc. Form 10-Q Summary
Reporting period: First quarter ended May 5, 2018, compared with the first quarter ended April 29, 2017. The request metadata identifies “2017 Q1,” but the filing covers fiscal 2018 Q1. Financial statements are unaudited.
Business Context
Tilly’s is a specialty retailer of casual apparel, footwear and accessories for young men, young women, boys and girls. As of May 5, 2018, the company operated 222 stores, including three RSQ-branded pop-up stores, in 31 states, and also sold merchandise through its e-commerce platform.
Financial Performance and Liquidity
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $123.6 million | $120.9 million | 2.2% increase |
| Gross profit | $35.0 million | $32.9 million | 6.4% increase |
| Gross margin | 28.3% | 27.2% | 110 basis-point improvement |
| SG&A expense | $33.6 million | $33.2 million | 1.2% increase |
| Operating income (loss) | $1.3 million | $(0.3) million | Improved by $1.7 million |
| Net income (loss) | $1.2 million | $(0.2) million | Improved by $1.4 million |
| Diluted EPS | $0.04 | $(0.01) | Improved |
- Comparable store sales, including e-commerce, increased 0.1%. Management attributed performance to improved store traffic and strength in branded men’s, boys’, girls’ and footwear assortments, partly offset by weakness in women’s and accessories.
- Retail-store sales were $108.5 million, compared with $104.7 million. E-commerce revenue declined to $15.1 million from $16.3 million and represented 12.2% of net sales versus 13.4%.
- Gross-margin expansion primarily reflected lower buying, distribution and occupancy costs, partly offset by lower initial markups from a higher mix of branded merchandise.
- SG&A increased due primarily to minimum-wage-related payroll costs and investments in order-management, website and point-of-sale systems, but declined as a percentage of sales to 27.2% from 27.5%.
- Net cash provided by operating activities was $0.7 million, compared with cash used of $5.0 million in the prior-year quarter.
- Investing activities provided $16.4 million, including $40.4 million of marketable-security maturities, partially offset by $21.1 million of purchases and $2.9 million of capital expenditures.
- Financing activities used $29.1 million, primarily for the $1.00-per-share special dividend paid in February 2018.
- Cash and cash equivalents were $41.2 million at May 5, 2018, and marketable securities were $63.8 million. Working capital was $113.3 million.
- The company had no borrowings under its $25.0 million revolving credit facility and was in compliance with all covenants. The facility matures June 26, 2020 and is secured by substantially all company assets.
- Total liabilities were $96.1 million, including $36.2 million of current and long-term deferred-rent liabilities. Total stockholders’ equity was $163.8 million.
Material Changes Versus the Prior Comparable Period
- The company returned to profitability, with operating income of $1.3 million compared with an operating loss of $0.3 million.
- Sales increased 2.2%, although management stated the increase was primarily attributable to the calendar-shift impact of the 53rd week in fiscal 2017; comparable sales increased only 0.1%.
- Gross margin improved 110 basis points, while SG&A leverage improved 30 basis points.
- Operating cash flow improved by $5.7 million, primarily because of net income and the timing of payroll and vendor payments.
- The company adopted ASC 606 on February 4, 2018 using the modified retrospective method. Opening retained earnings increased by approximately $1.4 million. For the current quarter, reported net sales were $592,000 higher and gross profit was $353,000 higher than they would have been without adoption.
- ASC 606 changed the timing of gift-card breakage recognition and recognizes e-commerce revenue when merchandise is shipped rather than when received by the customer.
- The company recorded a $145,000 non-cash impairment charge for one store; no comparable charge was recorded in the prior-year quarter.
Guidance, Outlook, Risks and Unusual Items
- For fiscal 2018, management planned to open up to 15 new stores and three additional RSQ-branded pop-up stores, while closing six stores.
- Management expected the effective income tax rate to decline to approximately 27% for fiscal 2018 as a result of the Tax Reform Act.
- Management expects to fund operations through cash, marketable securities and operating cash flow without borrowing under the revolving facility over the following twelve months.
- The retail industry continues to face declining physical-store traffic and increasing online shopping. Management noted that recent store-traffic improvement may not continue.
- Results are seasonal, with the third and fourth quarters historically producing stronger sales and operating results than the first two quarters.
- The company was evaluating the impact of the new lease accounting standard, which becomes effective in the first quarter of fiscal 2019 and is expected to materially affect the financial statements because the business operates primarily in leased facilities.
- The company had approximately $6.3 million of loss provisions for matters where losses were probable and reasonably estimable. Litigation includes California wage-and-hour matters, a TCPA class action subject to a settlement awaiting final court approval, and an appeal in another wage-and-hour case.
- The company completed the final payment on June 5, 2018 under a vendor-related copyright settlement guarantee; the amount paid was not materially different from the amount previously accrued.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting.
Investor Verification Points
- Verify the effect of ASC 606 on reported sales, gross profit, deferred revenue, inventory and retained earnings when comparing periods.
- Assess whether the limited 0.1% comparable-sales increase and declining e-commerce revenue support the planned store expansion.
- Monitor gross-margin sustainability, particularly initial markups, product mix, markdowns, shrinkage and occupancy costs.
- Review cash usage from special dividends against operating cash flow, capital expenditures and available liquidity.
- Confirm continued compliance with the revolving-credit covenants, including the $50.0 million minimum liquidity and eligible-inventory requirement.
- Evaluate the potential balance-sheet impact of ASC 842 lease accounting and the outcomes of pending litigation and the TCPA settlement approval.