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.

The Numbers

Tilly’s grew its revenues 7.9% during the quarter to $141.7 million. It ended the quarter with 220 stores in 33 states. $5.4 million of the increase was from 13 net new stores opened during the year. The other $5.0 million increase came from a comparable store sales increase of 3.9%. That’s nice to see.

Its gross margin rose to 31.5% from 30.9% in the same quarter last year. A third of that increase was from a higher merchandise margin. The rest was from running the place better.

This is a good time to remind you that former CEO Daniel Griesemer resigned and was replaced October 12th and was replaced by Edmond Thomas. Here’s what L. A. Biz said about the transition.

“Thomas is coming back to Tilly’s (NYSE: TYLS) after having served as its president and co-CEO from September 2005 to October 2007. He most recently was CEO and a director of retailer Wet Seal from September 2014 to August 2015 and was its president and CEO from October 2007 to January 2011. In January, Foothill Ranch-based Wet Seal closed more than half its stores and filed for Chapter 11 bankruptcy protection.” Well, alright, let’s move on.

SG&A expenses were up 22.8% from $32.0 to $39.3 million. As a percentage of sales they rose from 24.4% to 27.7%. $1.1 million was due to severance for the former CEO and $1.3 million a non-cash charge for asset impairment.

As a result operating income was down 36.8% from $8.6 to $5.4 million. Net income fell 45% from $5.1 to $2.8 million including a decline in income tax expense of $848,000.

For the first nine months of the year, net cash provided by operating activities was $6.4 million compared to $21.1 million in the same period the previous year. The decrease was “…primarily due to the timing of vendor and income tax payments, an increase in inventory due to operating 13 net additional stores and an increase in holiday merchandise flows year over year, the timing of collecting landlord allowances and lower operating income.”

There was no major change in the balance sheet I feel compelled to call out.

Issues of Strategy

Tilly’s characterizes itself as “…a 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.”

That market positioning statement could be used by an awful lot of retailers in our space. In fact, it more or less is. We are all in this much larger and more competitive active outdoor/fashion market.  And everybody is more or less trying to do the same thing.

Tilly’s goes on in its 10Q to describe industry trends.

“The retail industry…has been experiencing downward trends in mall traffic for an extended period of time. Conversely, online and digital shopping behaviors have generally resulted in sustained online sales growth for most retailers. We believe these traffic trends and shopping behaviors will continue in the near term and into fiscal 2016. As a result, we expect to slow the pace of new store openings during fiscal 2016 while focusing our efforts on improving the performance of our existing stores and expanding our online/digital capabilities through omni-channel initiatives designed to provide a seamless shopping experience for our customers, whether in-store or online.”

Some version of that has been said by most retailers in our space. Kudos to Tilly’s for saying it so directly.  I would be surprised if most retailers weren’t being more cautious about opening new stores at this point.

CEO Thomas, responding to some analyst questions, provides more insight into Tilly’s thinking in this area.

“We have evaluated our real estate portfolio and realized that a number of stores opened in recent years haven’t matured at what we feel as an expectable rate and many of these stores are in very good malls.”

He continues in response to another question.

“… it’s hard to figure out in this environment how many stores is the maximum potential, but certainly the company has tremendous potential to keep growing stores. So there is nothing fundamentally wrong, we just think that, I think that there is a lot more upside in stores that we have and that’s what we are going to focus on in the short term.”

I’ll end where I started. The process of opening stores has gotten more complex and uncertain. Stores in good malls aren’t working for Tilly’s as expected. Aside from the fact that there are too many retailers with too many stores, it’s no longer clear (at least to me) what retail formats make sense. Nor do we understand completely how brick and mortar interfaces with online/mobile. At least I don’t.

If your presence is national (international?) because of the internet, how do the roles of actual stores (brick and mortar or otherwise) change? What is their role in brand building? Are they just mini distribution centers?

From comments in the conference call, we know that Tilly’s may have gotten behind in addressing certain of these issues. But Mr. Thomas seems to be very much in touch with reality, and we’ll watch to see how they move forward.