Popups, Extra Week, Higher Costs; Tilly’s Quarter

Tilly’s sales for the quarter ended October 28th were down 3.9%, or $6 million, to $146.8 million from last year’s quarter.  However, the decline was due to “…the calendar shift impact of the 53rd week in fiscal 2017’s retail calendar, which caused a portion of the high sales volume back-to-school season to shift into the second quarter this year versus the third quarter last year, reducing last year’s comparable net sales base for the third quarter by approximately $14 million. This calendar shift impact was partially offset by higher comparable store sales and net sales from seven net new stores totaling approximately $8 million.”

Keep that $14 million in mind as you think about the quarter over quarter comparison.  That decline for the quarter was partly offset by seven new stores and higher comparable store sales (4.3%-  includes e-commerce) totaling $8 million.

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“A Destination Retailer.” Tilly’s August 4 Quarter

In its 10-Q Tilly’s describes itself as “…a leading destination specialty retailer of casual apparel, footwear and accessories for young men, young women, boys and girls with an extensive assortment of iconic global, emerging, and proprietary brands rooted in an active and social lifestyle.”

We all know what a destination retailer is; a store that customers go out of their way to shop in.  I think Tilly’s has to be a destination retailer because of where they locate their stores; “…in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations.”  If you are a destination retailer, you can be a bit more agnostic about locations.  You can put them where it makes  sense from a cost of operation perspective.  As they put it in a recent 8-K filing, “We have a flexible real estate strategy across real estate venues and geographies.”

Tilly’s “…operated 226 stores, including three RSQ-branded pop-up stores, in 31 states as of August 4, 2018 …Customers may also shop online, where we feature the same assortment of products as carried in our brick-and-mortar stores, supplemented by additional online-only styles. Our goal is to serve as a destination for the latest, most relevant merchandise and brands important to our customers.”

I want to note the use of pop-up stores.  These are not just tents which are there for a day or a week.  They average 2,600 square feet.  Tilly’s standard stores average 7.600 square feet.

I expect these are short term (months?) leases from owners happy to have somebody paying them some money.  I expect to see more of this- not just from Tilly’s.

The question is how you become a destination retailer if you carry many to most of the same brands your competitors carry.  Look at the brands they carry here.

From the same 8-K mentioned above, here’s how Tilly’s describes their efforts to differentiate their stores and be a destination retailer.

“We believe our experiential marketing efforts in our stores foster an environment that is vibrant, stimulating and authentic, serving as an extension to our customers’ individuality and passion for an active, connected lifestyle. We accomplish this by blending the most relevant brands and styles with music videos, product-related visuals and a dedicated team of passionate store associates. We continuously think of fun, creative ways to drive consumers to our stores, including augmented and virtual reality experiences, various social events, and partnerships with some of our vendors, all of which are posted on various social media platforms, further driving brand awareness. Additionally, in order to improve the look and feel of our stores, we have remodeled or refreshed nearly 90% of our stores in the last three years.”

Decide for yourself whether Tilly’s is a destination retailer.  The point I want to make is that being a destination retailer combined with skill and agility in managing your store portfolio is a very positive combination, as each of those characteristics enables the other.

Tilly’s had some problems during its fiscal 2012 through 2015 years.  Things started to improve after they brought in Ed Thomas as CEO in October of 2015.  If you read in that 8-K what they believe their strength are, you won’t find much different from what other successful brands and retailers are doing.  The question, as usual, is whether you have the balance sheet and management team to do these “things of importance” better than the competition.

Tilly’s has a solid balance sheet, allowing them to think long term, react to bumps in the road, and deal, or even prosper, in an economic downturn which, I guess, will eventually happen.  In the first six months of their fiscal year, cash generated from operations was $22.0 million, up from $2.87 million in the first six months of last fiscal year.

Revenues for the quarter ended August 4, 2018 were $157.4 million, up 13.4% from $138.8 million in the same quarter last year.  E-commerce revenues rose from $16.6 to $19.7 million, or by 18.7% and represented 12.5% of total revenues, up from 12.1% in last year’s quarter.  Comparable store sales, including e-commerce, were up 4.4% compared to an increase of 2.1% in last year’s quarter.

Of the $18.6 million increase in revenue, $12.3 million was the result of the quarter having a 53rd week.  It happens every few years.

The gross profit margin rose from 29.5% to 31.8%.  Product margins were flat.

SG&A expense as a percent of revenue fell from 30.4% to 23.9%.  In dollars it declined from $42.2 to $37.6 million.  This was the result of a reduction in legal expense of $7.6 million compared to last year’s quarter.

Operating income improved dramatically from a loss of $1.2 million to a profit of $12.5 million.  However, “Of this $15.4 million improvement in year-over-year operating income, approximately $7.6 million was attributable to the aggregate year-over-year impact of the legal matter noted above, approximately $5.2 million was attributable to the retail calendar shift impact noted earlier, and approximately $2.6 million was attributable to increased comparable store net sales results.”

Net income improved from a loss of $596,000 to a profit of $9.7 million, but don’t forget the impact of the factors mentioned in the paragraph above.

Tilly’s is doing a lot of what I think are the right things. We’ll see if they can continue to do them better than some of their competition.

Sales Go Nowhere, But Profits Rise- A Poster Child? Tilly’s Quarter Ended October 28th

How, when you increase your sales less than half of one percent (compared to the prior year’s quarter) from $152.1 to $152.8 million, do you manage to increase your net income 36.5% from $6.42 to $8.76 million even though tax expense rose by $1.38 million while operating with five less stores (220 total)?

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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.