More of the Same: Tilly’s April 29th Quarter

These quarterly reports from retailers are getting kind of repetitive.  It’s not just Tilly’s; they are all controlling inventory, slowing store openings (or closing stores), negotiating with landlords, trying to reduce operating expenses, doing omnichannel things and being generally grateful for anything that improves traffic and generates some incremental sales.

Tilly’s conference call printed out to just seven pages, with questions from three analysts.  It’s just remarkable how Wall Street is losing interest in retail.  Someday, this will translate into a huge buying opportunity in retail in general- kind of like Mexico right after Trump got elected.

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Tilly’s Has a Great Quarter, But I’m Not Sure They Completely Know Why

You can’t fault the numbers.  Sales grew 7.4% for the quarter ended October 29th compared to the same quarter last year.  That got them to $152.1 million in revenue for the quarter.  Comparable store sales rose 4.4%, accounting for $6 million of the revenue increase.  “Store comps were up low-single digits and e-commerce continued to grow at a double-digit rate.”  The rest of the increase ($4.4 million) came from five stores opened since the end of last year’s quarter.

Their gross profit margin, at 31.5%, didn’t change.  A 1.1% decline in product gross margin due to higher markdowns was offset by a reduction in expenses.

This is a good time to remind you how retailers calculate cost of goods sold to arrive at their gross profit margin.  Here’s how Tilly’s does it.

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What All Retailers Are Doing: A Short Note on Tilly’s July 30 Quarter

Tilly’s has the same issues all retailers are facing, and their response isn’t really different.  But at least they grew their sales and net income a bit.

Revenue in the quarter ended July 30 rose 4.9% to $136.4 million from $130.0 million in last year’s quarter that ended August 1, 2015.  They also managed to increase their gross profit margin from 28.1% to 28.5%.  Product margin fell by 0.3% due to higher markdowns.  The increase in gross margin was due to a 0.7% “Decrease in distribution, buying and occupancy costs as a percentage of net sales primarily due to a lease assignment and certain other favorable lease negotiations.”

It sounds like the gross margin would not have risen without the lease assignment.  It was a one-time occurrence and was worth about $300,000.    I would be interested to hear what the gross margin on just brick and mortar was.

And while SG & A expenses rose a bit to $36.6 million, they fell as a percentage of revenue from 27.3% to 26.8%.  Net income rose from $560,000 to $1.43 million.

Comparable store sales rose 0.9% compared to a 0.5% increase in last year’s quarter.  That includes ecommerce sales.  In fact, brick and mortar comparable store sales were “slightly” negative and ecommerce grew at a double digit rate.  That makes sense as average net sales in each brick and mortar store fell from $540,000 to $533,000 and average net sales per square foot was down a bit from $71 to $70.

At the end of the quarter Tilly’s was operating 225 stores, up from 216 at the end of last year’s quarter.  CEO Ed Thomas notes in the conference call, “Regarding real estate, for the time being we remain focused on improving the performance of our existing stores rather than opening a significant number of new stores. We believe that remaining cautious about new store growth is prudent in the current retail environment. We are carefully evaluating each store opportunity with the objective of improving company profitability.”

Here’s another comment he made:

“We continue to bring in new brands with limited distribution and work with our existing branded partners to emphasize uniqueness to Tilly’s, which we know our customers expect from us. We continue to evaluate micro merchandising and product allocation practices in certain underperforming stores with the goal of improving our operating performance in these locations.”

That sounds a lot like what other retailers are saying.  It particularly reminds me of the Zumiez’s results I just reviewed.

In fact, a lot of what Tilly’s said reminded me of what other retailers are saying, and that’s a pretty good stopping point.  Caution in store openings, negotiations with landlords for better deals, growth of ecommerce, searching for distinctive brands, and careful inventory management are things all retailers are dealing with as they watch retail consolidation work its way through the economy.

Fun Times at Other Industry Retailers

At almost the same time Abercrombie & Fitch (owner of Hollister), Tilly’s, The Buckle, and Genesco (owner of the Journeys chain) released, in early June, 10-Qs for their quarters that ended April 30th.

I was going to do my usual thing and review each one separately.  But I was busy, too much time passed and honestly, there’s so much sameness to what our industry’s retailers are saying that I wasn’t sure anybody would want to read four separate reports.  Hell, I didn’t even want to.

So what I’ve done is gone through the 10-Qs and collected a few observations and some summary data.  It is, I think, enough.

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Tilly’s Offers Us Some Thoughts on Retail Stores.

It used to be way easier to grow a retail chain. You found a good location, made a deal with the landlord, made improvements, and brought in some inventory and some experienced management to train the new group of employees. If you did this mostly right, a year later (maybe sooner) you had a cash flow positive store.

Tilly’s says a couple of things about why it’s not that easy any longer. After we take a brief look at the quarter that ended October 31, we’ll talk about what they say.

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Net Income Down 17% But It’s All Part of the Plan? Tilly’s Quarter

In the quarter ended November 1, Tilly’s grew its sales 6.1% to $131.3 million compared to the same quarter last year. But net income fell 17% from $6.15 million in last year’s quarter to $5.11 million.

Meanwhile, in the conference call, President and CEO Daniel Griesemer’s first statement about the result is as follows:

“We’re pleased with the meaningful progress we are making on our initiatives to increase sales and profitability as our third quarter results exceeded expectations.”

I actually just went back and checked to make sure I was looking at the right conference call transcript and financial statement. I am. I know there’s a certain promotional aspect to conference calls- that you want to put your best foot forward and all that stuff. But don’t you need to oh, I don’t know, mention in passing that your profit fell when revenues and the gross margin were up?

Perhaps not if you’re Tilly’s. After all, when they took the company public it was done in such a way that the founders and owners still controlled the voting shares. Well, as I said when they went public, I admire them for going public but maintaining control, though I can’t figure out why people bought the stock under those circumstances.

I’m the first one to champion the idea that one quarter doesn’t matter in the scheme of things. But hey people at Tilly’s, you’re really making me dig to try and explain why in this case. They do, by the way, give me some possible reasons to think that. I’ll get to those.

The gross margin rose from 30.6% to 30.9%, due to an increase in product margin. SG & A expense rose from 15.5% from $27.7 to $32 million. As a percentage of revenue, they rose from 22.4% to 24.4%.

Selling expense as a percentage of sales rose from 15.4% to 17.3%. 1% of that increase was because “…store and field payroll, payroll benefits and related personnel costs increased at a higher rate than net sales primarily due to the addition of new stores…” There was a 0.9% increase “…related to increased marketing costs, supplies and other store support costs, primarily due to higher catalog and other marketing spend compared to last year.”

General and administrative expenses rose just 0.1% from 7.0% to 7.1%.

Operating income was down from $10.2 to $8.6 million, or by 15.7% “…primarily due to a decline in our comparable store sales and increased costs related to new stores growing at a faster rate than sales. Our comparable store sales decreased 1.2% for the thirteen weeks ended November 1, 2014, which followed a 1.9% decrease for the full fiscal year 2013 and compares to a 2.4% decrease in the third quarter of fiscal year 2013.”

Average sales per store during the quarter fell from $592,000 last year to $571,000. For three quarters, it was down from $1.777 to $1.623 million. They ended the quarter with 207 stores.  They had 99 stores at the beginning of fiscal 2009.

Tilly’s stores are located “…in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations.” This feels like store location is strongly driven by how good a deal they can make on real estate. That may serve them well in coming years.

The balance sheet remains strong, with a solid current ratio and no long term debt. Cash flow from operations for the nine months was $21.1 million compared to $27.3 million in last year’s nine months.

CEO Dan Griesemer tells us in the conference call they are working to increase market share and improve profitability through “…increased product differentiation and innovation, a greater emphasis on our digital platform and evolving our real estate strategy.” Any retailer might say that. In fact, they mostly do. Tilly’s goes on to give us a little more information.

“In keeping with our history of offering our customer the most relevant assortment of action sports inspired merchandise, we introduce more products and brands that are new, unique or exclusive to Tilly’s. Our new brands, brand extensions, exclusives and collaborations continue to perform well and strengthen our confidence in this product strategy. We introduced new brand expansion including GoPro, Stance, Sector 9 and Full Tilt Dream. We delivered a number of exclusive products including collections from Hurley and LRG. We also introduced several new or exclusive collaborations including offerings from Volcom, Adidas and Vans.”

I don’t see how that differentiates them from what other retailers are doing, but having the right brands at the right time is obviously important. I also hate brands doing SMUs, but that just seems to be where we are in the market. If a brand does an SMU for Tilly’s just whose brand is it?

With regards to ecommerce, “…we launched a new state of the art responsive design e-commerce platform for desktop and mobile…The new platform offer significantly improved look and feel, navigation and performance and offers a much more compelling user experience… Given what we know about their shopping habit, we are now able to tailor our product, marketing and promotional activities based on user preferences as we believe will lead to improved sales and profitability.”

“We believe our new state of the art e-commerce platform dedicated e-commerce fulfillment center and omnichannel capabilities now put at significantly ahead of our peer set and position us well to take advantage of the extraordinary e-commerce opportunity we see ahead of us.”

Important, obviously, but what everybody else is trying to do. Is Tilly’s going to do it better? Don’t know.

In real estate, CEO Griesemer notes, “… our new stores opened this year are performing well and in line with the new store economic model and more stringent site selection process we outlined earlier in the year.” I don’t know what the specifics of that process are.

In the fourth quarter, Tilly’s “…expect to incur incremental marketing expenses in the fourth quarter based upon the continued strength in customer response to our marketing efforts to date.” Isn’t it wonderful to have a balance sheet and cash flow that allows you to do it!

In what was a pretty short conference call, a couple of analysts ask for some metrics around specific issues and were given none. It’s not like that never happens in a conference call, but I’m wondering if that doesn’t reflect the founder’s control of the voting stock.

Tilly’s has a strong balance sheet. Store growth has been pretty rapid, and may explain some of the higher expenses and lower profitability. I conjecture that real estate is a core competence for them and that may be particularly important over the next few years. Their other initiatives don’t seem different from other retailers. We’ll see if they can perform them better.

The stock opened at $18.80 the day Tilly’s went public on May 4, 2012. As I write this (December 15, 2014), it’s at $8.94. But it closed at $6.98 the day before earnings were announced, so I guess people liked what they heard.

You know, it took me a lot of work and reading between the lines to be able to conjecture on what might be going on here. Tilly’s is making money, and there are some possible reasons why the decline in profitability might make sense if you take a longer term perspective. But Tilly’s doesn’t do a very good job explaining that.

I wish they would, because then I wouldn’t be sitting here wondering what’s going on. I’m confused and don’t know what to think.

More of the Same: Tilly’s Annual Report

There is getting to be a certain sameness to all the reports I read from the retailers in our space. It’s not that Tilly’s has done anything bad, though their results aren’t good. It’s just that we seem to be in an environment where it’s hard to do something really distinguishing as a retailer. 

Tilly’s store numbers have grown from 111 at January 30, 2010 to 195 when the latest fiscal year ended- February 1, 2014. Revenues over the same period have risen from $283 to $486 million, up 6% from $467 million the prior year, though comparable store sales fell 1.9% during the year after rising 2.2% the previous year. Average sales per store were $2.396 million, down $2.676 million the prior year. They opened a net of 27 stores during the year. 
 
E-commerce sales were $57.8 million, up from $53 million the prior year.
 
Gross margin peaked in the year ended January 28, 2012 at 32.2%. It fell slightly to 32.1% last year and was down to 30.7% for the most recently ended year. One thing that contributed to the decline was markdowns:
 
“Total markdowns, including permanent and promotional markdowns, on a cost basis were $35.7 million, $32.2 million and $23.2 million and represented 7.2%, 6.9% and 5.8% of net sales in fiscal years 2013, 2012 and 2011, respectively. We accrued $0.9 million and $0.5 million for planned but unexecuted markdowns, including markdowns related to slow-moving merchandise, as of February 1, 2014 and February 2, 2013, respectively.” 
 
They had the smallest increase in SG&A expenses in dollar terms they’ve had in the last five year. They rose by just 3.16% from $118.8 to $122.6 million. As a percentage of sales, they fell from 25.4% to 24.7%.  Operating income was down from $31.4 to $29.7 million.
 
Net income fell pretty dramatically from $23.9 to $18.1 million due to a big jump in income tax expense from $7.4 to $11.6 million. However, it would still have fallen by $1.5 million if the tax provision had been unchanged.
 
Fourth quarter sales fell from $140.7 to $139.9 million. Operating income took a big hit, falling from $14.8 to $8.4 million during the quarter. 
 
The balance sheet is solid and I’d note particularly a minor decline in inventories even as Tilly’s increased its store count by 10%. They note in the conference call that inventory on a square foot basis was down 13.5% over a year ago. That is such an improvement that combined with the markdown expense described above I think they were probably over inventoried before. Cash generated by operations rose a bit from $41.7 to $43.8 million.
 
Now we get to the sameness part. They list four growth strategies; 1) Expand our store base, 2) Drive comparable store sales, 3) Grow our e-commerce platform and 4) Increase our operating margins.
 
In the first place, I don’t see those as strategies, but as metrics against which you measure your strategy. Essentially, however, there isn’t a retailer in our space that isn’t trying to accomplish those same four things and they are certainly not points of differentiation for Tilly’s (or for any other retailer).
 
Their strengths they list as; 1) Destination retailer with broad relevant assortment, 2) Dynamic merchandise model, 3) Flexible real estate strategy across real estate venues and geographies, 4) Multipronged marketing approach, 5) Sophisticated systems and distribution/fulfillment infrastructure to support growth and 6) Experienced management team.
 
Once again, you can see that these are things a lot of larger industry retailers might, and do, claim as strengths. As to whether Tilly’s, or another retailer, is meaningfully better at any of these than the competition, I have no idea. They talk about these in some detail in their 10K (which you can see here). I recommend you take a minute to read pages 3-6 and see if you feel differently about this than I do.
 
They sum it up like this on page 6:
 
“We seek to be viewed by our customers as the destination for West Coast and action sports inspired apparel, footwear and accessories. We believe we offer an unparalleled selection of relevant brands, styles, colors, sizes and price points to ensure we have what our customers want every time they visit our stores. Our extensive selection of third-party and proprietary merchandise allows us to identify and address trends more quickly, offer a greater range of price points and manage our inventories more dynamically. We offer a balanced mix of merchandise across the guys and juniors categories, with additional merchandise in the boys, girls, footwear and accessories categories. We believe this category mix contributes to our broad demographic appeal.”
 
I think we can all imagine other retailers, and brands with significant retail components, saying something similar. Tilly’s own brands, by the way, were 28% of revenues, down from 30% the prior year. Their largest brand accounted for just 4% of sales during the year.
 
Tilly’s President and CEO Daniel Griesemer, consistent with what they say in the 10K, describes how they are trying to improve their performance and notes, “We have reduced our expectations for annual net store growth in the near-term to low double digits compared to our prior targets of mid-teen growth.” He thinks e-commerce can represent a larger percentage of their total revenues. “We just recognized that given all of the initiatives we have in place, our customers engagement and activity online and in mobile really indicates that there is a significantly greater opportunity than just 15% that we recognized that also as we continue to grow out store footprint.” 
 
The more interesting issue, which I’ve raised before, is how you expand e-commerce revenues without cannibalizing brick and mortar and, maybe even more importantly, how you get mobile influenced brick and mortar sales. That’s not just interesting for Tilly’s.
 
Like others, Tilly’s is pursuing an omni-channel strategy and tell us they “…recently completed the implementation of our fully integrated digital platform” with the goal of “…giving our customers seamless access and increased ease of shopping.” 
 
He also expects new stores to be about 10% smaller. I see that as tied to the e-commerce strategy. They are also going to focus on outlet stores, and expects 30% of new stores this year to be outlet.
 
The issue of the outlet stores was one that attracted a lot of analyst attention. They were particularly unsure how that related to Tilly’s differentiated merchandising strategy. CEO Griesemer said Tilly’s was “…increasing the number of brands and increasing the number of products that are new or unique or exclusive…And then we’re using both our digital capability and our catalog capability and in-store capability to communicate that newness more effectively. That includes newness and exclusivity from very large and well-established brands…like Volcom and RVCA and Nike and all kinds. So I’m not just referring to adding on a few small new brands, it’s really across the board.”
 
Now, I don’t completely know what “newness” means in this context, and I wasn’t the only one uncertain. The next question was:
 
“So talking about having more differentiated exclusive merchandise in the stores and then talking about outlet strategy seem to be a bit diametrically opposed. So if you could talk about, when you’re thinking about the Volcom and some on of the world? And how you’re going to get more exclusive product from them? How are you sourcing and what kind of product will be expected to be seeing in the outlets? And are your channel partners, your brand partners comfortable with the idea of you pursuing both strategies?”
 
Mr. Griesemer’s answer was as follows:
 
“They are and they really are diametrically opposed that and they’re not really related. We’ve got a real great team of merchants that are driving the most relevant product for this action sports inspired customer across the broad range of brands and our own private label product in the full-line stores, which remains huge, the majority of the business. And we are launching an outlet specific format that gets us access to true outlet venues. And so that product will be uniquely sourced from our brands and from our own private label product.”
 
“It’s special purchases and things that are relevant and appropriate for the season and for the price point strategy and really don’t get in the way of the full price execution that we have in the majority of the stores.”
 
Another analyst didn’t find that answer completely satisfying (neither did I) and asked if there would be overlap between the products and brands in the outlet and full priced stores. The answer was yes.
 
We’re all sitting here in an economy where there are way too many retailers and our target consumers have a higher unemployment rate than the overall economy and less disposable income than they used to have. Meanwhile, our products are over distributed and differentiation is hard to come by.
 
We’ll be looking at some more retailers and will find they all have similar issues. Tilly’s can do everything well and find it still isn’t really differentiated from its competitors. A tough retail market and lack of a real competitive advantage is a hard place for any retailer to be.

 

 

Tilly’s Quarter and the Retail Environment

Tilly’s quarter ended November 2, though the 10Q didn’t come out until later. I’m late writing this, but I thought there were a few things in it you might want to think about, especially given the holiday results and warnings from industry retailers.

Just to be clear, I believe the country was over retailed even before ecommerce. With its explosion, it’s even more over retailed. Every retailer has to be thinking about where or if they should be opening (or closing) stores. Store sizes probably have to shrink. Inventory has to be managed differently as the coordination between brick and mortar and ecommerce becomes tighter.
 
Let’s start with some of Tilly’s President and CEO Dan Griesemer conference call comments. This first one sounds a lot like other CEOs.
 
“During the quarter, we experienced a continuation of the weak traffic trends that have affected many retailers, leading to lower than expected comparable store sales. Consistent with the past several quarters, consumers continue to focus their shopping into compressed peak periods and pullback during non-peak periods. This trend was consistent across all product categories, real estate formats and store vintages, as well as in our e-Commerce channel; affirming our view that our sales results were primarily driven by external factors.”
 
He seems to be implying that disappointing results are okay because they were caused by things outside of their control. I know a conference call has a high marketing content, but wouldn’t it be better if such results were caused by things they could fix?
 
“While acknowledging that teen unemployment remains high, and that other categories such as electronics and entertainment compete for teen dollars, we know that Tilly’s remains the top destination for the most relevant merchandise and brands important to our action sports inspired customers.”
 
You know if you aren’t a new reader that I don’t think that “action sports” is an adequate description of the market our retailers are in. More importantly, I’ve got a bit of a problem with the idea that Tilly’s is “the top destination.” If he’d said Amazon, well, maybe.
 
“Despite the challenging external environment, we continue to adhere to the proven business strategies that have guided Tilly’s success for over 30 years, including our differentiated business model and our sharp focus on evolving preferences and needs of our customer.”
 
Focus on customer requirements is a good thing and something all retailers are doing. Or should be doing. But I think Mr. Griesemer would agree the competitive environment has changed a bit in 30 years, and I hope Tilly’s business strategies have changed to reflect that. I don’t think any of us are using the same package of strategies we were using 30 years ago.
 
Finally, in response to an analyst’s question CEO Griesemer says, “…we recognize that we have a unique business, a unique business model.” Unique is a pretty strong word. Of course no analyst asked just what he meant by that. I don’t see Tilly’s as unique, and would have loved to hear why he’s comfortable using the term.
 
He talks about a lot of good things they are doing. They are “relentless” in pursuing the brands and styles their customers want. They are keeping the business and inventory clean, with inventory per square foot down 16% from a year ago. That’s a great result. They also talk about having “newness” in their stores multiple times a week. That certainly means with product, but it felt like he meant more, though he wasn’t specific.
 
Those are all good things, but I don’t see them rising to unique. But perhaps some of the discussion below will help us understand what Tilly’s thinks does.
 
Tilly’s balance sheet is solid, and doesn’t require any discussion.
 
Sales for the quarter fell very slightly, from $124.9 to $123.8 million. CFO Jennifer Ehrhardt reminds us that “This reflects approximately $8 million in back-to-school period sales that shifted into the second quarter from the third quarter this year, when compared to the 2012 fiscal calendar.” Ecommerce sales were $13.3 million, up from $12.9 million in last year’s quarter.  Gross margin fell from 33.5% to 30.9%. 2.4% of that decline was due to occupancy costs from new stores. Product margin improved by 0.2%.
 
Selling, general and administrative expense rose from $27.9 to $28 million. Net income was down 33.9% from $9.3 to $6.1 million.
 
They closed the quarter with 189 stores, up from 168 stores at the end of last year’s quarter. They expect to grow their store count by 15% in each of the next several years. “The stores are located in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations.” That’s an interesting mix. If I had to guess, it might be that getting a good deal on the rent was an especially important factor in choosing locations.
 
Comparable store sales fell 2.4%. That includes a 1% increase contributed by ecommerce sales. The average store size at the end of the quarter was 7,788 square feet, but average sales per store were $592,000, down 16% from 705,000 in last year’s quarter. Picture each of their stores being a square that’s about 88 feet on a side. My gut tells me those are low sales for stores that size, and makes me think I’m right about their negotiating well with landlords.
 
I’m wondering if CEO Griesemer would tell me that what was unique about their business model was their ability to make money on lower store sales volumes because of their lower occupancy costs. I’d still have a hard time with “unique,” but I might be okay with calling it a competitive advantage.
 
Tilly’s is facing the same uncontrollable, external, headwinds all retailers in our industry are facing. My expectation is that those will last a while. In addition, rapid change driven by ecommerce has to be managed- maybe harnessed is a better term. The look and roll of brick and mortar is going to be different as a result.
 
Yet most retailers seem to go along opening (more cautiously, I admit) new stores that, from a macro point of view, we don’t need. The assumption, I guess, is that all the bad stuff will happen to their competitors.
 
I would remind you all that unique doesn’t necessarily mean good. Even if your evaluation of your own market advantages doesn’t rise to “unique,” be careful that your confirmation bias* doesn’t have its way with you.
 
* Confirmation bias is the tendency of people to favor information that confirms their beliefs or hypotheses. People display this bias when they gather or remember information selectively, or when they interpret it in a biased way. The effect is stronger for emotionally charged issues and for deeply entrenched beliefs. People also tend to interpret ambiguous evidence as supporting their existing position.

   

Tilly’s Quarter; Income Down on Higher Sales.

For the quarter ended May 4, Tilly’s sales were $109 million. In last year’s quarter ending April 28, 2012, sales were $96.5 million. That 13% sales growth. But further down the income statement, we find that income before taxes fell 35% from $5.9 to $2.3 million. What went on? 

NOTE: Net income fell even more, from $5.9 to $2.3 million. In last year’s quarter the company wasn’t public yet and, due to a different corporate structure, showed only $68,000 in income tax expense. In this year’s quarter, as a public company following the change in legal structure, income tax expense was $1.56 million. Now that’s a real expense, but it does sort of screw up the comparison. They provide some proforma numbers that show their net income last year would have been just $3.6 million with the same tax situation they have now. That’s a drop of 36%. 
 
Okay, back to what went on. $11.6 million of the sales increase came from opening new stores that weren’t open in the quarter last year. Comparable store sales were up 1.1%, or by $1 million. They rose 4.3% in last year’s quarter. Ecommerce sales rose 16% from $10.9 to $12.6 million.
 
They ended the quarter with 175 stores in 30 states compared to 145 at the end of last year’s quarter and expect to open at least 25 new stores in this fiscal year. They “…plan to continue opening new stores at an annual rate of approximately 15% for the next several years…”
 
Average net sales per store in the quarter fell from $605,000 to $565,000.  
 
The gross profit margin fell from 31.5% to 29.5%. “The decrease in gross profit margin was due to a 1.1% increase in product costs as a percentage of sales due to increased markdowns and a 0.9% increase in buying, distribution and occupancy costs as a percentage of sales due to costs increasing faster than the growth in net sales.” That doesn’t sound good.
 
 Selling, general and administrative expenses as a percent of sales rose from 25.3% to 25.9%. Within this increase of $3.9 million or 16%, store selling expenses accounted for $2.6 million of the increase. The specific causes were: 
 
“• store and regional payroll, payroll benefits and related personnel costs increased $2.3 million, or 0.7% as a percentage of net sales, as these costs increased at a higher rate than net sales due to a relatively small increase in comparable store sales and a greater proportion of the store base this year comprised of newer stores with immature sales volumes”
 
“• marketing costs, credit card processing, supplies and other costs increased $0.4 million, which represents a decrease of 0.2% as a percentage of net sales, due to these costs increasing at a lower rate than the net sales.”
 
The biggest chunk of the general and administrative expenses increase was stock-based compensation expense of $0.9 million, which they didn’t have last year because they weren’t yet public.
 
In the conference call, President and CEO Daniel Griesemer described the quarter’s results this way:
 
“…our business performance was better than expected as we achieved positive comparable store sales and net income of $0.08 per diluted share reflecting the strength of our business model and the diligent execution of our team in support of our growth initiatives.”
 
There are no balance sheet issues to discuss. The balance sheet improved markedly as a result of the public offering as you would expect. They went public on May 12, 2012. Of the $107 million raised, $84 million went to pay notes previously issued to the pre-offering shareholders.
 
Total inventory rose consistent with the opening of new stores but was down 6% on a per square foot basis. They note they “…have always committed to in season not carrying forward into future seasons. So you know we begin each quarter with inventory that’s clean and current and ready to do business for the forward season.” I like that policy, though of course it’s no substitute for picking the right inventory in the first place.
 
For the current quarter, Tilly’s expects “…comparable store sales growth in the range of flat to a positive low single digit increase…” This compares to a 5.1% increase in last year’s quarter. They tell us that “…the 2013 fiscal calendar shift will cause the first week peak week of the company’s back-to-school season to fall on the last week of the second quarter this year compared to being the first week of the third quarter last year. As a result we expect an estimated $8 million to $9 million in sales will shift into the company’s second quarter from the third quarter when compared to the 2012 fiscal calendar.”
 
So their second quarter prediction of comparable stores sales growth of “flat to a positive low single digit increase” includes that additional $8 or $9 million in revenue.
 
Tilly’s has a strong balance sheet and it’s great to see any comparable stores growth. But the increase in expenses, decline in gross margin and resulting drop in income (even adjusting for the impact of the public offering) tells me this is a work in progress.

 

 

Tilly’s Quarter and Their Business Approach

Just for fun, let’s jump right to some comments in the conference call for Tilly’s quarter ended October 27, 2012. In discussing the quarter’s results, CEO Daniel Griesemer notes that, “While our third quarter comparable store sales growth of 1.9% [They were 8.5% in the same quarter last year] was below our expectations, this represents high quality growth at healthy margins.” 

Like other retailers I’ve reported on, he noted that back to school was strong, but then the market softened nationally. This seems to have carried into November for at least some companies.
 
He goes on to note that “…we chose not to pursue a course that would deliver a higher comp at the expense of earnings.”
 
I kind of like that approach. If you’ve followed me for more than a little while, you know that in the current and projected economic environment I’ve been a proponent of improving earnings through higher margins, better operations, and controlled distribution rather than big sales increases. My thinking is pretty simple; big sales increases are hard to come by right now. Focusing on operating income rather than sales makes some opportunities that exist among the interplay of production, distribution, marketing and operations in general clearer than they have been in a sales growth focused organization.
 
Just to give one example I’ve used before, the best marketing a brand can probably do is have a retailer sell through at full margin and then have to tell customers, “Sorry, sold out!”
 
This isn’t a panacea. Remember Billabong announced when the recession started that they were going to control promotions to support the brand and its image even at the expense of sales. We found out when they released their new strategic plan that they thought they had some operating issues to deal with. I agreed with Billabong’s decision. But what we now all know, and what I think Tilly’s CEO would agree with, is that the decision not to focus quite so much on sales growth requires that you look for the connections among the other parts of your business that not only reduce expenses, but improve the brand’s positioning.
 
In the case of a retailer, that has the potential to change the way they evaluate and decide to carry brands. Hey brands, that should resonate with you and lead you to evaluate your marketing and distribution differently.
 
Two other points from the conference call. First, like pretty much everybody else, Tilly’s is trying to give its customers an integrated experience across every touch point they have with the customers. CEO Griesemer says, “…we want our customer to get the same great Tilly’s brand experience across every channel, every access point; be it social media, or mobile, or in-store, or online, or through our catalog or e-mails, or whatever else – events, or all kinds of things.”
 
Working towards this consistency is no longer a choice.
 
And second, in my last two posts I’ve talked about Zumiez’s and PacSun’s quarters. I’ve compared them, saying Zumiez has a niche it owns but has to find a way to grow out of it without damaging that niche. PacSun, on the other hand, lost its niche and is trying to get a niche back to attract its customers.
 
Tilly’s CEO, talking about the action sports space in response to an analyst question, says, “Yes, we share an action sports-inspired lifestyle kind of platform with a whole lot of people. But as you well know, that has migrated significantly.” Later, still responding to that question, he says, “…this is a unique business with a unique customer. I think we’re going to continue to make sure we communicate that, so people resist the temptation to pigeonhole us into one particular category.
 
As action sports becomes comingled with fashion, youth culture or whatever you want to call it, figuring out where along the spectrum they belong is an issue Tilly’s is sharing with all brands and retailers in this space.     
 
Well, that was a little more fun than just starting with a bunch of numbers, but I suppose there’s no way to avoid that. If you’re so inclined, you can read the 10Q yourself here.
 
Sales for the quarter were up 16.4% from $107.3 million in last year’s quarter to $125 million this year. Ecommerce sales rose from $11.1 million to $12.7 million. They ended the quarter with 161 stores in 27 states. Average net sales per store declined from $730,000 to $705,000 and average sales per square foot were down from $94 to $90.
 
I would love to have some detailed information on how retailers thought ecommerce sales were impacting brick and mortar sales. Tilly’s does note that the 1.9% comparable store sales increase was “…due to higher net sales through our e-commerce store.” That’s not a surprise given the numbers on sales per store and square foot quoted above. 
 
The gross profit margin rose pretty much not at all from 33.4% to 33.5%. Selling, general and administrative expenses rose from $23.5 million to $27.9 million or from 21.9% of sales to 22.4%. Store selling expenses were up 17% to $18.8 million but as a percentage of sales rose 15.0% to 15.1%. 
 
Operating income rose from $12.3 million to $13.9 million, but net income was down 23.5% from $12.2 million to $9.3 million. The decline in net income was completely due to an income tax provision that rose from $140,000 to $4.53 million. That was the result of changing from a subchapter S to a C corporation as part of going public. You should look at this quarter’s tax provision as a percentage as more typical of what Tilly’s will experience going forward.
 
Okay that’s it. No big financial issues, and anyway I thought the first part of the discussion was way more interesting than this part.