Tilly’s is Going Public- A First Look at Their Registration Statement (S-1)

Tilly’s started in 1982 with a single store in Orange County, California. The company name is World of Jeans & Tops, but it does business as Tilly’s. It was founded by Hezy Shaked and Tilly Levine. As of April 30 2011, they had 126 stores in 11 states averaging 7,800 square feet each. They filed last week for their initial public offering.

As is normal, the initial filing  has some important blanks not filled in yet. They will be completed as the process moves forward. In the meantime, we can look at the historical financial statements. I also want to talk about the impact of changing from an “S” corporation to a “C” corporation, the ownership structure post offering, and their competitive strengths and brand strategy. Let’s get started.

Sales have grown from $199 million in the year ended February 3, 2007 to $333 million in the year ended January 29, 2011.   During the same period, they went from 51 to 125 stores. Comparable store sales rose 17.3% in the first year of that period. They then rose 8.7% before falling 12.5% and 3.1% in the next two fiscal years and rising 6.7% in the year ended January 20, 2011. E-commerce revenues have grown from $15.4 million to $32.8 million in the last three complete years.
 
One has to wonder these days, in evaluating any consumer based IPO, whether the company can hope to return to its pre Great Recession growth any time in the next few years. It’s not the company’s fault; it’s just the economy.
 
The gross profit margin was 37.1% in the year ended February 3, 2007. The following year, it was 37.2%. For the January 31, 2009 year, it fell to 32.5% and for the most recent two years it was 30.9%. Selling, general and administrative expenses have of course grown in absolute dollars with sales, but as a percentage of sales has been more or less constant around 23.3% in the last three complete years.
 
Of the 126 stores Tilly’s has as of April 30, 72 are in California and 16 in Florida. There are also 17 in Arizona. The other 21 are distributed in 8 states with New Jersey, at 7, having the most. I would be particularly interested in learning something about the performance of the stores by location (which isn’t included). As we’ll discuss, part of their growth strategy is to increase their number of stores, and I wonder if performance has been similar in all geographies.
 
“C” and “S” Corporations 
Tilly’s has always operated as an S corporation. What this means is that the earnings were distributed to the owners who reported the income on their personal income tax returns. It also means that “No provision or liability for federal or state income tax has been provided in our financial statements except for those states where the “S” Corporation status is not recognized and for the 1.5% California franchise tax to which we are also subject as a California “S” Corporation.”
 
The chart below shows Tilly’s Operating Income and Net Income as reported on their financial statements. The Pro Forma Net Income line shows what their net income would have been over the last five years had they been a C corporation accruing tax at typical rates. Big difference. They will transition to a C corporation before the company goes public. This is disclosed in the registration statement of course. But the point is that you would not want to purchase the stock expecting Tilly’s to report net income going forward at the levels of the past.     
     

FISCAL YEAR ENDED (millions of $):
   

Feb. 3

Feb. 2

Jan. 31

Jan. 30

Jan. 29
   

2007

2008

2009

2010

2011

Operating Income

$31.5

$39.7

$23.8

$21.4

$24.9

Net Income (as reported)

$31.4

$39.9

$23.6

$20.9

$24.4

Pro Forma Net Income

$19.1

$24.2

$14.3

$12.7

$14.8
 
Post Offering Ownership and Control and Use of Proceeds
Buyers of this common stock will receive Class A shares and will be entitled to one vote per share. There will also be Class B shares that will be entitled to ten votes per share “on all matters to be voted on by our common shareholders.” The Class B shares will be owned by the founders and their family. When the offering is completed Mr. Shaked, who is Chairman of the Board, will control more than 50% of the total voting power of Tilly’s common stock. We don’t know from this first draft of the registration statement exactly how much he’ll control, but it says more than 50%.
 
As a result, Mr. Shaked is in a position to dictate the outcome of any corporate actions requiring stockholder approval, including the election of directors and mergers, acquisitions and other significant corporate transactions. Mr. Shaked may delay or prevent a change of control from occurring, even if the change of control could appear to benefit the stockholders.”
 
Tilly’s will be considered to be a controlled company according to the rules of the New York Stock Exchange. As a result a majority of the board of directors don’t have to be independent. And the corporate governance and nominating committee and compensation committee do not have to be composed entirely of independent directors, as would otherwise be required.
 
Tilly’s says they will comply with these listing requirements anyway, but they don’t have to.
 
The company leases its 172,000 square foot corporate headquarters and distribution center from a company owned by its co-founders. It leases another 24,000 square feet of office and warehouse from one of the co-founders.
 
As usual, there are a lot of blank spaces in this early version of the Use of Proceeds section. We’ve seen from other sources that the goal is to raise $100 million. What’s going to be done with that money? The registration statement tells us the following:
 
“Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us.”
 
We don’t know what “most” is at this point.
 
After spending 30 years building a successful business, the owners deserve the benefits. But if they are getting “most” of the proceeds of the offering, where’s the money for growing the business to the 500 stores they are planning going to come from? At least that would be my perspective if I were a potential investor.
 
Competitive Strengths and Growth Strategy
Tilly’s lists six competitive strengths:
  • Destination retailer with a broad, relevant assortment.
  • Dynamic merchandise model.
  • Flexible real estate strategy across real estate venues and geographies.
  • Multi-pronged marketing approach.
  • Sophisticated systems and distribution infrastructure to support growth.
  • Experienced management team.
Their growth strategies are:
  • Expand our store base.
  • Drive comparable store sales.
  • Grow our e-commerce platform.
  •  Increase our operating margins.
If you read the discussions of their competitive strengths, you’ll note a great deal of similarity to other retailers in our space. Maybe that’s why they call them strengths and not advantages. Their growth strategies are exactly the same as every other multi store retailer.
 
It seems to me that an investor in this stock is basically betting on Tilly’s ability to operate better than its competitors. Of course they do have a successful operating history, but I don’t see an obvious competitive advantage here. I don’t think their plan to grow to 500 stores is necessarily unrealistic, but that most of the offering proceeds are being paid out to the owners makes me wonder how they’ll finance the growth.
 
We’ll get some more information as the amended S-1s show up.