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.