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.



Tilly’s Quarter: The Connection Between Operations and Marketing

We need to start by recalling that Tilly’s converted from an S to a C corporation on May 2nd, 2012 and went public May 3rd.  That had an impact on its comparative financial statements.  Let’s review the GAAP results than look at that impact. 

Sales grew 20.5% to $105 million from $87.3 million in the pcp (prior calendar period- same quarter last year). They ended the quarter with 155 stores, up from 131 at the end of the pcp. Comparable store sales were up 5.1% compared to 15.2% in the pcp. Ecommerce sales were $9.8 million, or 9.3% of total sales.
The gross profit margin was essentially the same, rising one tenth of a percent to 29.6%. However, the merchandise margin fell by 0.3% but was offset by a 0.4% improvement in leveraging their costs over more stores and sales. Selling, general and administrative expense (sg&a) rose from $22.2 million to $34.5 million. As a percentage of sales, they rose from 25.4% to 32.8%.
As a result, they went from pretax income of $3.5 million in the pcp to a loss of $3.3 million. Net income fell from $3.5 million to a loss of $1.2 million.
Okay, now the IPO impact. There was “a one-time charge of $7.6 million, or 7.3% of net sales, to recognize life-to-date compensation expense for stock options that was triggered by the consummation of our IPO during the quarter.” That was charged to sg&a and without it, those expenses as a percent of sales rose only 0.1%.
The income tax result included a one-time $1 million net tax benefit that resulted from converting from an S to a C corporation as part of going public.
Tilly’s says that if you adjust their income statement for the stuff related to going public, their proforma net income for the quarter would have been $2.6 million instead of the GAAP loss of $1.2 million. That’s still down from the $3.5 million profit they reported in the pcp. However, they also provide a proforma income statement for the pcp, and say that profit would have been $1.7 million compared to the $3.5 million they reported.
The balance sheet is fine. Changes reflects the IPO, the growth of sales, and the opening of new stores.
Okay, those are the numbers. On to the fun stuff. As you know, “Tilly’s operates a chain of specialty retail stores featuring casual clothing, footwear and accessories for teens and young adults.”
 According to President and CEO Daniel Griesemer, They “…plan to capitalize on the significant opportunities we see to expand the Tilly’s action sports-inspired lifestyle brand, through the following four growth drivers. By expanding our store base, by driving comparable store sales increases, by growing our e-commerce business, and by increasing our operating margins.”
Fair enough I guess. That’s pretty much what every retailer wants to do. Ah, here’s a little more useful information. He goes on to say, “By flowing in merchandise to our stores five days a week, we continue to offer our customers new, on-trend and relative merchandise across a broad assortment of brands and categories. This also allows us to quickly identify and satisfy emerging fashion trends. We drove traffic to our stores by staying connected to our young dynamic multitasking customer as we engaged them through our catalogs, e-mails, in-store events and contests, social media and grassroots community programs, and traditional media.”
Here’s another quote from him: “One of the things that we have been good at for a long time is inventory discipline, keeping our inventory current and fresh and full of the most relevant product that our customer wants. Our dynamic business model is built around flowing newness into our stores almost on a daily basis, and addressing the opportunities that we have by reordering and getting back into and expanding key trending fashion trends and categories.”
Here’s one more, then I’ll stop. “Constantly flowing in newness and testing new brands, and so I am pleased that you saw it and we’re continuing to go forward with it.”
If you’ve been reading many of my articles over the last year or so, you’ll recognize some familiar themes here. Good inventory management that permits a focus on gross margin dollars rather than sales growth. The criticality of operating well. Connecting with your customers the way they want to connect with you. The importance of new brands. Identifying and being on trend. The blurring of the lines between brands and retailers and the additional pressures retailers will put on brands.
I doubt doing any of this was ever a bad idea; it just wasn’t so necessary. Note the imperative of a close connection between operations and marketing. Tilly’s talked about its promotions being executed as planned. That is, they weren’t done in response to what competitors were doing or because they had to dump some inventory that hadn’t sold. You won’t be able to take that approach if you’re logistics and inventory management aren’t right.
As usual, good strategic and operating ideas will, eventually, be adopted by most management teams- at least at companies that expect to prosper. When that happens, they cease to be a source of advantage. That seems to be what’s going on in our industry. It’s not that Tilly’s is doing anything wrong. Their history is one of success. But, as I’ve been pointing out, many companies are doing the same things. What was innovative begins to become standard practice.
I think we’re early in what I’d construe as a massive change in the consumer market and the retail/brand relationship. But if everybody is catching on, it’s time to give some consideration to what will happen next.



Tilly’s First Quarterly Report

As you know, Tilly’s went public recently. They’ve just released their first quarterly 10Q report and held their first conference call as a public company. The report is for the quarter ended April 28. Their public offering was May 4, so the balance sheet doesn’t reflect the results of that offering yet, and I don’t have access to a balance sheet from a year ago, so I can’t compare the two. However, the balance sheet is just fine.

Tilly’s describes itself as “…a fast-growing destination specialty retailer of West Coast inspired apparel, footwear and accessories. We believe we bring together an unparalleled selection of the most sought-after brands rooted in action sports, music, art and fashion.” I’d be interested in chatting with them about what exactly makes a selection of brands “unparalleled.”

Sales in the quarter were $96.5 million, up 16% from $83.1 million in the same quarter the previous year. $9.9 million of that $13.4 million increase was from stores that weren’t opened in last year’s quarter.   Tilly’s ended the quarter with 145 stores in 19 states. A year ago, they had 126 stores. They opened five stores during the quarter and expect to open an additional 16 by the end of the year. They think they can expand to 500 locations over the next ten years.
The gross profit margin stayed the same at 31.5%. Selling, general and administrative expenses as a percent of sales fell a bit from 25.5% to 25.3%. You expect to see that decline with growth in the number of stores. Net income rose 21.7% from $4.86 million to $5.91 million.
We’ve got to talk about how income taxes impact those net income numbers. Reported income tax in this quarter was only $68,000. It was $56,000 in the same quarter last year. Historically, Tilly’s has been an S corporation, where taxable income flowed through to the shareholders and they paid the taxes. So the income taxes mostly showed on the shareholders’ income tax returns and not on the company’s income statement.
As part of the public offering, the company converted to a C corporation. If it had been a C corporation in this April 28 quarter, reported income taxes, assuming a 40% rate, would have been $2.39 million and net income would have dropped to $3.59 million. That’s more typical of what we’ll see in future quarters with Tilly’s as a C corporation and public company. 
Ecommerce sales were $10.9 million, up from $8.3 million in the same quarter last year and represented 11% of total revenue in this quarter. They think it can grow to represent 15% of revenues over time. I’m kind of wondering if some retailers won’t find it representing a lot more than that eventually.
Their comparable store sales grew by 4.3% and we learn in a footnote that the ecommerce sales were responsible for 2.8% of that. That’s 65% of the total comparable store sales growth.
Their brick and mortar comparable store sales, then, grew by just 1.5%. This is interesting. Do we say, “Wow, that’s not much of a brick and mortar increase.  Is there something wrong?” Or do we focus on the 4.6% and, acknowledging the increasing interdependence of ecommerce and brick and mortar, say that just fine. What does that imply about opening additional stores? What’s the multiplier between brick and mortar and ecommerce? I wrote yesterday (twice unfortunately) about Blue Tomato being acquired by Zumiez and doing 75% of their business on line. We all know there are other retailers that have a store or more, but do most of their business on line.
I expect most multi store retailers would agree you need fewer stores in the internet age. How many fewer? How do you think about site selection in terms of the impact on internet sales? Intriguing issue. 
Tilly’s describes its stores as located in “…malls, lifestyle centers, “power” centers, community centers, outlet centers and street-front locations.” I find this an interesting description, if only because I’m not certain I know what some of the terms mean. All they say about their location selection process is “…we are modeling long term a balance between mall and off-mall. So the chain today is roughly half mall, half off-mall and our long-term targets are to have the chain reflect that. We don’t manage specifically to that, it is really a function of where is the best location in the venue where we want to be, in a trade area where we know we have an opportunity.”
 I’d like to hear them describe that in more detail. I am wondering if stores in different kinds of locations are of different sizes and/or carry different kinds of inventory based on the type of location they’re in.
As you may recall, Tilly’s, as a public company, has two classes of stock and the founding shareholders are the only ones with voting stock. I also noticed from footnote eight (Related Parties) that Tilly’s leases its corporate headquarters, distribution center, some warehouse space, another office with warehouse space, and yet another building it will use as its ecommerce distribution center, from one of the co-founders.
But before they signed each of those leases, “…the Company received an independent market analysis regarding the property and therefore believes that the terms of each lease are reasonable and are not materially different than terms the Company would have obtained from an unaffiliated third party.”
So I guess it’s okay.
Tilly’s had a good quarter. I’ve found their 10Q and conference call lacking information in some areas, and I’ve highlighted those areas above. Partly, of course, that’s a function of the questions the analysts ask. Maybe next time they’ll ask some of mine.



Tilly’s IPO Moving Forward; Another S1 Amendment is Filed

Not much is different in this filing, but we do get a few additional pieces of information. You can review what I wrote about their initial filing last July here. I updated that analysis in March of 2012 when they released their numbers for the year. My opinion hasn’t changed and I think the analysis is still valid.

What we learn from the newly amended S1 is that the share price of the offering is expected to be between $11.50 and $13.50. They expect to raise about $86.4 million (assuming a $12.50 a share price). Of that amount $84 million will go to the existing shareholders and only $2.4 million will be available to be utilized in the business. Here’s how the filing puts it:

“The principal purposes of this offering are to obtain capital to pay all undistributed cumulative earnings to date to the current shareholders of World of Jeans & Tops [the former corporate name of Tilly’s], obtain additional capital, create a public market for our common stock and facilitate our future access to the public equity markets….We expect to use $84.0 million of the net proceeds from this offering to pay in full the principal amount of the notes, as well as any accrued interest. 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.”
When the offering is done, there will be Class A and Class B common stock. Purchasers of the offering will get the Class A, which has one vote per share. The Class B common stock has ten votes per share.
As a result, “The Shaked and Levine family entities [current owners of Tilly’s and the only ones who can own the Class B shares] will control approximately 96% of the total voting power of our outstanding common stock following the completion of this offering. As a result, the Shaked and Levine family entities will be able to control the outcome of all matters submitted to a vote of our stockholders…”
Tilly’s numbers for last year, as I discussed in my March article, were strong. It will be interesting to watch how the offering is received. 



Tilly’s Is Still Going Public

In July of 2011, Tilly’s filed an S-1 with the Securities Exchange Commission as a first step towards going public. I read through the filing back then and wrote about it in some detail. On March 23rd, they filed a third amendment to their S-1, so I think we can conclude they are still trying to get Tilly’s public.

The amended S-1 is about 269 pages long, so you will have to excuse me if I don’t compare it page by page with the initial filing. I reviewed it briefly, then went back and reread my original article. If this interests you at all, I suggest you do the same.  As far as I can tell, the points I highlighted about Tilly’s offering in my original article really haven’t changed. However, we do some more current financial data and a bit of other information. I thought I might share that with you and get us all up to date.

We still don’t know what the total net proceeds from the offering are expected to be, but we do know that “$ 84.0 million of the net proceeds from this offering [will be used] to pay in full the principal amount of the undistributed earnings notes held by our existing shareholders in connection with World of Jeans & Tops’ final “S” Corporation distribution.” In other words only the proceeds in excess of $84 million will be available to the company to run and grow the business. And after the offering, the company will still be controlled by the founders as I noted last July.
I really suggest you use the link above to read my original article before you continue.
Back in July, we had numbers for the January 29, 2011 year end. Now, we’ve got the results for the January 28 2012 year, so let’s start by looking at those.
Sales rose 20.5% from $333 to $401 million. Their own proprietary brands account for about 30% of their revenue. Gross profit percentage was up from 30.9% to 32.2%. It had declined for a couple of years and it’s nice to see that reversed. Of the 1.3% increase in gross margin percent, they say that 0.7% was the result of leveraging their costs over more stores. The rest was due to smaller promotional markdown. That’s good to hear. As you know, other brands and retailers have been pointing to a highly promotional environment and markdowns as a problem.
Selling, general and administrative expenses rose, but were basically constant as a percent of sales. There’s a little interest expense, but no other strange or unusual expenses below the operating income line. That’s refreshing to see. New income was up 40.6% from $24.4 to $34.3 million.
Remember the net income numbers I’ve just given you are effectively without any tax provision because Tilly’s is a subchapter S corporation where all the earnings pass through to the owners. They are converting to a C corporation as part of going public. If they were a C corporation now, the earnings for those two years, after a normal tax provision, would have been $14.8 and $20.8 million respectively.
During the year, the number of stores grew from 125 to 140. They plan to open 21 stores in 2012 and expect to grow stores at the rate of 15% for the next several years. They think they can grow to 500 stores over the next ten years. They say they need to invest between $500,000 and $550,000 to open a new store, and that they expect a new store to have revenue of $2.2 million in its first 12 months and cash flow of $300,000. Comparable store sales rose 10.7% compared to 6.7% the prior year. Ecommerce sales increases 33% over the prior year and represent 11% of total net sales (almost $44 million).
The balance sheet is pretty solid, and cash provided by operating activities has grown from $35 million two years ago, to $42 million last year, and to $53 million in the year ended January 30, 2011. They have a $15 million line of credit, but no drawings under it at the end of the year. They do have a long term liability of $30 million for deferred rent, and a capital lease obligation to a related party of $4.0 million. The company leases a facility from a company owned by the cofounders of Tilly’s, and I suspect that’s what it refers to.
Tilly’s had a strong year, and I would expect their financial performance would make it easier to take the company public. Yet, the first filing was last July and it isn’t done yet. As far as I can tell, Tilly’s owners don’t have any immediate requirement to get the company public, so maybe they were just waiting for better market conditions or to negotiate better terms. But as I said last July a big chunk of the proceeds are going to the owners and it will remain very much a family controlled business.
I’ll keep watching for further updates.   



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






Operating Income






Net Income (as reported)






Pro Forma Net Income





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.